Retention in Reinsurance
The purpose of reinsurance companies is to share risks with insurance companies. This risk-sharing can happen to different degrees. For instance, an insurance company may decide to cede its entire risk to a reinsurance company. On the other hand, the same insurance company could also decide to cede no part of its risk to the reinsurance company. These are both extreme ends of the spectrum.
In general, insurance companies tend to be somewhere in the middle. A percentage of the overall risk is generally transferred to the reinsurance company whereas the balance portion is assumed by the insurance company itself. Deciding how much risk needs to be transferred and how much needs to be retained on the books of the reinsurance company is a complicated task for the ceding insurance company.
The amount of insurance risk assumed by the reinsurance company is called retention. The retention ratio is an important concept in the reinsurance industry since it has an impact on many other aspects of the reinsurance business. In this article, we will have a closer look at what the retention ratio is and why is it important for any reinsurance company.
What is Retention in Reinsurance?
When reinsurance companies assume the risks of their customers i.e. the ceding insurance companies, they tend to look at many factors. Retention is one of the factors which is considered while such risk is being assumed. Retention is the amount of risk that the underlying ceding insurance company has decided to keep on its books.
The retention ratio tells the reinsurance company how confident the ceding insurer is about the quality of its portfolio. For example, if a ceding insurance company is trying to offload its entire risk, then it may be either strapped for capital or may know that the quality of its portfolio is not very good.
How is Retention Ratio Calculated?
There is no standard measure that can calculate the degree of risk which is being transferred from one party to another. It is for this reason that reinsurance companies around the world consider the percentage of premium ceded to be an accurate indicator of the risk ceded and therefore the risk retained. Whether or not this indicator is accurate is a completely different subject that has been widely debated around the world.
The amount of premium received by the insurance company as a result of underwriting various policies is called the gross premium. Out of this total premium, some amount of money is used to pay reinsurance premiums. The balance amount of money that is left after paying the reinsurance premium is called the net premium.
The retention ratio is calculated by dividing the net premium by the gross premium received. The idea is to find out the percentage of the overall premium which the company has decided to keep on its books. This premium is then considered to be an indicator of the overall risk that the insurance company has decided to keep on its books.
Issues With Retention Ratio Calculation
The retention ratio is calculated based on the method explained above. However, there are many experts in the industry who believe that this method is based on some unrealistic assumptions. Some of these assumptions have been listed below.
The fact of the matter is that the retention ratio is a very important metric in the reinsurance industry. It can be used to make some meaningful conclusions about the risk being transferred. However, it should not be considered to be a measure of the amount of risk which has been transferred between the ceding insurer and the reinsurance company.
- Benefits of Reinsurance
- Key Differences Between Insurance and Reinsurance
- How Inflation Impacts Reinsurance
Authorship/Referencing - About the Author(s)
The article is Written By Prachi Juneja and Reviewed By Management Study Guide Content Team. MSG Content Team comprises experienced Faculty Member, Professionals and Subject Matter Experts. We are a ISO 2001:2015 Certified Education Provider. To Know more, click on About Us. The use of this material is free for learning and education purpose. Please reference authorship of content used, including link(s) to ManagementStudyGuide.com and the content page url.