Key Takeaways
- Risk insurer keeps after ceding to reinsurers.
- Balances risk appetite with profitability goals.
- Measured by retention ratio of premiums.
- Influenced by insurer's financial strength and market.
What is Underlying Retention?
Underlying retention refers to the portion of risk that an insurance company keeps on its balance sheet after transferring some risk to a reinsurer. It reflects the insurer's actual exposure to potential losses from policies underwritten, making it a key metric in insurance company risk management.
This retention amount is crucial for understanding how much risk the insurer assumes directly versus how much is ceded through reinsurance agreements like obligatory reinsurance.
Key Characteristics
Underlying retention has several defining features that impact insurer risk and financial strategy:
- Net vs. Gross Retention: Net retention is the risk retained after reinsurance deductions, while gross retention includes all retained liabilities.
- Retention Ratio: Measured by comparing net premium to gross premium, indicating the proportion of risk kept on the books.
- Risk Appetite Influence: Retention levels depend on the insurer's willingness and capacity to absorb losses.
- Regulatory Impact: Compliance with regulatory capital requirements shapes retention decisions.
- Financial Strength: Companies like Prudential often maintain higher retention due to strong balance sheets.
How It Works
When underwriting insurance policies, the insurer accepts potential liability but often shares risk with reinsurers to limit exposure. The underlying retention is the remaining risk that the insurer carries after reinsurance cessions.
This balance requires careful consideration: insurers pay reinsurance premiums to reduce risk, which affects profitability. Using earned premium as a base, companies calculate retention to optimize financial outcomes while maintaining solvency.
Examples and Use Cases
Understanding underlying retention is critical across various industries and insurers:
- Healthcare Insurance: UnitedHealth Group manages retention carefully to balance claims risk and capital efficiency.
- Financial Services: JPMorgan Chase uses data-driven risk models to adjust retention levels in insurance subsidiaries.
- Property and Casualty: Companies like Citigroup assess retention to manage catastrophic loss exposure.
Important Considerations
When evaluating underlying retention, consider the insurer's financial stability and regulatory environment to gauge risk tolerance accurately. Excessive retention can increase vulnerability to large losses, while too little retention may erode profitability through high reinsurance costs.
Incorporating data analytics enhances retention strategies by providing insights into risk patterns and loss probabilities, allowing you to make informed decisions about your risk exposure.
Final Words
Underlying retention reflects how much risk an insurer keeps versus transfers, directly impacting profitability and exposure. Review your insurer's retention ratio to gauge their risk appetite and financial strength before committing to a policy.
Frequently Asked Questions
Underlying retention is the amount of risk an insurance company keeps on its own balance sheet after transferring some risk to a reinsurer. It represents the insurer's net exposure to potential losses from the policies it has underwritten.
When an insurer underwrites policies, it assumes risk but often transfers a portion to reinsurers through agreements. The underlying retention is the risk the insurer retains itself, balancing potential losses against the cost of reinsurance premiums.
There are two main types: net retention, which is the risk retained after deducting reinsured amounts, and gross retention, which includes all retained risk, both self-insured and reinsured portions.
Retention is measured using the retention ratio, calculated by dividing net premium (gross premium minus reinsurance premiums) by the gross premium. This ratio shows the percentage of premium the insurer keeps on its books, indicating its retained risk level.
Retention levels depend on the insurer's risk appetite, financial strength, regulatory requirements, market conditions, and company maturity. Larger, financially stable insurers usually retain more risk, while smaller ones retain less.
In pro rata contracts, retention is a percentage of policy limits or a set dollar amount. In excess of loss contracts, retention is the dollar amount the insurer covers before reinsurer payments start, and may include provisions that adjust retention for multiple losses.
Underlying retention reflects an insurer’s financial strength and risk management strategy. It influences profitability since retaining more risk can increase returns but also potential losses, while reinsurance premiums reduce profits but limit exposure.
