Retrocession

What Does Retrocession Mean?

Retrocession occurs when one reinsurance company transfers some of its risks to another insurance company. Like other forms of insurance, this is done for a fee and to mitigate overall risk exposure.

Reinsurance companies engage in retrocession agreements with other reinsurers for reasons similar to those that prompt primary insurers to purchase reinsurance. By doing so, reinsurers aim to reduce the likelihood of being unable to fulfill financial obligations in the event of a disaster, which could result in a surge of claims.

At times, reinsurance companies themselves need assistance in managing their risks. If a reinsurer feels overexposed, it may use retrocession to shift some of its risks to another reinsurer. Events such as tornadoes, hurricanes, monsoons, tsunamis, earthquakes, and acts of war can trigger a large number of claims simultaneously. Retrocession is especially valuable in these situations.

By using retrocession, reinsurers can avoid becoming overexposed to claims. For instance, if a reinsurance company holds substantial risk in an area prone to high winds and anticipates potential claims due to wind damage, retrocession helps to spread the risk. This ensures that no single insurance company is burdened with significant losses or financial obligations that it cannot manage.

Insuranceopedia Explains Retrocession

The simplest way to understand retrocession is when a reinsurer seeks to transfer a large risk to another party.

For example, imagine a customer requesting a $30 million life insurance policy for a legitimate reason. The insurance adviser, life insurance broker, and insurance company are all eager to close the deal. However, the reinsurer may face a problem: a policy of this size exceeds their comfort level. In such a case, the reinsurer can turn to a pool of life insurance companies to see if they are willing to share the risk.

Let’s assume there are ten companies in the pool. In the event of a claim, each company will cover a portion of the risk, so no single company is responsible for the entire amount. This shared responsibility makes the risk more manageable for the reinsurer.

Retrocession insurance companies provide a certain level of capacity for each pool they participate in, but they also have rules, restrictions, and principles that govern their involvement. While these rules can vary somewhat, they typically include an upper limit on the amount of risk that can be shared. Over the years, the need for retrocession pools has increased as larger risks with substantial financial exposure have entered the market.