Cyber Risk in Reinsurance
February 12, 2025
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In the previous article, we have already studied what retention is and why it is important for many insurances as well as reinsurance companies. We are now also aware of the fact that some insurance companies tend to retain more risks on their balance sheet whereas there are others who pass on more risks from their balance sheet. The decision to hold on to risk or to pass it on to a reinsurer is not arbitrary. Instead, it is the result of a careful decision made after considering many factors.
In this article, we will have a closer look at some of the factors which influence the retention decision.
Also, there are many investors willing to provide capital to these companies if they want to underwrite more business. Such companies tend to use reinsurance only as a means of transfer of risk and not as a tool to unlock capital. Hence it can be said that larger insurance companies have a higher retention ratio as compared to smaller insurance companies.
It is a well-established fact in the insurance business that larger portfolios have a lower probability of loss as compared to smaller portfolios. It is for this reason that when insurance companies have a smaller portfolio, they cede their premiums to reinsurance companies so that the smaller portfolio can be merged into a larger portfolio.
It is a known fact that diversification within the portfolio tends to lower losses. This diversification could be in terms of different lines of business or it could also be in terms of geography.
Insurance companies that have a well-diversified portfolio of risks tend to retain a higher percentage of risks on their balance sheet. On the other hand, insurance companies whose portfolio is not as well diversified tend to cede more risks to different reinsurance players.
On the other hand, if an insurance company feels that the primary market is saturated and that more underlying business cannot be obtained, then they are likely to retain more risk on its balance sheet. Insurance companies want to unlock capital only if they have an alternate use for the same.
Hence, continuity is a big factor when it comes to retention rates. Based on the existing trend, it can be assumed that insurance companies tend to keep their retention rate fairly stable unless some drastic changes are being made to their business model.
In many parts of the world, there are regulatory agencies that provide guidelines regarding the minimum as well as the maximum amount of reinsurance cover that an insurance company can undertake. This is done to make sure that the risks insured by the company do not face a credit default. Hence, regulators also have a significant influence over the retention ratio.
The bottom line is that a retention ratio is a complex number that is influenced by many different factors. Reinsurance companies need to understand all these factors in order to be able to make an educated guess about what the retention rate will be in the future.
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