Underlying Retention: What It Is and How It Works

Definition

Underlying retention is the portion of risk or liability from an insurance policy (or portfolio of policies) that a ceding insurer keeps for itself after transferring the remainder to a reinsurer. It represents the insurer’s retained exposure and the threshold before reinsurance coverage applies.

Why it matters

• Limits reinsurance costs: By retaining lower-risk or more profitable exposures, an insurer can reduce reinsurance premiums.
• Preserves incentives: Retention keeps the insurer financially responsible for a portion of losses, encouraging prudent underwriting and claims management.
• Supports capacity and solvency: Reinsurance combined with appropriate retention lets insurers underwrite larger or more numerous risks while protecting capital from catastrophic losses.

How underlying retention works

Insurers evaluate their portfolio and choose which risks to retain based on profitability and risk tolerance. Retention can be applied at the policy level, per-occurrence, or across an aggregate period. The retained amount is the layer of loss the ceding company absorbs before the reinsurer becomes liable.

Types of reinsurance (and where retention fits)

• Proportional reinsurance: The reinsurer takes a fixed share of premiums and losses. Retention may be expressed as a quota-share slice the insurer keeps before ceding the agreed proportion.
• Non-proportional reinsurance: The reinsurer pays only when losses exceed a specified retention (also called a priority or attachment point). Underlying retention is especially relevant here.
• Excess-of-loss (XoL): A common non-proportional form where the reinsurer covers losses above the insurer’s retained limit. It can apply per occurrence or against aggregate losses over a period.
• Risk-attaching vs loss-occurring: In risk-attaching contracts, risks underwritten during the policy period are covered even if claims arise later; coverage rules affect when and how retention applies.

In proportional arrangements, reinsurers typically reimburse a share of acquisition and processing costs along with a share of premiums and losses. In non-proportional arrangements, the reinsurer generally does not share premiums or losses proportionally—coverage begins once retention is exceeded.

Example

An insurer has a reinsurance treaty with a limit of $500,000 and decides to retain $200,000 as underlying retention. The insurer might keep most small, low-risk policies (e.g., claims under $100,000) and cede larger, higher-risk policies to the reinsurer. The reinsurer then becomes liable for losses that exceed the insurer’s retained layer according to the treaty terms.

Practical considerations

• Determining retention involves assessing loss history, capital position, credit for reinsurance, regulatory requirements, and business strategy.
• Higher retention reduces premium paid to reinsurers but increases the insurer’s volatility and capital at risk.
• Retention layers can be structured to balance cost savings with solvency and risk appetite.

Key takeaways

• Underlying retention is the net risk an insurer keeps after transferring other risks to a reinsurer.
• It helps insurers manage reinsurance costs while maintaining underwriting incentives.
• Retention is central to non-proportional contracts (like excess-of-loss), but also relevant in proportional agreements.
• Choosing the right retention balances cost savings against increased exposure and capital requirements.