Placement StructuresApplied

Retrocession

Q: In a retrocession, the reinsurer buying the cover is called the:

Retrocedent — The buyer retro-cedes, so it is the retrocedent. The seller is the retrocessionaire.

Reinsurance of the reinsurer

A reinsurer buying protection for the book it has already assumed.

Open the interactive version → definition, quiz, structure diagram and progress tracking

Definition

Retrocession is reinsurance purchased by a reinsurer. The buyer is the retrocedent; the seller is the retrocessionaire. It exists because reinsurers accumulate the same perils from dozens of cedents at once: fifty Florida treaties are, in a hurricane, one risk.

Primary uses: capping peak-zone catastrophe accumulation, protecting the whole-account net, and freeing capital for growth.
Increasingly sourced from capital markets — catastrophe bonds, sidecars and collateralised retro rather than traditional carriers.
The classic hazard is the spiral: risk ceded round a closed circle of reinsurers until a single loss returns to its originator several times over, as in the London Market Excess (LMX) spiral of the late 1980s.

Worked example

A reinsurer holds $2.0B of aggregate Caribbean windstorm exposure. It buys retro of $500M in excess of $500M so that no single hurricane season can consume more than a fifth of its capital.

Scenario · figures in USD

A loss passing through three balance sheets

A cedent retains $200M per event and buys $300M excess of $200M. Its reinsurer, having assumed that layer, buys retro of $200M excess of $100M on its own net account. A single event costs the cedent $600M gross.

Gross loss to the original insurer	$600M
Cedent retention	$200M
Reinsurer pays (layer $300M xs $200M)	$300M
Loss above the top of the programme — back to cedent	$100M
Reinsurer's own retention under the retro	$100M
Retrocessionaire pays ($200M xs $100M)	$200M
Reinsurer's net loss	$100M
Cedent's net loss	$300M

So whatThree balance sheets, one event. Follow the money layer by layer and each party's exposure is arithmetic — the danger is only when nobody can see the full circle.

Check your understanding

In a retrocession, the reinsurer buying the cover is called the:

Retrocedent. The buyer retro-cedes, so it is the retrocedent. The seller is the retrocessionaire.

What is the "spiral" risk in retrocession markets?

The same loss circulating among a closed group and returning amplified. When a small group of carriers repeatedly retrocede to one another, a single large event is recycled through the circle and each participant can end up paying it several times.

Word problem

A reinsurer assumes a $400M excess of $100M layer at 100%. It retains $150M of that and retrocedes $250M excess of $150M. An event produces a $620M gross loss for the original cedent. What does each of the three parties bear?

Show a hint

Work outward. The cedent's retention first, then the reinsurer's layer, then the retro layer within the reinsurer's share.

Reveal the worked answer

Cedent retention = $100M
Reinsurer's layer covers $100M to $500M, so it pays the full $400M limit
Loss above $500M = $620M − $500M = $120M, unprotected and back to the cedent
Cedent's total net = $100M + $120M = $220M
Within the reinsurer's $400M, the retro pays $400M − $150M = $250M (full limit)
Reinsurer's net = $150M

Cedent $220M · reinsurer $150M · retrocessionaire $250M — totalling the $620M loss. Notice the cedent, not the reinsurer, is worst hit: it bought a limit that stopped $120M short.