What is retrocession and why do reinsurers buy it?

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AcadiFi · Accepted Answer

Retrocession is reinsurance for reinsurers — the practice by which a reinsurer like BorealisRe cedes part of its accumulated cat book to other reinsurers or the capital markets. Because reinsurers write global portfolios, their peak-zone accumulations (e.g., Florida wind, Japan earthquake, California quake) can exceed their capital appetite. Retro helps manage these peaks. Structurally, retro looks similar to primary reinsurance: proportional QS, non-proportional XoL, industry loss warranties (ILWs), and aggregate covers. The retro market is thinner and more volatile — perhaps $25-35B of capacity globally — and its pricing cycle amplifies the primary cat cycle. ILS (insurance-linked securities), particularly collateralized retro funds and cat bonds, supply a large share of retro capacity. When retro prices harden (post-Ian, post-Harvey), reinsurers pass through higher costs to primary insurers, who in turn raise homeowner premiums — a three-step pricing transmission. 'Trapped collateral' is a retro-specific issue: after a loss event, collateral is frozen pending loss development, reducing recyclable capacity for the next renewal. Sidecars (special-purpose vehicles funded by investors that share in a reinsurer's book proportionally) have become popular retro vehicles, combining features of QS and ILS. Regulators watch retro concentration because a failure cascade through retro chains could destabilize the system.

What is retrocession and why do reinsurers buy it?

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