Setting-up of insurers' retention under the circumstances of rising reinsurance prices

Abstract

Reinsurance provides protection to the Insurer against large and catastrophe claims and mitigates fluctuations in the aggregate amount of claims, thus contributing to the reduction in insolvency risk. However, a transfer of part of liability under the insurance contract to the reinsurer comes at a price, which reduces the Insurer's profitability. The current increase in reinsurance prices, which was caused by a constellation of natural, macroeconomic and political shocks, is one of the largest ever. Under such circumstances, stating the adequate self-retention is of crucial significance for the Insurer's performance. The paper presents a possible approach to defining the level of self-retention based on the revenue and risks. The approach is based on stochastic simulations of the probability distribution of the aggregate amount of claims at the level of the insurance portfolio and the effects of different reinsurance programs on such distribution, in order to select the program that achieves the maximum ratio between the revenue and risk. Such a reinsurance program corresponds to a level of self-retention that is optimal for a given insurer.