Legal Definitions - retrocessional agreement

A retrocessional agreement is a contract where a reinsurance company transfers some of the risk it has assumed from an original insurer to another reinsurance company. Essentially, it's a way for a reinsurer to protect itself from potential large losses by sharing that risk with a third party. Think of it as an insurance policy for an insurance company that already insures other insurance companies.

• Example 1: Managing Catastrophic Event Exposure

  Imagine "Coastal Homes Insurance" provides policies to thousands of homeowners in a hurricane-prone region. To protect itself from massive payouts in the event of a major storm, Coastal Homes Insurance buys reinsurance from "Global Risk Re." Global Risk Re, in turn, provides reinsurance to many such primary insurers across various hurricane zones. Realizing it has accumulated a very large total exposure to hurricane risk, Global Risk Re decides to protect its own financial stability. It enters into a retrocessional agreement with "Worldwide Re-Reinsurers" to transfer a portion of the hurricane risk it has assumed from Coastal Homes Insurance and other primary insurers.

  This illustrates a retrocessional agreement because Global Risk Re, a reinsurer, is transferring a part of the risk it took on from primary insurers (like Coastal Homes Insurance) to another reinsurer, Worldwide Re-Reinsurers.

• Example 2: Spreading High-Value, Specialized Risk

  Consider "Aviation Shield," an insurance company that insures a new, experimental satellite launch for a private space company. The potential loss if the launch fails is extraordinarily high. Aviation Shield purchases reinsurance from "SpaceGuard Re" to cover a significant portion of this risk. SpaceGuard Re, while specializing in aerospace risks, has a policy to limit its exposure to any single, exceptionally high-value project. To adhere to this policy and further spread the immense potential financial impact of a satellite failure, SpaceGuard Re enters a retrocessional agreement with "Cosmic Re-Re" to transfer a specific percentage of its liability for that particular satellite launch.

  Here, SpaceGuard Re, having reinsured Aviation Shield, is using a retrocessional agreement to transfer a segment of its own assumed risk for the satellite to Cosmic Re-Re, another reinsurer.

• Example 3: Diversifying a Reinsurer's Portfolio

  "CreditSure Re" provides reinsurance to numerous regional banks, covering a portion of their loan default risks. Over time, CreditSure Re notices that a significant percentage of the loan default risk it has assumed from these banks is concentrated in a particular economic sector, such as commercial real estate. To reduce its concentrated exposure to this sector and diversify its overall risk portfolio, CreditSure Re enters into a retrocessional agreement with "Diversify Re." Under this agreement, CreditSure Re transfers a specific portion of the commercial real estate loan default risk it has assumed from its client banks to Diversify Re.

  This example demonstrates a retrocessional agreement because CreditSure Re, acting as a reinsurer, is managing its own risk exposure by transferring a segment of the risk it assumed from the primary insurers (the banks) to another reinsurer, Diversify Re.