An Analysis of Life Insurer Retention Limits

Abstract

This study examines the relationship between ceding life insurers' retention limits on an insured life basis and certain operational and financial characteristics of the companies. Analysis is performed using 97 major U.S. insurers with 1987 assets ranging from $108 million to $32 billion. Retention limits for these insurers vary from $25,000 to $20,000,000 per insured life. Five factors are shown to have the greatest impact on life insurer retention limits. Not unexpectedly, firm size is found to be the most important factor. Four other explanatory factors, each statistically significant at the 0.01 level, provide important additional insight into this relationship. These factors are (1) form of insurer organization (i.e., mutual or stock), (2) the firm's emphasis on new business, (3) average policy size, and (4) the company's emphasis on term insurance. Collectively, the principal components regression model explains nearly 90 percent of the total variation in retention limits for the sample insurers. The life reinsurance decision centers on the establishment of retention limits. Retention is the amount of any insured loss to be borne by the primary (or ceding) company. Life retention limits normally are expressed as an amount per insured life. Claim amounts in excess of the insurer's retention are the responsibility of its reinsurers. This study examines the relationship between the size of ceding companies' retention limits and certain insurer characteristics. The setting of an appropriate retention limit is a non-trivial decision for an insurer. It ultimately affects both the risk exposure and the profitability of the ceding company. It establishes the maximum individual claim amount that the insurer believes it can tolerate, given its financial and operating characteristics. Further, the dollar retention limit is directly related to other elements in the total reinsurance process. For example, an automatic binding