Recapture Provision

DEFINITION of 'Recapture Provision'

A provision in a reinsurance treaty that allows the ceding party in the contract to take back some or all of the risk that it had originally ceded to the reinsurer. Recapture provisions outline the circumstances in which a recapture can occur.

BREAKING DOWN 'Recapture Provision'

When an insurance company underwrites a new policy, it agrees to indemnify the policyholder in exchange for a premium. This indemnification is a liability, and the insurer is responsible for covering losses in the event that a claim is filed. The insurer’s ability to take on more risk is reduced with each new policy, as there are regulatory and financial limits to the amount of risk the insurer can assume. Insurers can reduce their exposure to risk by entering into a reinsurance treaty.

In a reinsurance treaty, the insurer cedes some of its liabilities to the reinsurer. This reduces the insurer’s total liability, and frees up underwriting capacity. In return for taking on risk, the reinsurer receives a fee or a portion of the premiums that the insurer collects from policyholders. Typically, the reinsurance treaty covers the insurer’s risk until the underlying policies expire. The risk that the insurer cedes is often the amount of risk in excess of its retention level.

One of the fundamental principles of reinsurance is that the some of the interests of the ceding company take precedence over the interests of the reinsurer. The ceding company, for example, should be able to retain as much liability as it wants, and enter into a reinsurance treaty to cover losses that exceed its retention. For example, an insurer may want to increase its retention because it has grown and is better able to handle the financial impact of losses. The rules addressing how ceding companies can recapture risk are outlined in the reinsurance treaties recapture provision.

In most cases, reinsurers do not fight the addition of a recapture provision to a reinsurance treaty. They will, however, add conditions that restrict how the ceding company can recapture risk. Since the reinsurer receives a portion of the ceding company’s premiums, it is not in the interest of the reinsurer to allow the ceding company to recapture risk and cut the flow of premiums off whenever it wants. It is in the interest of the reinsurer to ensure that it recovers the administrative costs associated with putting the reinsurance treaty in force, as well as a minimum level of profit. To this end, reinsurers often require the ceding company to refrain from recapturing risk for a minimum period of time. The recapture provision also requires the ceding company to provide sufficient advanced notice that it intends on taking back some of its liabilities.