What is 'Retrocession'
Retrocession is the practice of one reinsurance company providing services to another by insuring the activities of another reinsurance company. This is done by accepting business that the other company had agreed to underwrite. Retrocession can refer to the process of differentiating or diversifying assets by consolidating and then subdividing them among a number of stakeholders.
BREAKING DOWN 'Retrocession'Retrocession can also refer to the voluntary act of returning ceded property currently under the control of one group to another group that often exhibited previous ownership of the aforementioned property. These property exchanges may potentially be made by request but are not the result of a forced transaction.
Retrocession in Insurance
Retrocession occurs when one reinsurance company has other reinsurance companies partially underwrite some of its reinsurance risk. This diversifies the risks in a portfolio and helps to limit potential losses as a result of a catastrophe. For example, if a hurricane causes widespread damage to businesses, homes, automobiles and lives, a single insurer could face bankruptcy without retrocession.
Retrocession and Property
Retrocession, in regards to property, applies to a situation where ownership of a particular property is relinquished to another party voluntarily. A well-known international act of retrocession is when Hong Kong was given back to the Chinese from the British in 1997. Britain claimed ownership of Hong Kong after the Opium Wars, and additional territory was subsequently leased to the British by the Chinese. On July 1, 1997, the lease ended and Britain officially transferred control of the area back to the Chinese.
Hedge Fund-Backed Reinsurance Companies
Hedge funds became involved in the reinsurance, as the agencies buy very valuable single assets and divide them on a pro-rata basis among partnership unitholders. Just as risk and liabilities can be retroceded, so can assets. This allows hedge funds to back reinsurance opportunities with assets in their possession.
At times, the hedge fund-backed reinsurance companies are opened on foreign soil, allowing the assets to be transferred out of the United States to reduce or defer tax liability. At times, the relocated assets were in amounts significantly higher than necessary to provide proper backing to the reinsurance options being offered. In response to the activity, the Internal Revenue Service (IRS) proposed new regulations in 2015 to define the nature of the businesses as well as what activities can be considered allowable, especially those activities related to investment income compared to the companies' insurance premium income.