Business Net Retention

Business Net Retention

Investopedia / Xiaojie Liu

What Is Business Net Retention?

Business net retention is a measure of how many policies an insurance company has on hand at any particular time. The measurement reflects the number of underwritten insurance plans that remain in effect after deducting those canceled, lapsed, or ceded to a reinsurer. Business net retention represents an insurance company’s policy turnover over a specific period. Also, companies will keep only select policies, deemed significant to their long-term growth outlook. The provider will cede other, less favorable, or less profitable plans to a reinsurance company.

Key Takeaways

  • Business net retention is a measurement of a company's growth and strength during a specific period.
  • In insurance, it is the number of policies remaining after deducting canceled, lapsed, or ceded insurance plans.
  • The measure represents the company's policy turnover, with only profitable policies kept for the long-term.
  • Net retention indicates a business's ability to manage risk and remain profitable.

Understanding Net Retention

The calculation of net retention is from dividing net premiums paid on underwritten policies by gross premiums from the written plans. Net premiums are what the company has left after deductions such as the cost for underwriting, ceding, or otherwise servicing the policy.

The goal is to determine a company's growth and compare the number of policies sold to the amount that remains active. A decrease in business net retention over time suggests the business is struggling and should look at cost-cutting and other ways to fight these losses. An increase in business net retention over time represents a company with profit expansion and growth.

In other terms, business net retention measures the strength of an insurance company, showing that it has been able to hold a group of policies in its account while also adequately managing the risks involved in maintaining those accounts, without having to cede them to reinsurers.

Although companies strive for 100% retention, it is both difficult and impossible to achieve.

The Importance of Net Retention

Business net retention is a crucial measurement of not only an insurance company’s ability to continue to write new policies and keep its clients but also of how it manages risk. Reaching new customers, and thus accumulating more earnings, requires an insurance company to recognize its strengths and weaknesses. Does the insurance company have an extensive network of offices and salespeople? Does it offer a large basket of insurance products to different market segments, or does it focus on a handful of products? Do some of its product offerings result in significant losses?

To reduce their exposure to the risks associated with the policies they write insurance companies will often cede policies to reinsurance companies. Ceding is a common practice with companies that provide home owner's insurance. A business will limit its exposure to hazards such as hurricanes, earthquakes, and forest fires by ceding some of its underwritten policies to a reinsurer. The reinsurer will assume the risk of paying a claim for a portion of the premium in return.

By ceding an underwritten insurance plan, the ceding company will move some of the possible claim paying risk from the liability column to the asset column. With lowered liability, the insurer may continue to underwrite policies and expand their business. Reducing exposure to claim risk and contract management costs may help the insurer increase its earnings and improve its capitalization. Reducing liability increases net retention and indicates a financially sound company.

Companies have several methods of reducing risk at their disposal. In the case of an insurance group, the organization can improve the way it manages risk by streamlining the list of reinsurers they use rather than going to the open market to find a reinsurance company. The insurer may also improve its risk profile by diversifying the policies that it writes. In the case of a property insurer, they may underwrite policies in a different geographic area, less prone to claims for damage. Also, the company may broaden the types of policies they market and expand to include health, auto, and other lines of coverage.

Example of Net Retention

Net retention is an excellent indicator of a company's strength. For example, XYZ Insurance wants to look at its business net retention rate in 2020 versus five years ago, in 2015, to see how it has been progressing.

In 2015, XYZ had 5000 accounts and lost 500 through cancellations and non-renewals, giving the business a net retention rate of 90%. (5,000 - 500 / 5,000 = 0.9 or 90%).

In 2020, XYZ managed to add more accounts but failed to retain as many policies. The company's business net retention rate declined. XYZ had 5,500 accounts, but lost 1,000 of them, giving it a net retention rate of just under 82%. (5,500 - 1,000 / 5,500 = 0.818 or just under 82%).

This result may suggest the company is struggling in recent years and should look at ways to cut costs or reduce its exposure to claims.

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