What it means
The word comes from the idea of ceding, or yielding something to another. In everyday law, cession can mean assigning a right, such as a debt owed to you, to someone else.
In finance and insurance, the most common use is risk transfer, where one party passes some of its exposure to another in exchange for payment. Insurers use cession to avoid putting too much risk in one place.
If an insurer writes a large number of policies in a region exposed to storms, one bad season could wipe out its capital. By ceding a share of those policies to reinsurers, it caps the damage and can write more business than its own capital alone would allow.
There are two main structures. In proportional arrangements such as quota share, the reinsurer takes a fixed percentage of every policy, along with the same percentage of the premium and the claims.
In non-proportional arrangements such as excess of loss, the reinsurer pays only when losses pass an agreed threshold. The reinsurer usually pays the ceding company a commission to cover the costs of finding and servicing the policies.
In the financial statements, the premium passed on is shown as ceded premium and the claims recovered are shown as reinsurance recoveries. The difference between gross and net figures tells you how much risk the insurer actually keeps.
The nuance is that cession reduces risk without removing it. If the reinsurer cannot pay, the ceding company remains responsible to its policyholders, so the financial strength of the reinsurer matters.
Cession also appears outside insurance, for example when a business assigns its receivables to a lender.
In practice
Real-world examples.
Example
A property insurer covering coastal homes cedes 40% of its portfolio to a reinsurer under a quota share. When a storm causes $5,000,000 of claims, the reinsurer pays $2,000,000 and the insurer's own loss is $3,000,000. Its capital stays within regulatory limits.
Example
A small manufacturer with a trade receivables facility cedes its invoices to a finance company. The finance company advances cash against them and collects from customers. The manufacturer gets money now rather than waiting 60 days.
Example
A life insurer wants to write a very large policy for a business owner but its internal limit is lower. It cedes the amount above its limit to a reinsurer and keeps the rest. The customer gets full cover and the insurer stays within its risk appetite.
Formula
Calculation
Ceded premium = Gross premium x Cession rate
Ceding commission = Ceded premium x Commission rate
Suppose an insurer writes $2,000,000 of gross premium and cedes 30% under a quota share treaty. Ceded premium = 2,000,000 x 0.30 = $600,000, so the insurer keeps 2,000,000 - 600,000 = $1,400,000 of premium. The reinsurer pays a 25% ceding commission, which is 600,000 x 0.25 = $150,000, so the net cost of the cession is 600,000 - 150,000 = $450,000. If claims on the portfolio reach $1,200,000, the reinsurer pays 30% of them, which is 1,200,000 x 0.30 = $360,000, leaving the insurer to bear $840,000.Case study
Seen in the real world.
Maplewood Mutual is a fictional regional insurer that wanted to double its home policies in a flood-prone area. Its capital would not support the extra risk, and the board feared a single bad year could threaten the whole company.
The finance team arranged a quota share in which 35% of the new policies were ceded to a highly rated reinsurer. Ceded premium reduced reported revenue, but the commission received helped cover the cost of writing the policies and the capital strain eased.
This is an illustrative case with an invented company. The lesson is that cession trades some profit for stability and capacity, and that the quality of the reinsurer is part of the price.
Watch out
Common mistakes.
- Reading gross premium as the insurer's true revenue. After cession, the amount actually retained is the net figure.
- Assuming ceded risk is no longer the insurer's problem. The insurer still owes its policyholders, and it carries the risk that the reinsurer fails to pay.
- Confusing cession with assignment of a contract in general law. The ideas are related, but the insurance meaning involves risk and premium shared under a treaty.
Questions
People also ask.
Who is the cedent?
The cedent, or ceding company, is the party that passes risk on, which is usually the original insurer. The party that takes the risk is the reinsurer.
What is a retrocession?
It is when a reinsurer in turn passes part of its risk to another reinsurer. It works the same way as cession, one level higher.
Why would a reinsurer pay a commission?
Because the ceding company did the work of finding customers and handling the policies. The commission compensates for those costs.
From the founder's library
Take it further with the book.
Build your financial confidence beyond this definition. Shihan's full-length guide, Accounting Fundamentals, takes the same plain-English approach and turns it into a complete, practical playbook for non-finance managers, business owners and students - with chapter-end quiz answers and presentation slides included.
25% off with code MMHQ25, applied at checkout. Priced in USD - checkout may show the equivalent in your local currency.
View the book and save 25%