What it means
When an insurer writes a policy, it collects a premium and takes on the risk of paying claims. To control that risk, it may buy reinsurance, which means it cedes some of the premium and some of the risk to another insurer.
The amounts passed on are described as ceded. The insurer reports its figures on a gross basis, before reinsurance, and on a net basis, after reinsurance.
Net premiums written equal gross premiums written minus premiums ceded, plus any premiums assumed from other insurers. This difference shows how much risk the insurer is retaining.
The ceded share can be arranged in different ways. With proportional reinsurance, the reinsurer takes a set percentage of every policy and of every claim.
With non-proportional reinsurance, the reinsurer pays only when losses exceed a stated amount. Ceding has several benefits.
It protects capital against large or catastrophic claims, it smooths results and it allows the insurer to write more business than its capital alone would support. The cost is that the insurer gives up some premium, although it often receives a ceding commission in return.
The ratio of ceded to gross premium is closely watched by analysts and regulators. A high ratio shows heavy reliance on reinsurers, which brings credit risk if those reinsurers cannot pay.
A very low ratio suggests the insurer keeps most of its risk, which can mean higher volatility in earnings. Accounting for ceded reinsurance requires care.
Premiums ceded are shown as a deduction from revenue, and the reinsurers' share of claims is shown as a recovery. Insurers present both gross and net figures so that readers can see the size of the business written and the part that the insurer actually keeps.
In practice
Real-world examples.
Example
A motor insurer cedes 20% of every policy to a reinsurer under a quota share treaty. When it writes $50,000,000 of premium, $10,000,000 is ceded and $40,000,000 is retained. The reinsurer also pays its 20% share of each claim, so the insurer's results become less volatile.
Example
A property insurer buys catastrophe cover for the part of its losses that exceeds $20,000,000. The premium it pays for this protection is recorded as ceded and reduces net earned premium.
Example
A rating analyst compares two insurers. The one with the higher cession rate has steadier results but depends more on its reinsurers' ability to pay. The analyst therefore asks for a list of the reinsurers and their financial strength ratings before forming a view.
Formula
Calculation
Net premiums written = gross premiums written - reinsurance premiums ceded
Cession rate = reinsurance premiums ceded / gross premiums written
An insurer writes $80,000,000 of gross premiums and cedes $22,000,000 to reinsurers. Net premiums written = $80,000,000 - $22,000,000 = $58,000,000. Cession rate = $22,000,000 / $80,000,000 = 27.5%.Case study
Seen in the real world.
Tidewater Casualty is an illustrative, fictional insurer that grew its commercial book by a third in a single year. Its capital did not grow as fast, and its regulator expressed concern about the ratio of premiums to capital.
Management increased the share of reinsurance ceded from 15% to 30% of gross premium. This brought the net premium to capital ratio back to a comfortable level and let the company keep growing. It also meant paying more to reinsurers and giving up part of its profit. The finance team estimated that the extra reinsurance cost reduced annual profit by about $3,000,000 but allowed the company to keep writing new policies without breaching its capital limits. The illustrative lesson is that ceding is a way to trade profit for stability and capacity.
Tidewater also reported its gross and net results side by side to investors, explaining how much of the growth came from business retained. The disclosure reassured analysts, who had been unsure how much of the profit was exposed to a large storm.
Watch out
Common mistakes.
- Treating gross premiums as the insurer's real revenue, when part of the premium goes to reinsurers and net figures show what is retained.
- Assuming ceded risk is completely gone, when the insurer is still liable to its policyholders if the reinsurer fails to pay.
- Comparing insurers without looking at the cession rate, when differences in reinsurance can explain big gaps in earnings volatility and in the profit each insurer keeps.
Questions
People also ask.
What does ceding company mean?
It is the insurer that transfers risk and premium to a reinsurer, and it is also called the cedant in some markets.
Is ceded the opposite of assumed?
Yes, assumed reinsurance is risk that an insurer takes on from other insurers, while ceded reinsurance is risk it passes out, and many insurers do both at the same time.
Why do insurers cede risk?
To protect capital, reduce volatility and support growth beyond what their own capital would allow, and sometimes to gain access to a reinsurer's expertise in a specialised class of business.
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