Retrocession

What Is a Retrocession?

A retrocession is a reinsurance arrangement in which a reinsurer transfers part of the risk it has accepted to another reinsurance company, called the retrocessionaire. It sits one level above ordinary reinsurance. An insurer passes risk to a reinsurer, and the reinsurer may then pass some of that same risk further along through retrocession. The term is also used in investment funds for a different practice, described below.

How It Works in Insurance

Insurance companies sell policies to individuals and businesses, and they often buy reinsurance to protect themselves against large or unusual losses. Reinsurers face the same problem on a larger scale. A reinsurer that has accepted a big share of many policies, each funded by an insurance premium, can become too concentrated in one type of risk, such as hurricanes in a single region. By ceding part of that exposure through retrocession, it spreads the risk across more capital providers and lowers the chance that one catastrophe threatens its ability to pay claims.

Retrocession in Investment Funds

In the investment industry, retrocession refers to a payment in which the manager of a mutual fund returns part of the management fee it collects to a distributor, such as a bank or investment platform that sells the fund to clients. The payment is compensation for distribution, but it is made from fees the fund's investors pay. Because of this, some regulators have restricted or banned such payments in certain markets, and fund documents generally disclose them.

Why It Matters to Investors

For individual investors, the insurance meaning is mainly useful background for understanding how the industry manages catastrophic risk. The fund meaning matters more directly. Retrocession payments come out of fees that are already included in a fund's total costs, so they can affect the net return an investor receives. Investors can review a fund's prospectus or annual report to see how its fees are structured and how they are shared among the manager and intermediaries.