What Is a Recapture Provision?

Breaking Down Recapture Provision

When an insurance company underwrites a new policy, it agrees to indemnify the policyholder in exchange for a premium. This indemnification is a liability, and the insurer is responsible for covering losses of claims filed. There are regulatory and financial limits on the amount of risk to which an insurer can expose itself. With each new policy written, the insurer lessens its ability to assume new risks. To reduce or spread the inherent risk, an insurer may enter into a reinsurance treaty. The reinsurance treaty will contain rules addressing how ceding companies may recapture risk in the recapture provision.

Explaining Reinsurance Treaties

In a reinsurance treaty, the insurer cedes some of its liabilities to the reinsurer. Relinquishing part of the insurer’s total commitment frees up underwriting capacity. The reinsurer will receive a portion of the premiums or a fee in return for taking on the liability. In most cases, the reinsurance treaty will remain in effect until the underlying policy expires. The insurer will often cede higher risk policies seen as above its retention level.

A fundamental principle of reinsurance is that the interests of the ceding company take priority over the interests of the reinsurer. The ceding insurer will retain the policies it sees as profitable and low risk while entering into a reinsurance treaty to cover those policies that exceed the company's retention profile.

Reinsurance Recapture Provisions

At times, an insurer may want to increase its retention. Wishes to increase retention could be due to company financial growth or changes in the geographical region the company covers. At this point, the insurer may wish to invoke the recapture provision of the treaty.

Recapture of risk will end the payment of premiums and fees from the ceding company to the reinsurer. The reinsurer must ensure coverage of all administrative and holding costs for the policies it assumes as well as realize a profit for holding the high-risk policies. Most reinsurers do not fight the addition of a recapture provision to a reinsurance treaty. However, a reinsurer will add conditions restricting how the ceding company may recapture its risk. 

Reinsurers often require the ceding company to refrain from recapturing risk for a minimum period. The recapture provision also requires the ceding company to provide sufficient advanced notice that it intends on taking back some of its liabilities.