What does the term 'Retention' refer to in a reinsurance context?

In the context of reinsurance, the term 'Retention' specifically refers to the portion of risk that remains with the ceding company after a reinsurance agreement has been made. When an insurer cedes risk to a reinsurer, it does so to mitigate potential losses from high-risk situations, spreading the risk across different insurers. However, the original insurer holds onto a defined amount of that risk, known as retention. This retained risk is significant because it reflects the level of exposure the ceding company is willing to manage on its own.

For example, if an insurer has a policy with a risk of $1 million and decides to retain $250,000, the insurer will be responsible for that $250,000 in claims, while the reinsurer covers the remaining risk up to the total policy limit. This concept is crucial for understanding how insurers balance their risk portfolio and manage their financial stability.