What is a retention limit in insurance?

In the context of insurance, a retention limit refers to the maximum amount of risk that an insurance company will accept from a single insured entity or policyholder. This limit plays a critical role in managing a company's overall risk exposure and ensures that the insurer does not take on more liability than it can handle.

When an insurer reaches its retention limit for a particular type of coverage or individual policy, it may seek to transfer some of that risk to reinsurance partners or impose limitations on coverage for new policies. This practice helps to stabilize the financial health of the insurer by preventing significant losses from overwhelming its ability to pay claims.

In contrast to the other definitions, the minimum amount of claims processed, average payouts, and the total number of policies issued do not capture the concept of retention limits. Rather, they focus on different aspects of insurance operations, such as claims management, payment structures, and business volume. Understanding retention limits is essential for grasping how insurance companies maintain their balance and mitigate potential financial risks.