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| Excess Of Loss Reinsurance |
What Exactly Is Excess Loss Reinsurance?
Excess of loss reinsurance is a type of reinsurance in which the reinsurer compensates the ceding company for losses that exceed a predetermined limit. A reinsurer is an insurance company that provides financial protection to other insurance companies; a ceding company is an insurance company that transfers its insurance portfolio to a reinsurer.
Non-proportional reinsurance includes excess of loss reinsurance. Loss retention is the foundation of non-proportional reinsurance. The ceding company agrees to accept all losses up to a predetermined level with non-proportional reinsurance.
Excess of loss reinsurance can apply to either all loss events during the policy period or losses in aggregate, depending on the contract language. Treaties may also employ loss bands that are reduced with each claim.
Understanding Loss Excess Reinsurance
Treaty or facultative reinsurance contracts frequently specify a loss limit for which the reinsurer will be liable. The reinsurance contract stipulates this limit, which protects the reinsurance company from dealing with unlimited liability. Treaty and facultative reinsurance contracts are thus similar to standard insurance contracts in that they provide coverage up to a certain amount. While this is advantageous to the reinsurer, it shifts the burden of loss reduction to the insurance company.
Excess of loss reinsurance differs from treaty or facultative reinsurance in its approach.
The reinsurance company is held liable for any losses that exceed a certain threshold. A reinsurance contract with an excess of loss provision, for example, may state that the reinsurer is liable for losses in excess of $500,000. In this case, if the total losses exceed $600,000, the reinsurer will be liable for $100,000.
Excess of loss reinsurance operates in a slightly different manner. Rather than requiring the reinsurer to be responsible for all losses in excess of a certain amount, the contract may specify that the reinsurer is responsible for a percentage of losses in excess of that amount. This means that the ceding company and the reinsurer will split the total losses.
A reinsurance contract with an excess of loss provision, for example, may state that the reinsurer is responsible for 50% of losses in excess of $500,000. In this case, if total losses exceed $600,000, the reinsurer will be liable for $50,000 and the ceding company will be liable for $50,000.
An excess of loss reinsurance policy protects the ceding insurer's equity and solvency by covering it against excessive losses. When unusual or major events occur, it can also provide more stability.
Reinsurance also enables an insurer to underwrite policies that cover a greater volume of risks without significantly increasing the costs of covering their solvency margins—the amount by which the insurance company's assets, at fair value, are considered to exceed its liabilities and other comparable commitments. In fact, reinsurance provides insurers with substantial liquid assets in the event of catastrophic losses.
To summarize, a stop loss is a non-proportional coverage that protects the insurer against negative outcomes. The Reinsurer pays whenever the total losses for the year exceed the treaty's deductible, which is usually specified as a loss ratio, up to a coverage limit.
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