Excess of loss reinsurance is a strategic tool used by insurance companies to safeguard against substantial financial losses. This form of reinsurance allows a ceding company—an insurance provider transferring insurance portfolios—to receive compensation from a reinsurer for losses that exceed a predetermined threshold. A reinsurer is an entity that offers backup financial protection to insurance companies.
Excess of loss reinsurance falls under the category of non-proportional reinsurance, which is based on loss retention rather than sharing a portion of risks. The ceding company agrees to bear all damages up to a certain limit, beyond which the reinsurer steps in.
Contracts of excess of loss reinsurance can be tailored to meet specific needs, covering either individual loss events or aggregate losses throughout the policy period. These agreements may utilize cost calculation metrics such as the burning-cost ratio to determine pricing.
Key Takeaways
- Excess of loss reinsurance indemnifies the ceding company for losses surpassing a specific limit.
- This form of reinsurance differs from treaty or facultative reinsurance by holding the reinsurer accountable for losses above a certain threshold.
- Depending on the contract, the reinsurer may cover all losses or a percentage of losses beyond the agreed amount.
Embracing the Basics of Excess of Loss Reinsurance
Reinsurance contracts—be they treaty or facultative—typically outline a ceiling for losses the reinsurer will cover. This serves to protect reinsurers from boundless liability similar to a standard insurance policy, which assures coverage up to a specific sum.
Unlike treaty or facultative reinsurance, excess of loss reinsurance makes the reinsurer fully responsible for losses exceeding a set limit. Consider a reinsurance contract where losses over $500,000 fall to the reinsurer. If aggregate losses reach $600,000, the reinsurer pays $100,000.
These contracts can also stipulate that the reinsurer covers a certain percentage of losses above the limit. For example, if they cover 50% of losses beyond $500,000 and total losses amount to $600,000, both the reinsurer and the ceding company would each be responsible for $50,000.
Financial Security and Stability
Excess of loss reinsurance bolsters an insurance company’s financial stability and solvency by covering it against exorbitant losses. This arrangement provides a more secure backing for the insurer’s equity and creates a safety net in times of extraordinary or major events.
Moreover, reinsurance enables insurers to underwrite policies encompassing higher volumes of risk without disproportionally increasing the cost of maintaining their solvency margins—the buffer of assets over liabilities.
Ultimately, reinsurance makes substantial liquid assets available to insurers should exceptional losses occur, paving the way for financial robustness and operational stability.
Related Terms: ceding company, reinsurer, burning-cost ratio, treaty reinsurance, facultative reinsurance, solvency margins, liabilities.
