A quota share treaty is a powerful tool in the world of reinsurance. It’s a type of pro-rata reinsurance contract where the primary insurer and the reinsurer share premiums and losses according to a fixed percentage. This mechanism enables insurers to retain part of the risk and premium while pushing the rest onto a reinsurer up to a predefined maximum coverage. Overall, it serves as an effective solution for insurers to amplify and conserve their underlying capital.
Key Highlights
- Boost Your Capacity: A quota share treaty is optimal for insurers aiming to enhance cash flow and underwrite more policies.
- Mitigate Financial Risks: By sharing risks, primary insurers reduce their financial exposure.
- Promote Risk Diversification: These treaties support insurers looking to diversify risks, even at the cost of a portion of the premiums.
Dive Deeper into Quota Share Treaties
When an insurance company underwrites a new policy, the policyholder pays a premium. The insurer, then, commits to indemnify the policyholder up to the predefined coverage limit. With an increasing number of policies, liabilities escalate, eventually capping the insurer’s capacity to underwrite additional policies.
To release capacity, the insurer can transfer some of its liabilities to a reinsurer via a reinsurance treaty. In exchange for accepting the insurer’s liabilities, the reinsurer receives a percentage of the policy premiums.
Specially, a quota share treaty allows the insurer to cede a portion of its risks and premiums up to a certain dollar limit. Losses exceeding this limit remain the insurer’s responsibility, although excessive losses can be covered using an ’excess of loss’ reinsurance agreement.
Sometimes, quota share treaties also set per-occurrence limits to control the amount of losses a reinsurer will share in individual events. This type of agreement is less enticing for insurers, as it can make them responsible for most of the losses due to a specific peril, such as a disastrous flood.
Therefore, quota share treaties are a form of proportional reinsurance, empowering a reinsurer with a designated percentage of a policy.
How Quota Share Treaties Operate
Visualize a quota share treaty as distributing part of an insurer’s retention. The result? The insurer gets to extend its acceptance capacity seamlessly.
A tangible advantage is the mitigation of financial exposure to unpredictable claim fluctuations. The original insurer (or cedent) still holds a carved-out share of the underwriting gains through a negotiated percentage, despite having reinsured the business, and gains access to the external advice and expertise from the reinsurer.
Example Scenario
Consider an insurance company eager to reduce its exposure to liabilities emerging from its underwriting operations. It signs a quota share reinsurance contract. Under the contract arrangement, the insurer retains 40% of premiums, losses, and coverage limits, and transfers the remaining 60% to a reinsurer. This contractual scenario represents a 60% quota share treaty since the reinsurer absorbs that particular percentage of the insurer’s liabilities.
In sum, leveraging a quota share treaty enables the primary insurer to optimize resource allocation, expand underwriting capacity, and strategically allocate risks.
Related Terms: reinsurance, liability, premiums, cedent.
