What Is a Quota Share Treaty?
Let me explain what a quota share treaty is: it's a pro-rata reinsurance contract where you, as the insurer, and the reinsurer share premiums and losses according to a fixed percentage. This setup lets you retain some risk and premium while sharing the rest with the reinsurer up to a predetermined maximum coverage. Overall, it's a straightforward way for you to boost and preserve your capital as an insurer.
Key Takeaways
You should know that a quota share treaty comes into play when you want to free up cash flow to underwrite more policies. It directly lowers the financial risk to you as the primary insurer. These treaties are typically enacted when you're looking to diversify your risk and are willing to take less profit from a premium in exchange for that security.
Understanding Quota Share Treaties
When you underwrite a new policy as an insurance company, the policyholder pays you a premium, and in return, you agree to indemnify them up to the coverage limit. The more policies you underwrite, the more your liabilities grow, and eventually, you'll hit a point where you can't take on any new ones due to capacity limits.
To free up that capacity, you can cede some of your liabilities to a reinsurer through a reinsurance treaty. In exchange for taking on those liabilities, the reinsurer gets a portion of the policy premiums.
A quota share treaty specifically means you cede a portion of your risks and premiums up to a maximum dollar limit. Any losses above this limit remain your responsibility, but you can cover those with an excess of loss reinsurance agreement for losses exceeding the maximum per policy coverage.
Some quota share treaties include per-occurrence limits that cap the amount of losses the reinsurer will share on a per-occurrence basis. As an insurer, you might be less inclined to accept this because it could leave you responsible for most losses from a single event, like a catastrophic flood.
Remember, quota share treaties are a form of proportional reinsurance, giving the reinsurer a certain percentage of a policy.
How Quota Share Treaties Work
Think of a quota share treaty as you giving away part of your retention as an insurer. In return, you increase your acceptance capacity with automatic cover.
This type of treaty reduces your financial exposure to adverse claim fluctuations. As the cedent, you can still participate in the underwriting gains in some negotiated percentage, even after reinsuring the business, and you gain access to outside expertise from a professional reinsurer.
Consider this example: if you're an insurance company aiming to reduce exposure to liabilities from your underwriting activities, you enter into a quota share reinsurance contract. The contract has you retaining 40% of premiums, losses, and coverage limits, while ceding the remaining 60% to a reinsurer. This would be called a 60% quota share treaty because the reinsurer takes on that percentage of your liabilities.
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