What Is Excess of Loss Reinsurance?
Let me explain excess of loss reinsurance directly: it's a type where the reinsurer compensates you, the ceding insurance company, for losses that go beyond a set limit. As a reinsurer, I provide financial protection to insurance companies, and you as the ceding company transfer your insurance portfolio to me.
This is non-proportional reinsurance, based on loss retention. You agree to handle all losses up to a certain level. Depending on the contract, it covers all loss events in the policy period or aggregate losses. Treaties might use bands of losses that decrease with each claim, and we use calculations like the burning-cost ratio to set prices.
Key Takeaways
- Excess of loss reinsurance compensates the ceding company for losses exceeding a specified limit.
- It differs from treaty or facultative reinsurance by making the reinsurer responsible for the total amount of losses above a certain limit.
- Contracts can also specify that the reinsurer covers a percentage of losses over the threshold, sharing the burden with the ceding company.
Understanding Excess of Loss Reinsurance
Treaty or facultative reinsurance contracts set a loss limit for the reinsurer's responsibility, protecting me from unlimited liability, much like a standard insurance policy caps coverage. This benefits me but puts pressure on you to minimize losses.
Excess of loss reinsurance works differently: I'm responsible for all losses above a certain limit. For instance, if the contract says I'm liable for losses over $500,000 and total losses reach $600,000, I cover the $100,000 excess.
It can also operate by having me cover a percentage of losses above the threshold, so we share aggregate losses. Say the contract specifies 50% responsibility over $500,000; for $600,000 in losses, I pay $50,000 and you handle the rest.
By using excess of loss reinsurance, you gain more security for your equity and solvency, plus stability during major events. It lets you underwrite more risks without hiking solvency margin costs—the excess of your assets over liabilities. In fact, reinsurance provides substantial liquid assets for exceptional losses.
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