What is Excess of Loss Reinsurance?

What is Excess of Loss Reinsurance? – Excess of loss reinsurance is a form of reinsurance where the reinsurer compensates the ceding company for losses that go beyond a set limit. A reinsurer offers financial protection to insurance companies, while a ceding company transfers its insurance portfolio to a reinsurer.

It is a type of non-proportional reinsurance. Non-proportional reinsurance relies on loss retention. Under non-proportional reinsurance, the ceding company agrees to bear all losses up to a set level.

Different languages of contracts may have different rules for excess of loss reinsurance. In some cases, it can cover all loss events that occur during the policy period, while in others it may only apply to losses in aggregate. Treaties may also have specific bands of losses that decrease with each claim. To determine prices, reinsurers and ceding companies use cost calculations like the burning-cost ratio.

Learn more about Excess of Loss Reinsurance

Treaty or facultative reinsurance contracts frequently state a maximum amount of losses that the reinsurer will be accountable for. This limit is agreed upon in the reinsurance contract to safeguard the reinsurer from unlimited liability. In a similar manner, treaty and facultative reinsurance contracts resemble a regular insurance contract, which offers coverage up to a specific sum. Although this benefits the reinsurer, it places the responsibility on the insurance company to minimize losses.

It differs from treaty or facultative reinsurance in its approach. The reinsurance company bears the responsibility for all losses exceeding a specific limit.

Some Examples

A reinsurance contract with an excess of loss provision means that the reinsurer will cover losses exceeding $500,000. If the total losses reach $600,000, the reinsurer will be accountable for $100,000.

It can function in a slightly altered manner as well. Instead of making the reinsurer accountable for all losses exceeding a specific amount, the agreement might state that the reinsurer is liable for a portion of losses surpassing that threshold. Consequently, the ceding company and the reinsurer will jointly bear the burden of aggregate losses.

For instance, a reinsurance agreement with an excess of loss clause might state that the reinsurer is accountable for 50% of the losses exceeding $500,000. In this scenario, if the total losses reach $600,000, the reinsurer will bear the responsibility for $50,000, while the ceding company will bear the responsibility for $50,000.

An excess of loss reinsurance policy offers the ceding insurer added protection from significant losses. This policy helps to safeguard the insurer’s equity and solvency, while also ensuring stability during unexpected or major events.

Reinsurance enables insurers to provide coverage for a greater number of risks without significantly increasing the expenses of maintaining their financial stability. It also provides insurers with a significant amount of liquid assets to handle unexpected losses.