2. There are two distinct types of pro rata reinsurance - quota share and surplus share.
PRO RATA QUOTA SHARE
1. Quota share reinsurance is a form of pro rata reinsurance whereby the ceding company is indemnified for a fixed percent of loss on each risk covered by the treaty contract. All liability and premiums are shared from the first dollar. “Quota” or “definite” share relates to the fixed percentage as stated in the treaty.
2. Also referred to as an “obligatory reinsurance contract,” the quota share treaty requires the primary company to cede and the reinsurer to accept each and every policy underwritten by the reinsured. The treaty will usually include a maximum dollar amount over which the reinsurer is not willing to be committed on any one risk.
QUOTA SHARE CALCULATION EXAMPLE
1. The ceding company has a 60% quota share treaty. Therefore, 40% of all premiums and losses will be retained by the company and 60% of all premiums (less commission) and losses will be ceded to the reinsurer subject to the limit of the treaty. The commission to the ceding company is agreed upon at 30%.
2. Assume a risk is written for a limit of $400,000 at a premium of $2,000.
3. Assume a total loss of $400,000 occurs. For this loss, the ceding company would pay $160,000 (40% of $400,000) and the reinsurer would pay $240,000 (60% of $400,000).
PRO RATA SURPLUS SHARE
1. Under a surplus share type of treaty, the pro rata proportion ceded depends on the size and type of risk. The ceding company has the right to decide how much it wants to retain on any one risk. This retention is called a “line.” Any risk that falls within this retention or line is handled totally by the primary company.
2. Whenever the company insures a risk that is larger than the retention, the amount over the retention is ceded to the surplus share treaty as a multiple of the retention. All losses between the insurer’s retention on the risk and reinsurer’s participation are pro rated.
3. Since the ceding company decides how much of each risk it will cede to the treaty, the particular percentage between the insurer and reinsurer will vary. This concept differs from a quota share treaty where the percentage is fixed between the insurer and the reinsurer’s participation, for all risks.
PRO RATA SURPLUS SHARE CALCULATION EXAMPLE
1. Assume the minimum retention or line is $50,000. The limit of the treaty is then expressed as a multiple of the line. A 9-line surplus treaty would be (9 x $50,000) or $450,000. The total capacity to the insurer is $500,000.
2. Any risk with a value of $50,000 or less is retained and not ceded to the treaty. For risks greater than $50,000, the insurer determines how many lines it will retain above the $50,000 and how many lines will be ceded up to the $450,000 limit. Scenarios as follow.
3. A low hazard risk with a limit of $350,000. The insurer may retain 5 lines (or $250,000) and cede 2 lines or $100,000 to the treaty
4. A moderate hazard risk with a limit of $400,000. The insurer may retain 3 lines (or $150,000) and cede 5 lines (or $250,000) to the treaty.
5. A high hazard risk with a limit of $500,000. The insurer may retain 2 lines (or $100,000) and cede 8 lines (or $400,000) to the treaty.
XOL TREATIES
1. In XOL treaties, the reinsurer does not get involved with a loss until a predetermined retained limit of loss or retention, which the ceding company will pay, is exceeded.
2. XOL treaties provide the cedent with the ability to provide greater coverage limits. Reduce the fluctuation in loss experience by limiting the amount of sustained losses. Lessen the impact of losses from a single large event with multiple losses or the accumulation of losses from frequent events.
VARIATIONS OF XOL TREATIES
1. Property Per-Risk Excess Of Loss - The reinsurer indemnifies the primary company for any loss in excess of the specified retention on each risk.
2. Catastrophe Per-Occurrence Excess Of Loss - The purpose of a catastrophe excess treaty is to protect a primary company against adverse loss experience resulting from the accumulation of losses arising from a single, major natural disaster or event such as a hurricane, tornado, earthquake, flood, windstorm, etc. For a given event, the treaty applies once the accumulation of losses paid by the primary company, less inuring reinsurance (the amount the ceding company expects to receive via other reinsurance agreements), reaches a predetermined retention.
3. Stop Loss/Aggregate Stop Loss - This excess of loss cover is designed to protect a company’s overall underwriting results after application of other types of reinsurance it may have. It provides reinsurance for losses incurred during the treaty term, usually one year, in excess of either a specified loss ratio or a predetermined dollar amount.
XOL TREATIES EXAMPLE
1. Assume an insurer needs capacity to write casualty business of $1,000,000 in order to compete in its market niche. Because it is a small company, it determines that it can retain the first $300,000 loss on any risk. However, it needs reinsurance to apply to that part of any loss that exceeds the retained limit of $300,000. In this example, an excess of loss treaty would be expressed as $700,000 x/s $300,000.
2. Assume each of these risks below is written by the insurer for a limit of $1,000,000 to determine how much payment is required by the reinsurer.
3. Has a loss of $600,000. The insurer pays the first $300,000 (retention) and the reinsurer the remaining $300,000.
4. Has a loss of $250,000. The insurer pays the entire loss with no indemnification by the reinsurer as the loss is within the retention of $300,000.
5. Has a loss of $1,000,000. The insurer pays the first $300,000 (retention) and the reinsurer, $700,000.
THOUGHTS
1. From a reinsurer’s perspective, it is possible to experience adverse selection under the treaty. The ceding company may retain most of the lines on low and moderate hazard risks and may cede most of the lines on high hazard risks to the treaty. As a result, the reinsurer may not experience a good spread of all risks written by the ceding company.
2. A surplus share treaty can aid the ceding company by helping to build policyholders’ surplus, providing capacity needed to write larger lines, stabilizing results, and minimizing insurer’s exposure to large losses and catastrophic events.
(Source: MunichRe)
