Definition:Excess of loss reinsurance
🛡️ Excess of loss reinsurance is a form of non-proportional reinsurance in which the reinsurer indemnifies the ceding company for losses that exceed a predetermined retention (also called the attachment point), up to a specified limit. It stands in contrast to proportional reinsurance, where premiums and losses are shared on a fixed percentage basis regardless of loss size. In the insurance industry, excess of loss treaties are foundational tools for protecting an insurer's balance sheet against the financial impact of large individual claims or the accumulation of many claims from a single catastrophic event.
📊 The mechanics hinge on the retention and the treaty limit. Suppose an insurer sets a retention of $2 million per occurrence and buys excess of loss cover up to $10 million. If a single claim costs $7 million, the insurer absorbs the first $2 million and the reinsurer pays the remaining $5 million. Losses below $2 million never touch the treaty. These arrangements come in several varieties: per-risk excess of loss protects against large individual losses on a single policy; per-occurrence (or per-event) excess of loss responds when a single event — such as a hurricane — generates aggregate losses above the retention across many policies; and aggregate excess of loss triggers when cumulative losses over a defined period breach a threshold. Underwriters on both sides negotiate the retention, limit, and premium using actuarial models, historical loss experience, and catastrophe models.
💡 Without excess of loss protection, many insurers would be unable to write the large or catastrophe-exposed risks that their policyholders need covered. The product effectively caps an insurer's downside on any single event, enabling more confident underwriting and smoother earnings. It also plays a central role in capital management: regulators and rating agencies give credit for well-structured reinsurance programs when evaluating an insurer's solvency and financial strength. During hard-market cycles, the cost and availability of excess of loss cover can shift dramatically, rippling through primary market pricing and capacity across entire lines of business.
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