Excess of Loss or Quota Share Reinsurance When Excess of Loss is the Better Bet.

• Author: Chvasta, Joe

* Recently, I had the opportunity to compare claims scenarios of an excess of loss proposal with a quota share proposal for the liability coverage of our captive risk association. The results surprised me.

Excess of loss is a form of non-proportional reinsurance in which the reinsurer indemnifies the ceding company for losses that exceed a specified limit. In some cases the reinsurer is responsible for all losses over a certain amount and in other cases, such as ours, the reinsurer's losses are capped at a percentage of losses.

Quota share is a proportional reinsurance in which the reinsured and reinsurer share insurance liability, premium and losses beginning with the first dollar of loss.

When we were presented an excess of loss and a quota share proposal for the same program, I assumed that we would just go with quota share. Without comparing the two proposals I automatically assumed the quota share proposal was better as it is proportional reinsurance and the reinsurer will pay its share of the losses (90% in this case) no matter how many or how large. I understood that we could not lose money with quota share but we could with excess of loss if the losses were high enough. It seemed to be an easy decision. Then I did the loss scenarios and it wasn't so simple. Excess of loss was the better reinsurance if we could ensure that the loss ratio stayed low, typically below fifty percent.

The excess of loss and quota share proposals we received were not uncommon for a liability program.

The quota share option had the cedent or insured company retaining 10% and the reinsurer assuming 90% of the liability and receiving 90% of the premium less the ceding commission. The ceding commission was only at 22% as the class of business is considered challenging but it did increase to 25% if the final loss ratio was below 40%. The premium retained by the insured company consists of the ceding commission and the company's share of the premium after losses.

The excess of loss proposal had an attachment point of $100,000, a minimum premium of 20% and a maximum of 65%. The loss adjustment factor was 10%. The reinsurer's aggregate maximum loss was 300%. The premium retained by the insured company is calculated after losses paid within the attachment, the minimum premium and losses paid by the reinsurer including a 10% adjustment expense, up to the maximum premium.

Along with our actuary I worked up a number of loss scenarios comparing the two proposals. We...