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Chapter 5 Features and operation of non-proportional reinsurance treaties 5/3

A1 Excess of loss treaties

Consider this…
What do you think is meant by ‘excess of loss treaties’?

Non-proportional reinsurance treaties are characterised by a distribution of liability between the
Distribution of liability
reinsured and the reinsurer on the basis of losses rather than sums insured, as is the case in between the reinsured
proportional reinsurance. In consideration of the cover granted, the reinsurer receives part of the original and the reinsurer
premiums but this is not that part of the premium corresponding to the sum reinsured, which would be
the case in proportional reinsurance. Several types of non-proportional cover exist and we will look at
these later.
Unlike a proportional treaty, the size of cession is not determined case by case. This allows the
reinsured to dispense with cession bordereaux (which is a list of risks ceded by the reinsured to the
reinsurance policy) and reinsurance registers, while losses are shown on a loss bordereau or, more
generally, on an individual basis.

A1A Use of excess of loss treaties
When considering which method of reinsurance to adopt for the protection of individual risks or a
particular class of business, an insurer has to take a number of different factors into account before
deciding which is the most appropriate to meet all or most of its business objectives. Traditionally,
proportional reinsurance has been the mechanism by which an insurer can increase its capacity to
underwrite more and bigger risks or to expand its portfolio of business by the reciprocal exchange of Chapter
business.
However, an insurer must always be conscious of the potential effect on its account of situations that its 5
proportional reinsurance arrangements either cannot respond to or will leave it with higher net retained
losses than it is prepared or able to accept.
Examples of such situations include:
• losses on single risks that by their nature or size fall partially or totally outside the scope of any Reference copy for CII Face to Face Training
existing proportional arrangements;
Consider this…
What defining terminology under insurer A’s quota share treaty might prevent it ceding a portion of a £10m multi-
tenure timber-built converted mill?

• losses arising on a number of original risks at the same time, all as the result of one particular
occurrence or event; and
• the general deterioration of the performance of an account or class of business due to an abnormal or
unpredictable increase in the incidence of losses.
In these circumstances, the various options provided by excess of loss reinsurance should be
considered.

Nature of business to be protected
When considering the choice of reinsurance protection, particular attention must be paid to the nature of
Particular attention
the original business to be protected. While all original risks could probably be reinsured individually on must be paid to the
a facultative basis, this would prove inconvenient and administratively expensive for an insurer with any nature of the original
business
sizeable portfolio of business. If the portfolio is made up of a number of small risks for which there is
little exposure, the insurer may not wish to pass on the substantial volume of premium to its reinsurer
on a largely profitable account but merely protect against an ‘unforeseen’ event, which may accumulate
the exposure of the insurance company to a degree which substantially affects its profitability.
Exposure to large losses
Excess of loss can be used specifically to protect the insurer against an exposure to a specific large loss
event, such as a windstorm, where the portfolio is exposed to large individual losses and to the effects
of the accumulation of loss as a result of that particular event. While protection for large specific cases
can be catered for by surplus treaty arrangements, full protection for classes of business without known
sums insured cannot. Provision should be made for the effects of any possible catastrophe situation that
may arise; this can be achieved by arranging excess of loss reinsurance protection on a per event basis.