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Chapter 10 Property reinsurance 10/11

C2 Risk excess of loss
An excess of loss treaty may be used by the property insurer as an alternative to proportional
reinsurance, to cover all the risks on its books and where, on the basis of its past experience, it can bear
a specified deductible for all those claims it is likely to have, but where it needs protection for the
difference between the deductible and the total sum insured for which it is liable.
Example 10.3
An insurer has a book of fire and special perils business with sums insured ranging from £0–500,000. It considers
its maximum retention on any one risk to be £100,000 and it knows from its experience how many losses there will
be, on average, which exceed this figure. Unfortunately, it cannot know which of its risks will be affected. Instead of
reinsuring them all on a proportional basis and ceding premium in the process, it can arrange a non-proportional
treaty which will cover it for losses in respect of all its risks above £100,000 and up to £500,000. This would be
expressed as an excess of loss treaty for £400,000 excess of £100,000 per risk or each loss.

The deductible chosen would relate to the reinsured’s normal retention for a category of risk. This type of
Deductible chosen
treaty is an alternative to a proportional treaty and is commonly referred to as a working layer, as it is would relate to the
knowingly exposed to losses and is expected to be active in providing recoveries for claims within the reinsured’s normal
retention for a
cover. This means that the reinsured will be protected against losses in excess of £100,000 for all such category of risk
risks with a sum insured up to £500,000. The reinsurer’s ‘limit’ will be up to the balance of £400,000 as
illustrated by figure 10.1.

Figure 10.1: Risk excess of loss

£400,000 (limit) XS
£100,000 (deductible)

£100,000 retention/deductible

The reinsured pays all losses below £100,000 in their entirety and the first £100,000 of every loss larger Reference copy for CII Face to Face Training
than £100,000. If a risk with a sum insured of £350,000 were to suffer a loss of £89,000, the reinsured
would pay the whole amount. However, in a loss of £250,000 for the same risk, the reinsured would in
the first instance pay the whole of the £250,000 and would then be entitled to recover the amount in
excess of the £100,000 deductible, that is, £150,000 from the reinsurer.

Where the sum insured on a property exceeds the capacity of the treaty, for example, a sum insured of
£600,000, the reinsured is responsible for the difference between the latter and £500,000 in addition to
its deductible so, in essence, the excess of loss reinsurer’s limit is fixed.
The effect of this type of treaty is that the reinsured pays for all of the claims within and up to the
Reinsured pays for all
deductible for any type of risk within the portfolio, but is able to recover sums in excess of that amount of the claims within
from the excess of loss reinsurer, up to a defined monetary limit. A feature of this type of contract is that and up to the
deductible
the cover can be ‘reinstated’ after it has paid claims, usually up to a defined number of times. There are
also some ‘high level’ risk excess of loss contracts which protect the reinsured against EML error.
Several individual risks all insured with the reinsured may be affected at the same time by the same
event. For example, several buildings on an industrial estate belonging to different parties are damaged
by an explosion. The insurer would have to pay each claim and then look to the excess of loss reinsurer
for a recovery in respect of each risk, for the amount exceeding the deductible.

Question 10.9
How do reinsurers avoid giving potentially unlimited cover in per risk treaties for numerous losses attributable to the
same incident? Chapter

It is vital to understand what an event is in relation to reinsurance and why it is important. An event is
the incident giving rise to a claim under the treaty on account of a single occurrence. It is important as it 10
may be used to determine the extent of the treaty’s liability.
Thus, by way of example, a reinsured has a per risk treaty for £400,000 excess of £100,000 with five
reinstatements and sustains losses from Buildings A to G in the same event. In the absence of an event
limit the claims recoveries the reinsured can make are as shown in table 10.2.