There are many different types of reinsurance. Current market conditions have created uncertainty and market chaos in the reinsurance community. Reinsurance buyers are looking for solutions to rising prices. It is important for buyers to look at alternatives.
Reinsurance, generally, breaks down into two types of coverage. Excess of Loss (XOL) and Proportional or Quota Share reinsurance. Both provide tools to protect your balance sheet but recent pricing increases for XOL make this coverage a less cost-effective purchase, especially for smaller insurance companies.
Larger companies with scale may choose to pursue Excess of Loss (XOL) Reinsurance to provide coverage in excess of a certain attachment point. It helps to protect an insurance company on a per risk, catastrophic or aggregate basis. The coverage is typically customized for each customer on a bespoke basis.
Per Risk XOL
In Per Risk XL, the cedant’s insurance policy limits are greater than the amount of reinsurance retention. An example will be if an insurance company insures commercial property risks with policy limits up to $5 million. Then, they purchase per risk reinsurance of $3 million in excess of $2 million. Assuming a loss of $5 million occurs, $3 million is recovered from the reinsurance insurance company. As per risk insurance policy contracts, there are usually event limits to prevent the usage of Per Risk XOL instead of Catastrophe XL.
In Catastrophe XOL, the cedant’s retention is generally a multiple of the predetermined underlying policy limit, and the contract often features a multi-risk warranty. The risk warranty contract clauses are designed to protect the cedant against catastrophic events that involve more than one policy. Consider an example where an insurance company issues homeowners’ policies with limits of up to $100,000 and then purchases catastrophe reinsurance equal to $10 million in excess of $2 million. It implies that the insurance company would only recover from reinsurers in the event that there are multiple policy losses in one event, such as a flood or earthquake.
Aggregate XOL provides frequency protection to the reinsured. Consider the case that a company retains $500,000 net in any one vessel, as well as a $3.0 million annual aggregate limit in excess of $2.0 million annual aggregate deductible. It will result in the cover equating to six total losses. Commonly, aggregate covers can also be linked to the cedant’s gross premium income during a 12-month period, with the deductible and limit expresses as a nominal amount of proportional percentage.