DEFINITION of ‘Excess Of Loss Reinsurance’
A type of reinsurance in which the reinsurer indemnifies the ceding company for losses that exceed a specified limit. Excess of loss reinsurance is a form of non-proportional reinsurance. Depending on the language of the treaty, it can apply to either the all loss events during the policy period or can apply to losses in aggregate. Treaties may also use bands of losses that are reduced with each claim.
BREAKING DOWN ‘Excess Of Loss Reinsurance’
Reinsurance contracts often specify a limit in losses that the reinsurer will be responsible for. This limit is agreed to in the reinsurance treaty, and protects the reinsurance company from dealing with an unlimited liability. In this way, it is similar to a standard insurance contract, which provides coverage up to a specific amount. While this is beneficial to the reinsurer, it places the onus on the insurance company to reduce losses.
Excess of loss reinsurance takes a different approach. The reinsurance company is held responsible for the total amount of losses above a certain limit. For example, a reinsurance contract with an excess of loss provision may indicate that the reinsurer is responsible for losses over $500,000. In this case, if aggregate losses amount to $600,000 the reinsurer will be responsible for $100,000.
Rather than require the reinsurer to be responsible for losses over a certain amount, the treaty may instead indicate that the reinsurer is responsible for a percentage of losses over that limit. This means that the ceding company and the reinsurer will share aggregate losses. For example, a reinsurance contract with an excess of loss provision may indicate that the reinsurer is responsible for 50% of the losses over $500,000. In this case, if aggregate losses amount to $600,000, the reinsurer will be responsible for $50,000 and the ceding company will be responsible for $50,000.