What Is Excess of Loss Reinsurance?
Excess of loss (XOL) reinsurance is a form of non‑proportional reinsurance in which the reinsurer indemnifies the ceding insurer for losses that exceed a specified retention (attachment) point, up to a contract limit. Unlike proportional treaties (e.g., quota share), XOL is based on loss size: the cedant keeps losses up to the retention and the reinsurer pays losses above that level according to the contract terms.
Source: Investopedia — https://www.investopedia.com/terms/e/excess-loss-reinsurance.asp
Key concepts (quick)
– Attachment point (retention): the loss amount the ceding insurer must absorb before the reinsurer pays.
– Limit: maximum amount the reinsurer will pay under the contract (often per event, per risk, or in aggregate).
– Non‑proportional: the cedant’s share is determined by the retention, not a fixed percentage of each policy.
– Common forms: per risk, per occurrence (per event), and aggregate (stop‑loss).
– Pricing drivers: frequency and severity of losses, “burning‑cost” analysis, exposure models, risk correlations.
How Excess of Loss Reinsurance Works
– Attachment point (A): The cedant retains losses up to A.
– Reinsurer layer: Pays losses above A up to a limit L (so reinsurer liability per claim/event = min(loss − A, L − A) depending on wording).
– Sharing options: Some treaties make reinsurer responsible for all loss above A; others share losses above A by a percentage (co‑participation).
– Layers: Multiple XOL layers can be stacked (e.g., layer 1 covers A to B, layer 2 covers B to C, etc.). Each layer has its own premium and capacity.
Common XOL structures
– Per risk excess: Pays when an individual risk’s loss exceeds the retention. Typical for property damage to a specific asset.
– Per occurrence / per event excess: Pays when the aggregated losses from a single occurrence (e.g., hurricane, earthquake) exceed the retention. Used for catastrophe cover.
– Aggregate excess (stop‑loss): Pays when cumulative losses for a period exceed an aggregate retention; useful for protecting underwriting results across many claims.
– Layered covers: Multiple bands/layers of cover with different reinsurers and rates.
Illustrative examples
– Full reimbursement above attachment: Retention $500,000. If aggregate losses for an event are $600,000, reinsurer pays $100,000 (600k − 500k).
– Co‑participation example: Retention $500,000; reinsurer agrees to pay 50% of losses above the retention. If losses = $600,000, reinsurer pays $50,000 and cedant pays $50,000 of the excess.
Why cedants use XOL reinsurance (benefits)
– Solvency protection: Caps extreme losses that could threaten capital and surplus.
– Earnings stability: Limits impact of large, infrequent losses and catastrophe events.
– Capacity: Allows the insurer to underwrite more or larger policies without tying up excess capital.
– Flexibility: Attachment points and limits can be tailored to risk appetite and balance sheet needs.
Why reinsurers offer XOL (benefits & motivations)
– Earn premium for taking on large severity exposures; can diversify by writing many unrelated risks.
– Ability to price using modeling and select layers that match capacity.
– Attractive for reinsurers with strong capital positions and catastrophe modeling capabilities.
Pricing and underwriting fundamentals
– Burning‑cost method: Historical loss costs (actual paid losses including LAE) are used to estimate expected losses in the layer. Premium = expected loss + loading for expenses, profit and risk.
– Frequency/severity modeling: Catastrophe models and GLMs for ordinary risks.
– Exposure analysis: Assess limits, aggregation exposure, policy terms and coverages that create accumulation.
– Loadings and margins: Include cost of capital, commission to brokers, reinstatement premiums, and allowance for uncertainty.
– Reinstatement provisions: If the limit is used and cover is reinstated, an additional premium (reinstatement premium) is often charged.
Contract terms to watch
– Scope of coverage: per risk, per event, aggregate; per policy wording matters.
– Retention (attachment) and limit (including layer width).
– Co‑participation / coinsurance percentages, if any.
– Event definition: How is a “single occurrence” defined for aggregating losses? (Critical for catastrophe exposures.)
– Claims reporting and settlement procedures: timing, documentation, and subrogation rights.
– Reinstatement clauses: Number of reinstatements allowed and cost.
– Follow‑form vs specific wording: Does the XOL “follow” the underlying policy wording or have independent terms?
– Commutation and termination conditions.
Practical steps for a ceding insurer to obtain XOL reinsurance
1. Assess risk appetite and objectives
– Decide whether you want per‑risk, per‑event, or aggregate protection and the primary goal (catastrophe protection, reserve protection, P&C underwriting result smoothing).
2. Quantify exposures and model layers
– Use internal data and catastrophe/exposure models to estimate frequency and severity at different attachment points and for different layers. Produce expected loss and scenario analyses.
3. Determine attachment point and limit
– Choose retention based on capital structure, regulatory solvency margins, and cost/benefit analysis. Consider affordability vs. protection.
4. Prepare an RFP/placement brief
– Include underwriting portfolio details, limits requested, retrocession history, aggregations, policy terms, loss development triangles and prior reinsurance placements.
5. Engage brokers and markets
– Use reinsurance brokers to approach reinsurers, negotiate pricing, and structure multi‑layer placements. Compare alternatives (single market vs syndicated layers).
6. Negotiate contract terms
– Pay attention to event definitions, reinstatement terms, coinsurance, exclusions, and reporting requirements.
7. Complete due diligence & credit checks
– Evaluate reinsurer creditworthiness and agree on collateral or trust arrangements if needed.
8. Finalize placement and premium payment
– Execute treaty/facultative slips; ensure regulatory filings where required.
9. Implement claims handling protocols
– Agree on notice requirements, documentation standards, settlement processes and timings.
10. Post‑placement monitoring and renewals
– Review performance, burning costs, and changes in exposure; adjust retention, layers or markets at renewal.
Practical steps for a reinsurer evaluating XOL business
1. Analyze cedant’s portfolio and exposure accumulation (per risk/event/aggregate).
2. Run scenario and catastrophe models for the layer(s) being quoted.
3. Estimate expected losses, volatility and tail risk; set premiums with appropriate loadings.
4. Assess cedant’s underwriting, claims handling and prior loss history.
5. Consider retrocession needs—do you need to lay off parts of the layer?
6. Check credit exposure and collateral mechanisms.
7. Structure terms (limits, exclusions, reinstatements) to match risk appetite.
8. Implement monitoring/reporting covenants and reserve for potential recoverables.
Claims handling and recoveries (practical)
– Prompt notice: Cedant should notify reinsurer per contract timelines when losses approach or exceed attachment points.
– Documentation: Submit claims data, loss reserving schedules, investigations, and supporting invoices.
– Reconciliation: Agree on final loss amount and legal liabilities before payment. Use independent adjusters or loss adjusters where appropriate.
– Reinstatement and additional premiums: If reinstatement is contractually required after an event, ensure premium payment/arrangements are clear.
– Dispute clauses: Arbitration or dispute resolution methods should be pre‑specified.
Common pitfalls and how to mitigate them
– Poorly defined event wording leading to disputes: Use clear, industry‑accepted definitions.
– Underestimating accumulation: Use robust accumulation modeling and stress tests.
– Misalignment between underlying policy and reinsurance wording: Prefer “follow‑form” when appropriate or explicitly reconcile differences.
– Overconcentration in a single market/layer: Spread risk via multiple reinsurers and retrocession.
– Neglecting counterparty credit risk: Use collateral, trust accounts, or limit exposures to single reinsurer.
– Ignoring reinstatement economics: Model potential costs of reinstatement premiums after major events.
Regulatory and capital considerations
– XOL can materially affect regulatory capital and solvency ratios: cedants often reduce required capital by buying protection for low‑probability, high‑severity losses.
– Reserving and accounting: Reinsurance recoverables must be shown on balance sheets; cedants should ensure recoverables are realizable per accounting and regulatory rules.
– Licensing and filings: Treaty placements may require regulatory notice or approval depending on jurisdiction.
Checklist for a ceding insurer before placing XOL
– Have you modeled expected loss and tail risk for attachment points considered?
– Is the chosen retention supported by capital and earnings volatility objectives?
– Has a broker market run been completed and multiple quotations compared?
– Are event definitions and contract wording aligned with underlying policies?
– Is there a plan for claims notification, documentation and settlement timing?
– Have reinsurer creditworthiness and collateral needs been assessed?
– Are reinstatement and commutation terms acceptable?
– Are regulatory filings and accounting treatments understood?
Conclusion
Excess of loss reinsurance is a cornerstone tool for insurers to protect against catastrophic and extreme losses while managing capital and underwriting capacity. Successful use of XOL rests on careful exposure modeling, well‑drafted contract language, prudent selection of attachment points and layers, and robust claims and counterparty management. Both cedants and reinsurers benefit from transparent underwriting data, clear event definitions, and realistic pricing that reflects tail risk.
Primary source for definitions and examples: Investopedia — “Excess‑of‑Loss Reinsurance” (https://www.investopedia.com/terms/e/excess-loss-reinsurance.asp).