Excess of loss
Excess of loss is the most common of the non-proportional reinsurance forms. An excess of loss cover can be either of the following:
- On a per-risk basis; or
- On a per-event basis.
A per-risk cover gives protection for each risk involved in a loss when it exceeds a pre-agreed level (the priority) and up to the pre-agreed limit. Thus, if the number of risks is involved in the same loss event, the reinsured pays the priority on each, and the reinsurer pays the amount exceeding the priority on each and every risk affected.
Per-risk covers are used to protect accounts against large individual losses, for example, motor third-party liability or public liability insurances. A per-event limitation is often included to ensure that the cover only provides protection against large single losses and not an accumulation of losses from one event.
Per-event covers protect the reinsured against an accumulation of losses. When the sum of the losses exceeds the pre-agreed amount (known as the priority), the reinsurer will be liable to pay the excess up to a pre-agreed upper limit. Typically,per-event covers are used to protect a company against catastrophe events, such as windstorms or the accumulation of losses in a personal accident account from a major accident affecting many individuals. A per-event cover often contains a two-risk warranty to ensure that it will not be affected by a single claim.
More than loss reinsurance, it is particularly important to ensure that the definitions of the terms "risk" and "event" are unambiguous.
The premium for an excess of loss cover is subject to negotiation between the parties and is based on the claims' experience and/orthe potential exposure to a claim. Consequently, it can vary considerably from reinsurer to reinsurer and from one year to another.
The premium on a per-event cover would normally only pay for the use of the cover once. However, the reinsured may require protection for more than one total loss. Therefore, a per-event excess of loss cover could contain a reinstatement condition implying that the cover can be reinstated an agreed number of times, subject to the payment of an additional (reinstatement) premium.
Advantages of an excess of loss reinsurance are as follows:
- Simple and inexpensive administration; and
- Efficient and clear protection.
Disadvantages of an excess of loss reinsurance are as follows:
- Premium cost might vary considerably;
- The sum of retentions for a per-risk cover can be relatively high if the frequency of losses is large; and
- Risk of running out of cover if an unexpected frequency exhausts the automatic reinstatements. Further reinstatements might be available,but the price of these could prove to be expensive.