September 30, 2025
In the world of insurance, risk is a constant companion. While insurers are experts at pricing and managing everyday risks, the threat of catastrophic losses - those rare but severe events that can threaten an insurer’s solvency - looms large. That’s where excess of loss reinsurance comes in. As a cornerstone of non-proportional reinsurance, excess of loss arrangements provide a powerful tool for insurers to shield themselves from the financial shock of large, unexpected claims.
Excess of loss reinsurance is a form of non-proportional reinsurance, meaning the reinsurer’s participation is triggered only when losses exceed a specified threshold, known as the “retention” or “attachment point.” Unlike quota share reinsurance, where the reinsurer takes a fixed percentage of every policy’s premiums and losses, excess of loss is designed to protect insurers from the volatility of large claims.
Here’s how it works: The primary insurer agrees to retain losses up to a certain amount per risk, per event, or in aggregate over a period. If losses surpass that amount, the reinsurer steps in to cover the excess, up to a predetermined limit. This structure allows insurers to cap their exposure to severe losses while retaining the more predictable, lower-severity claims.
Excess of loss reinsurance comes in several flavors, each tailored to different risk management needs:
This type covers individual risks (such as a single property or policy). The reinsurer pays when a claim on any one risk exceeds the retention. For example, if an insurer retains $500,000 per risk and a claim comes in at $1 million, the reinsurer covers the $500,000 excess.
Designed for catastrophic events affecting multiple policies at once (think hurricanes, earthquakes, or wildfires), this coverage kicks in when the total losses from a single event exceed the retention. It’s a vital tool for insurers operating in catastrophe-prone regions.
This structure protects against the accumulation of losses over a defined period (usually a year). If total claims paid during the period exceed the aggregate retention, the reinsurer covers the excess. This is especially useful for smoothing out the impact of a bad claims year.
The primary motivation for excess of loss reinsurance is protection against large, infrequent losses that could destabilize an insurer’s balance sheet. By capping their maximum exposure, insurers can:
In an excess of loss arrangement, premiums paid to the reinsurer are typically lower, reflecting the lower frequency but higher severity of covered losses. Insurers must carefully track recoveries from reinsurers and establish appropriate reserves for both retained and ceded losses. The timing of recoveries can also impact financial statements, especially in the aftermath of a major event.
While both quota share and excess of loss reinsurance transfer risk, they do so in fundamentally different ways. Quota share is proportional, sharing all premiums and losses at a fixed percentage, making it predictable and easy to administer. Excess of loss, on the other hand, is non-proportional, focusing on protecting against the tail risk of large claims. Insurers often use both types in tandem, with quota share smoothing out everyday volatility and excess of loss providing catastrophe protection.
Excess of loss reinsurance isn’t without its challenges. Setting the right retention and limit is critical - too low, and the insurer pays unnecessary premiums; too high, and the protection may not be meaningful. Pricing can be complex, as reinsurers must model the probability and severity of large losses, often relying on sophisticated catastrophe models. There’s also the risk of coverage gaps if retentions and limits aren’t carefully coordinated across different layers of protection.
Excess of loss reinsurance is an essential tool for insurers seeking to manage catastrophic risk and protect their financial stability. By transferring the most severe losses to reinsurers, insurers can focus on their core business with greater confidence, knowing that even the worst-case scenarios won’t threaten their survival. As the insurance landscape evolves and catastrophic events become more frequent and severe, the importance of excess of loss reinsurance will only continue to grow.
For additional guidance, please contact us. Larson and Company has developed a suite of services specifically to serve the needs of insurance companies.