Reinsurance plays a vital role in the stability of the insurance industry, enabling insurers to manage financial risk, increase underwriting capacity, and remain resilient in the face of unexpected losses. While the concept of "insurance for insurance companies" may seem straightforward, the strategies and structures behind reinsurance can vary significantly depending on an insurer's objectives. This guide provides a comprehensive overview of reinsurance, explaining how it works, why insurers rely on it, and how key arrangements—including quota share, excess of loss, and funds held reinsurance—help insurance companies balance risk, protect capital, and strengthen long-term financial performance.
Bad things happen. Cars crash, fires break out, crime occurs. Insurers take on the risk of bad things happening through the form of insurance policies. They insure cars against accidents, homes against accidental damage, and lives against untimely death. Through these insurance policies, insurers are responsible for paying insureds for valid claims. For those risks and promises to pay valid claims, the insurance companies receive premiums. Ideally, insurers are able to charge premiums to insureds and then cover claims and costs while making an appropriate profit for their efforts.
Although insurance providers are in the business of risk management, insurers have risks of their own that they need to manage. Insurance companies attempt to manage the risk they take on for each policy through underwriting and obtaining as much information as possible about the risk associated with the insured. Some risks are too great for insurers to accept at allowed premium levels. We have seen this cause the exodus of insurance carriers in the California property and casualty insurance market due to recent fire and claim activity.
When risks become too great for insurers, they also have the option of integrating reinsurance into their business model. When pricing insurance policy premiums, insurers utilize actuarial science to develop estimates of what the ultimate cost of claims will most likely be. Although these estimates are generally reliable, unanticipated events or unidentified underwriting risks can drive claims to be higher than these estimates. If an insurance company were to have claims in excess of their estimates, the solvency of the insurance company could come into question.
In order to protect against insolvency, excess risk associated with insurance policies can be ceded to reinsurers via indemnity reinsurance or assumption reinsurance. Indemnity reinsurance is when a portion of the risk associated with insurance policies is transferred to the reinsurer, with the original insurer transferring a portion of premiums to the reinsurer to take on that risk. However, all obligations to the insured remain with the original insurer. The original insurer is still responsible to fulfill claims and the obligations of the policy. The reinsurer has the obligation to the insurer based on the reinsurance agreement. Assumption reinsurance is when the original insurer essentially sells policies to a reinsurers and all obligations transfer to the reinsurer. Policyholders must approve assumption reinsurance transactions as they are essentially getting a new insurance company to fulfill the obligations of the policy.
Using reinsurance as part of a risk management strategy eases the minds of insurance companies and provides a backstop for worst case scenarios. Risk is shared between insurers and reinsurers in order to provide stability and meet the risk tolerance of all parties involved. If reinsurers have reached too high of risk for their tolerance then another level of reinsurance can be obtained with retrocession. Risks continue to be shared amongst various insurers, reinsurers and subsequent retrocession until all parties are satisfied with the risk that remains with them. Proper reinsurance transactions share the risk of the insured and meet the insured’s goal of mitigating their risk.
In the section above, we introduced the foundational purpose of reinsurance: helping insurers spread risk, manage capital, and ensure long-term solvency. In this section, we’ll dive into one of the most widely used forms of reinsurance—Quota Share.
Simple, consistent, and reliable, quota share reinsurance is a proportional reinsurance method that allows primary insurers to cede a fixed percentage of every policy to a reinsurer. Let’s explore how it works, how to account for it, and when it’s the best fit for your company.
Quota share reinsurance is a type of proportional reinsurance agreement in which a primary insurer cedes a fixed percentage of every policy in a defined portfolio or block of policies to a reinsurer. In return, the reinsurer receives the same percentage of premiums and is responsible for the same percentage of losses and expenses.
Let’s say an insurer enters a 40% quota share agreement with a reinsurer. That means:
If a $100,000 claim is incurred:
Likewise, if the premium on that policy is $1,000, the reinsurer receives $400 in premium and pays its proportional share of underwriting expenses.
From an accounting perspective, quota share arrangements are relatively straightforward to account for:
One of the key advantages of quota share reinsurance is its consistency and simplicity. Because the ceding company transfers a fixed percentage of every covered policy to the reinsurer, both underwriting and accounting become more predictable. This kind of proportional arrangement makes it easy to calculate how much premium and risk is being shared, and it simplifies the internal systems needed to track that data.
Quota share can also provide meaningful capital relief. By ceding a portion of premium and loss exposure, insurers can reduce their net liabilities, which in turn lowers the amount of surplus required to support the book of business. This can be especially important for growing companies or new entrants to the market who want to expand their underwriting capacity without overextending their capital base.
In addition, many quota share agreements include a ceding commission paid by the reinsurer to the insurer. This commission helps cover acquisition and administrative costs, and in some cases can even result in an upfront profit for the ceding company, depending on the terms of the agreement. Over time, this shared risk and reward model can help smooth out volatility in underwriting results and improve financial stability.
Despite its simplicity, quota share reinsurance is not without its limitations. One of the most important considerations is the trade-off involved in ceding both risk and reward. While an insurer shares losses with the reinsurer, it also shares premium and potential underwriting profit. This can reduce the ceding company’s overall return on profitable books of business and may lead to a long-term cost if not properly negotiated.
Another challenge is that quota share does not differentiate between high-risk and low-risk policies within the ceded portfolio. The reinsurer receives the same percentage of every policy, regardless of risk quality. This means that the ceding company may inadvertently subsidize the reinsurer by passing along more profitable policies or underprice business that it might otherwise handle more selectively. If not paired with strong underwriting discipline, quota share arrangements can create misaligned incentives or a lack of focus on individual policy performance.
Additionally, while quota share reinsurance agreements are easier to administer than other types of agreements, they still require careful implementation and monitoring. Reinsurance agreements must be reviewed regularly to ensure they remain aligned with the company’s financial goals, loss trends, and capital needs. Overreliance on quota share reinsurance can sometimes mask weaknesses in underwriting or pricing strategies, which can become problematic if terms change or the reinsurer becomes less willing to share risk.
At Larson, we work closely with insurers and captives to navigate the technical accounting and strategic implementation of quota share and other reinsurance arrangements. If you’d like help reviewing the accounting treatment of your reinsurance agreements or improving documentation for compliance, please reach out and we would be happy to work with you.
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.
Funds held is a key feature of reinsurance agreements that determines how cash moves between insurers and reinsurers. It can affect liquidity, alter investment income, and change collateral needs in ways that matter for both parties. Its impact is especially noticeable in quota share treaties, where premium and loss activity is more consistent. Understanding why funds held play such a central role helps make the rest of the structure far easier to follow.
Funds held reinsurance is when the ceding insurer keeps the premiums that would normally be paid to the reinsurer, instead of transferring the cash immediately.
In quota share reinsurance, things are more consistent.
Funds held will simplify this process because only the net amount is settled periodically.
This reduces friction and collateral needs. If a reinsurer’s share of premium is $10m, the cedant may hold that $10m and credit interest, instead of wiring it out and then requesting reimbursement for losses later.
Funds held would be less common in an excess of loss treaty because while premiums are usually fixed and paid upfront, losses are also infrequent and large. It may still be used as collateral in excess of loss treaty agreements if the reinsurer is offshore, or the cedant wants collateral for recoverables.
To compensate the cedant for acquisition costs and overhead, the reinsurer will also pay a ceding commission. The ceding insurer will treat this as income, while the reinsurer will treat this as expense. The ceding commission is typically recognized in proportion to the ceded written premium.
We can look at a scenario and see the impact of how that looks on the face of the financials for both a ceding insurer and their insurer.
A ceding insurer enters into a 40% quota share treaty. During the first quarter:
Under a funds‑held arrangement, the cedant keeps the $10 million of ceded premium instead of sending it to the reinsurer. As losses occur, the cedant deducts the reinsurer’s share from the funds‑held balance.
The entries for the ceding insurer are as follows:
|
Entry |
Account Name |
Debit |
Credit |
|
Direct Premium |
Cash/Premium receivable |
25,000,000 |
|
|
|
Gross written premium |
|
25,000,000 |
|
Direct Losses |
Losses |
4,000,000 |
|
|
|
Losses payable |
|
4,000,000 |
|
Ceded Premiums |
Ceded Premium |
10,000,000 |
|
|
|
Funds held liability |
|
10,000,000 |
|
Losses recovered |
Funds held liability |
1,600,000 |
|
|
|
Losses recoverable |
|
1,600,000 |
|
Interest income |
Interest credited to reinsurer |
100,000 |
|
|
|
Funds held liability |
|
100,000 |
|
Commission income |
Funds held liability |
1,000,000 |
|
|
|
Ceding commission income |
|
1,000,000 |
The impact to the funds held liability on the cedant financial statements are as follows:
|
Description |
Amount |
|
Ceded premium |
10,000,000 |
|
Less: |
|
|
Ceding commission |
(1,000,000) |
|
Losses recoverable |
(1,600,000) |
|
Plus: |
|
|
Interest credited |
100,000 |
|
Ending balance |
7,500,000
|
The entries for the reinsurer are as follows:
|
Entry |
Account Name |
Debit |
Credit |
|
Direct Premium |
N/A |
|
|
|
Direct Losses |
N/A |
|
|
|
Ceded Premiums |
Funds held receivable |
10,000,000 |
|
|
|
Assumed premium |
|
10,000,000 |
|
Losses recovered |
Losses assumed |
1,600,000 |
|
|
|
Funds held receivable |
|
1,600,000 |
|
Interest income |
Funds held receivable |
100,000 |
|
|
|
Interest income |
|
100,000 |
|
Commission income |
Ceding commission expense |
1,000,000 |
|
|
|
Funds held receivable |
|
1,000,000 |
The impact to the funds held receivable on the reinsurer financial statements are as follows:
|
Description |
Amount |
|
Assumed premium |
10,000,000 |
|
Less: |
|
|
Ceding commission |
(1,000,000) |
|
Losses recoverable |
(1,600,000) |
|
Plus: |
|
|
Interest credited |
100,000 |
|
Ending balance |
7,500,000 |
In summary, funds held is a reinsurance arrangement where the ceding insurer keeps the reinsurer’s share of premium instead of sending it immediately. The reinsurer records the amount as an asset, and the cedent hold sit as a liability.
Reinsurers choose funds held because it reduces collateral requirements, lowers financing costs, and aligns cash flow with long tail loss development.
Regardless of the type of reinsurance agreement you’re looking at, funds held can be a useful tool to help manage collateral requirements and cash flow needs.
A well-designed reinsurance program is more than a financial safeguard—it's a strategic tool that enables insurers to grow responsibly, manage uncertainty, and remain resilient in an increasingly complex risk environment. By understanding the differences between quota share, excess of loss, and funds held arrangements, insurance professionals can make more informed decisions about how risk is transferred, financed, and managed. Whether you're new to reinsurance or looking to deepen your understanding of its core structures, these concepts provide the foundation for building stronger, more effective risk management strategies across the insurance industry.
What is reinsurance?
Reinsurance is insurance purchased by insurance companies. It allows insurers to transfer a portion of their financial risk to another insurance company, known as a reinsurer, helping protect against large or unexpected losses while improving financial stability and underwriting capacity.
What is the difference between quota share and excess of loss reinsurance?
Quota share reinsurance is a proportional arrangement in which the insurer and reinsurer share premiums and losses based on an agreed percentage. Excess of loss reinsurance is a non-proportional arrangement that provides coverage only after losses exceed a predetermined retention amount, making it especially valuable for catastrophic or unusually large claims.
What is funds held reinsurance?
Funds held reinsurance is a collateral arrangement in which the ceding insurer retains premiums that would otherwise be paid to the reinsurer. Those funds serve as security for the reinsurer's obligations while allowing the ceding company to maintain control of invested assets, subject to the terms of the reinsurance agreement.
Why do insurance companies purchase reinsurance?
Insurers use reinsurance to reduce their exposure to large losses, improve capital management, stabilize financial results, increase underwriting capacity, meet regulatory requirements, and protect policyholders by strengthening long-term solvency.
How do insurers determine which type of reinsurance is right for them?
The appropriate reinsurance structure depends on factors such as the insurer's risk profile, capital resources, underwriting strategy, lines of business, and tolerance for volatility. Many insurers combine multiple reinsurance arrangements to create a program tailored to their unique risk management objectives.
For further guidance, please contact the Larson Insurance Team. Larson and Company has developed a suite of services specifically to serve the needs of insurance companies.