Surplus reinsurance

Definition

Surplus reinsurance is a type of reinsurance that allows an insurance company to transfer part of its risk for larger policies to a reinsurer, protecting itself from potential losses that exceed a certain threshold. This arrangement helps insurers manage their capital more effectively by providing coverage for risks that surpass their retention limits, thereby enhancing their ability to underwrite larger policies while maintaining financial stability.

5 Must Know Facts For Your Next Test

1. Surplus reinsurance is typically used for large policies where the potential loss could significantly impact the insurer's financial health.
2. In this arrangement, the primary insurer retains a portion of the risk (up to the retention limit) while transferring the excess to the reinsurer.
3. This type of reinsurance helps insurers comply with regulatory capital requirements by reducing their net exposure to large claims.
4. Surplus reinsurance agreements are usually structured with a limit on the total amount of coverage that can be ceded to the reinsurer.
5. The premiums paid for surplus reinsurance are based on the volume and type of business being reinsured, along with the associated risks.

Review Questions

• How does surplus reinsurance help insurance companies manage their risk exposure?
  • Surplus reinsurance helps insurance companies manage their risk exposure by allowing them to cede a portion of their larger policies to a reinsurer. This way, they can protect themselves from potential losses that exceed their retention limits. By transferring excess risk, insurers can maintain a healthier balance sheet and continue underwriting larger policies without overextending their financial capacity.
• What are some key differences between surplus reinsurance and excess of loss reinsurance?
  • Surplus reinsurance and excess of loss reinsurance differ primarily in how they handle risk transfer. Surplus reinsurance involves ceding specific portions of individual risks above a predetermined retention limit, allowing insurers to retain some level of exposure. In contrast, excess of loss reinsurance provides coverage for aggregate losses exceeding a set threshold across multiple policies, focusing on catastrophic events rather than individual policy limits. Both methods aim to manage risk but apply different strategies depending on the insurer's needs.
• Evaluate the impact of surplus reinsurance on an insurer's capital management and overall underwriting strategy.
  • Surplus reinsurance significantly impacts an insurer's capital management by allowing it to free up capital that would otherwise be tied up in reserves for large claims. By transferring excess risk, insurers can optimize their balance sheets, comply with regulatory requirements, and enhance their capacity to underwrite larger policies. This strategic use of surplus reinsurance not only improves financial stability but also enables insurers to explore new market opportunities, thereby driving growth while maintaining prudent risk management practices.

Related terms

reinsurer: A company that provides insurance to primary insurers, helping them mitigate risk by covering part of the losses from policies they issue.

retention limit: The maximum amount of risk that an insurance company is willing to retain on its own balance sheet before seeking reinsurance.

excess of loss reinsurance: A type of reinsurance that provides coverage for losses that exceed a specified amount, allowing insurers to protect themselves against high-severity events.