Catastrophe Per Occurrence Excess of Loss Reinsurance

ByMunyaradzi Mafaro

Catastrophe Per Occurrence Excess of Loss (Cat XOL) is a type of reinsurance. Reinsurance is insurance for insurance companies. It protects them from really big losses.

With Cat XOL reinsurance, the insurance company is protected if a whole bunch of bad stuff happens all at once from the same event, like a hurricane or earthquake. The reinsurance company will pay for some of those losses so the insurance company doesn’t go broke trying to pay everyone’s claims.

How does it work?

The insurance company and reinsurance company make a deal. They agree on a few important things:

Attachment point

This is how much the insurance company has to pay in losses from one event before the reinsurance kicks in. It’s kind of like a deductible. Let’s say the attachment point is $20 million. The first $20 million in losses are the insurance company’s problem.

Limit

The limit is the most the reinsurance company will pay for any one event. If the limit is $100 million, that’s all they’ll pay, even if the total losses are more than that.

Premium

The insurance company has to pay the reinsurance company for this protection. That payment is called the premium. The riskier it is, the more they have to pay.

Term

The deal is for a set amount of time, usually one year. When that year is up, they have to make a new deal.

An example

Imagine Sunny State Insurance Co. sells a lot of homeowners insurance policies in Florida. Florida has hurricanes sometimes. Hurricanes can destroy a lot of houses really quickly.

Sunny State could have to pay a ton of money all at once if a big hurricane hits and a lot of their customers’ houses are damaged. They might go out of business!

To protect themselves, Sunny State buys Cat XOL reinsurance from ReInsure Ltd. They agree that:

  • The attachment point is $20 million
  • The limit is $100 million
  • The premium is $5 million
  • The term is one year

Three months later, Hurricane Wanda slams into Florida. Sunny State’s customers file claims totaling $80 million for the damage to their homes.

Here’s what happens:

  1. Sunny State pays the first $20 million. That’s the attachment point.
  2. ReInsure Ltd. pays the next $60 million.
  3. Sunny State doesn’t go out of business, even though a lot of bad stuff happened all at once.

If the losses had been $200 million, ReInsure Ltd. would still only pay $100 million. That’s the limit.

Why do insurance companies buy Cat XOL?

Insurance companies buy Cat XOL reinsurance because really bad stuff sometimes happens. When it does, they could owe a huge amount of money really fast.

Most insurance companies don’t keep that much cash lying around. They need it to protect them in case a whole lot of their customers have losses all at once from the same event.

Reinsurance spreads the risk around. The insurance company knows the most it will have to pay is the attachment point. The reinsurance company charges a premium that it thinks will be more than enough to cover any losses it has to pay.

Negotiating Cat XOL contracts

Insurance companies and reinsurance companies have to negotiate the terms of their Cat XOL deals. They might fight about:

The attachment point

The insurance company wants it to be as low as possible. The reinsurance company wants it to be higher.

The limit

The insurance company wants it to be really high. The reinsurance company doesn’t want to be on the hook for too much.

The premium

The insurance company wants to pay as little as possible. The reinsurance company wants to charge as much as it can.

They usually end up somewhere in the middle. The reinsurance company does a lot of math to figure out how likely it is that it will have to pay, and how much. That helps them set the premium.

The insurance company looks at how much reinsurance it needs and shops around for the best deal. It might buy reinsurance from more than one company.

The benefits of Cat XOL

Cat XOL reinsurance helps insurance companies in a few ways:

  1. They are less likely to go out of business from one really bad event.
  2. They can insure more people and charge lower premiums, because they know they have the reinsurance to back them up.
  3. They have a more stable bottom line from year to year, even if bad stuff happens.

Reinsurance companies like it because they can make money from the premiums without having to deal with a bunch of individual policyholders. They are spreading their risk over a lot of insurance companies in different places.

The drawbacks of Cat XOL

Cat XOL reinsurance isn’t perfect. Here are some potential problems:

  1. It’s complicated. There are a lot of details to negotiate and the contracts can be hard to understand.
  2. It’s expensive. Insurance companies have to pay a lot for the protection, and that cost gets passed on to the policyholders through higher premiums.
  3. It doesn’t cover everything. If the losses are more than the limit, the insurance company is on its own for the rest.
  4. The reinsurance company might go out of business. If that happens, the insurance company is out of luck.

Is Cat XOL the only kind of reinsurance?

No, there are other types of reinsurance too. Some common ones are:

Quota share

The insurance company agrees to give the reinsurance company a set percentage of all the premiums it collects. In return, the reinsurance company agrees to pay that same percentage of any losses.

Surplus share

It’s like quota share, but the percentage the reinsurance company gets depends on how much insurance the insurance company is selling.

Excess of loss

The reinsurance company agrees to pay any losses over a certain amount for an individual policy. It’s kind of like Cat XOL, but for one policy at a time instead of a bunch of policies all at once.

Insurance companies usually have more than one type of reinsurance. They try to build a program that protects them the best for the least cost.

Munyaradzi Mafaro is a music enthusiast and he also likes to tackle topics of business, productivity, and the possibilities for growth in the digital world.