What is Aggregate Excess of Loss Reinsurance?
Aggregate excess of loss reinsurance is insurance that insurance companies buy. It protects them from losing too much money in a year if many people and businesses they insure have claims that cost the company a lot.
How Regular Insurance Works
We first need to understand how regular insurance works to understand aggregate excess of loss reinsurance. When you buy insurance, such as for your car or house, you pay the insurance company a certain amount each month or year. This is called your premium.
If something wrong happens that is covered by your insurance, like a car crash or house fire, the insurance company will pay you to help fix the damage or replace what was lost. When the insurance company pays out money, it’s called a claim.
The Problem of Too Many Claims
Insurance companies make money by collecting more in premiums than they pay in claims. But sometimes, a lot of bad things can happen in one year. Maybe there are a bunch of big hurricanes or wildfires that damage many homes that the insurance company covers.
When this happens, the insurance company might have to pay more money in claims than it collected in premiums. This could cause the insurance company to lose money or even go bankrupt. That’s a big problem because those who bought insurance from that company might not get the payments they expected if they had a claim.
How Reinsurance Helps
This is where reinsurance comes in. Reinsurance is insurance for insurance companies. The regular insurance company, the primary insurer, buys a reinsurance policy from another company called the reinsurer.
There are different types of reinsurance. One common type is called excess loss reinsurance. With this type, the primary insurer is responsible for paying up to a certain amount of all the claims. If the claims exceed that amount, the reinsurer pays the extra amount up to a specific limit.
Aggregate Excess of Loss Reinsurance
Aggregate excess of loss reinsurance is a specific type of excess of loss reinsurance. The key word here is “aggregate.” This means it looks at the total or combined amount of all the claims in a year rather than just one big claim.
Here’s how it works:
- The primary insurer and the reinsurer agree on a threshold amount. This is the total amount of claims the primary insurer is responsible for in a year.
- They also agree on a limit, the maximum amount the reinsurer will pay out over and above the threshold.
- If the total number of claims in a year exceeds the threshold, the reinsurer will pay the amount of claims above the threshold up to the limit.
For example, the threshold is $10 million, and the limit is $5 million. Suppose the primary insurer has $12 million in total claims that year; the reinsurer would pay $2 million (the amount over the $10 million threshold). However, if the primary insurer has $18 million in claims, the reinsurer would pay $5 million (the limit).
Why It’s Important
Aggregate excess of loss reinsurance is essential because it helps protect primary insurers from years with many claims, even if the dual claim isn’t huge. It spreads the risk and helps ensure the primary insurer can continue operating and paying claims, even in a bad year.
Without reinsurance, many primary insurers couldn’t offer as much coverage or charge much higher premiums to account for the risk of an awful year. Reinsurance helps keep insurance available and affordable for regular people and businesses.
How the Cost is Determined
The cost of aggregate excess of loss reinsurance, which is the premium that the primary insurer pays to the reinsurer, depends on a few factors:
- The threshold and limit amounts. A lower threshold or higher limit means more risk for the reinsurer, which raises the premium.
- The types of risks the primary insurer covers. For example, if they insure many properties in hurricane or wildfire zones, the reinsurance will be more expensive.
- The primary insurer’s history of claims. If they’ve had a lot of big claims in the past, the reinsurer will charge more.
The reinsurer uses complex mathematical models to determine the proper premium to charge based on all these factors.
The Reinsurance Market
There’s a whole market for reinsurance, with many different reinsurance companies specializing in various types of risks. Some of the biggest reinsurers are companies you may have heard of, like Munich Re, Swiss Re, and Berkshire Hathaway.
Reinsurers often buy reinsurance, too, which is called retrocession. This further spreads out the risk. The reinsurance market is global, with reinsurers taking on risks from primary insurers worldwide.
