Excess of loss reinsurance helps insurance companies protect themselves from very large losses by sharing claims above a set amount.
Insurance companies don’t just sell insurance — they also buy insurance for themselves. This may sound surprising, but it’s a key part of how the insurance industry stays stable. One important way insurers protect themselves is through excess of loss reinsurance.
In simple terms, excess of loss reinsurance is a loss-sharing arrangement. The insurance company agrees to pay claims up to a certain limit, and the reinsurance company steps in to pay anything above that amount.
How Excess of Loss Reinsurance Works
Think of excess of loss reinsurance as a financial safety valve for insurers. The insurer keeps responsibility for “normal” claims, but very large losses are shared with a reinsurer.
Here’s a simple example:
An insurance company agrees to cover claims up to $1 million for a single event. If a claim comes in at $700,000, the insurer pays the full amount. But if a claim reaches $2 million, the insurer pays the first $1 million, and the reinsurance company pays the remaining $1 million.
That preset limit is often called the retention. Everything above it is covered by the reinsurer.
Why Insurance Companies Use Excess of Loss Reinsurance
Large and unexpected claims can seriously damage an insurance company’s finances. Excess of loss reinsurance helps prevent that by limiting how much the insurer must pay on any one loss or group of losses.
Insurance companies use this type of reinsurance to:
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Protect against catastrophic losses
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Stabilize financial results year to year
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Increase their ability to write more policies
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Meet regulatory capital requirements
Without reinsurance, insurers would have to charge much higher premiums or limit coverage options.
Real-Life Example of Excess of Loss Reinsurance
Imagine an insurance company that provides homeowners insurance in an area prone to hurricanes. Most claims are small, but a major storm could cause massive damage.
If a hurricane causes $50 million in claims from one event, paying all of that alone could threaten the company’s survival. With excess of loss reinsurance in place, the insurer might only be responsible for the first portion of the loss, with the reinsurer covering the rest.
This allows insurance companies to continue operating even after major disasters.
Types of Excess of Loss Reinsurance
Excess of loss reinsurance can be structured in different ways depending on the risk being insured:
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Per risk: Covers losses from a single policy or insured risk
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Per event (or catastrophe): Covers losses from a single event, such as a storm or earthquake
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Aggregate: Covers total losses over a specific time period once they exceed a set amount
Each type helps manage different kinds of financial exposure.
Who Is Involved in Excess of Loss Reinsurance?
There are two main parties:
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The insurer (ceding company): Sells insurance to customers and pays claims up to the agreed limit
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The reinsurer: Takes on the portion of losses that exceed the insurer’s retention
Policyholders don’t deal directly with the reinsurer. For customers, the insurance company remains fully responsible for paying claims.
How Excess of Loss Reinsurance Benefits Policyholders
Even though customers don’t see reinsurance directly, they benefit from it. Excess of loss reinsurance helps insurers remain financially strong and reliable, even after major losses.
That means:
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Claims are more likely to be paid
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Insurance coverage remains available and affordable
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Insurance companies are more resilient during crises
In short, reinsurance helps keep the insurance system working smoothly.
Final Thoughts
Excess of loss reinsurance is a critical tool that helps insurance companies manage large and unpredictable losses. By sharing claims above a set amount with a reinsurance company, insurers protect their finances and ensure long-term stability.
While most policyholders never notice it, excess of loss reinsurance plays a behind-the-scenes role in keeping insurance companies strong — and keeping coverage available when people need it most.
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