STOP LOSS REINSURANCE - An overview (2024)

STOP LOSS REINSURANCE

The risk excess of loss enables a company to limit its exposure from any one loss. The catastrophic excess of loss provides protection against aggregate losses from a single event. The stop loss reinsurance indemnifies the insurer against aggregation of losses during a period of time. I always felt that stop loss contracts are technically more difficult to underwrite and understand. This type of reinsurance limits the aggregate amount of loss the reinsured would suffer on a given class of business in a given period, usually in an annual period, over and above the pre-agreed deductible. Claims occur and are settled throughout the contract period. If the line of business covered is a long tail, then the settlement of claims takes time and arriving at the net ultimate loss ratio also has to wait. Under such contracts, provision for commutation of outstanding losses is usually present.

The insuring clause of a Stop Loss contract will set out the deductible, which is the attachment point at which reinsurers’ liability in respect of the aggregate losses attaches. It will also provide the limit of reinsurers’ liability for losses exceeding the deductible.

To understand it more easily let us take an individual health portfolio covering pandemic or any legionnaires disease. The sum insured of each individual policy cannot be covered under a risk excess of loss as the company needs to keep a very low deductible, making the cover meaningless, cumbersome, and expensive. It also cannot be covered by an Event (Cat) Excess loss cover, as cases happening at different points of time at different places cannot be linked to a single event. In order to protect the portfolio, Stop Loss is the only viable option. But for this protection, the company may be imperiled due to an unforeseen rise in claims from a pandemic situation, which may affect the bottom line adversely in that particular year.

Now let us see the operation of a Stop Loss Reinsurance Contract

The cover is normally expressed in percentage terms. In the event of reinsured’s net loss ratio in a given year exceeds the pre-agreed percentage, then the stop loss reinsurers pay the excess loss over and above the deductible up to an agreed percentage, beyond which again the losses fall back on the reassured. Stop loss reinsurance applies to the loss ratio of the reinsured for any one class of business.

The net loss ratio is arrived at by applying the percentage on the net written premiums. The net premium income is arrived at after deduction of all other reinsurances, namely, treaty reinsurances, facultative reinsurances, and any other excess of loss reinsurances both premiums paid, and claims recovered. These reinsurances ‘inure to the benefit’ of stop loss reinsurers’. This is because the premiums paid on the other contracts and also the claims recovered go to reduce the net premium and net loss to arrive at the ultimate net loss ratio for stop loss reinsurance. However, any minimum / deposit premium for the stop loss cover shall not be deducted as it does not inure to the benefit of stop loss reinsurers.

Like in the case of any other excess of loss reinsurance, in stop loss contract also a minimum/deposit premium is paid in advance, which will be adjusted after the expiry of the contract.

Example 1

Imagine ABC insurer has taken a stop loss cover to protect its health portfolio with XYZ reinsurers. ABC insurer agrees to bear aggregate loss up to 80% and the XYZ reinsurers agreed to bear 90% of excess of loss ratio over 80% subject to maximum loss ratio of 150%. Let us take few scenarios as under:

From the above table one can understand that the reinsurer’s liability is restricted to 90% of the loss ratio in excess of 80% of the loss ratio up to a maximum of 150% loss ratio.

Example 2

Instead of percentage if the limits are expressed in monetary terms as fixed amounts, then the cover is known as ‘aggregate excess of loss’.

Imagine ABC insurer has taken a stop loss cover to protect its home portfolio with XYZ reinsurers.

The home portfolio is protected as under:

(i)Original Gross Premium ₹1,00,00,000

(ii)60% QS with maximum gross acceptance of ₹2,00,000

(iii)Cat cover ₹10,00,000 Xs ₹300,000

(iv)The adjustment rate for Cat cover is say 7%.

(v)The company decides to buy stop loss cover of 50% of retained premium in excess of 100% of retained premium.

(vi)Two scenarios are considered with retained loss after all the prior reinsurance recoveries amounting to ₹50,00,000 and ₹70,00,000. Two scenarios have been worked out as under:

Stop Loss Reinsurance can be written either on a loss occurring basis or on a risk attaching basis. In the former case it is simple and straightforward. In the latter case, the results will not be known until all claims arising from the risks attached are settled.

In a nutshell, I would say, stop-loss reinsurance provides a safety net for insurance companies, as it limits their exposure to losses to a desirable level and transfers some of the losses to reinsurers. This way, in a portfolio where large number of small claims may aggregate to exceed the intended level of retention, it helps the reinsurers to manage their portfolio more effectively.