Reinsurance Treaty Structures: Quota Share, Excess of Loss, and Aggregate Stop-Loss

Reinsurance treaty design is the architecture through which a primary carrier transforms its gross risk position into its net retained position after cession. The choice of treaty structure — proportional quota share versus non-proportional excess of loss, per-risk versus catastrophe, per-occurrence versus aggregate — determines how different types of losses are shared between the cedent and the reinsurer, what premium the cedent pays for the protection, and what net risk the cedent retains after all treaties respond. Most carriers operate with multiple treaties in combination — a quota share for capacity support, a per-risk XL for large individual risk protection, a catastrophe XL for event aggregation protection, and sometimes an aggregate stop-loss for overall annual performance protection.

Proportional Treaties: Quota Share and Surplus Share

Proportional (pro rata) treaties are characterized by a defined percentage split of both premiums and losses between the cedent and the reinsurer from the first dollar of every loss. The two primary proportional structures are quota share and surplus share.

Definition — Ceding Commission: The reinsurer’s payment to the cedent under a proportional treaty, expressed as a percentage of the ceded premium. The ceding commission compensates the cedent for the acquisition costs (agent/broker commissions, premium taxes) and overhead expenses associated with generating the ceded business. A ceding commission of 30% on a 40% quota share means the reinsurer, after receiving 40% of gross premium, returns 30% of that ceded premium to the cedent as commission — so the reinsurer’s net retained premium is 40% × (1 − 30%) = 28% of gross premium. Sliding scale ceding commissions adjust the commission percentage based on actual loss experience — higher commissions when actual loss ratios are favorable, lower when adverse — aligning incentives and reducing moral hazard.

A surplus share treaty is a more flexible proportional structure in which the cession percentage varies by the size of each risk. The cedent establishes a “line” — the maximum amount it will retain on any single risk (e.g., $500,000). For risks whose total sum insured (TIV) exceeds the line, the excess above the line is ceded to the reinsurer in proportion to how many “lines” the TIV exceeds the retained line. A $2M TIV risk with a $500K cedent line results in cession of $1.5M (3 lines) out of $2M = 75% to the reinsurer. This structure automatically adjusts the cession percentage to the risk’s size — small risks below the line are retained 100%; large risks are ceded proportionally. Surplus share treaties are common in commercial property lines where risk sizes vary widely.

Non-Proportional Treaties: Per-Risk and Catastrophe XL

Non-proportional (excess of loss) treaties provide coverage only when losses exceed a specified retention — the reinsurer pays nothing on losses below the retention, and pays the excess above the retention up to the treaty limit. The cedent retains the full premium (minus the reinsurance premium paid to the XL reinsurer) but absorbs all losses below the retention.

Per-risk excess of loss (per-risk XL) protects against large individual risk losses. Structure: “[limit] xs [retention] per risk” — e.g., “$4M xs $1M per risk” means the reinsurer pays the portion of any single risk loss between $1M and $5M. The cedent retains all losses below $1M and all losses above $5M (unless additional XL layers are purchased). Per-risk XL is appropriate for portfolios with individual TIV concentrations that could produce single-risk losses above the cedent’s comfortable retention — commercial property, marine cargo, large residential risks.

Catastrophe excess of loss (cat XL) protects against the aggregate accumulation of losses from a single catastrophe event across multiple policies. Structure: “[limit] xs [retention] per occurrence” — the retention and limit apply to the net loss from a single defined occurrence (typically defined as losses arising within 168 hours from the same cause). Reinstatements allow the treaty to respond to multiple events in the same policy year — the first reinstatement restores the full treaty limit after exhaustion, at an additional premium (typically 100% of the pro rata original premium). Without reinstatement, a single catastrophe event exhausting the treaty leaves the cedent exposed to the next catastrophe event in the same year.

Aggregate Treaties and Stop-Loss Structures

Aggregate excess of loss treaties aggregate losses across multiple events or across the entire portfolio, providing protection only when cumulative losses exceed the aggregate retention. Catastrophe aggregate XL aggregates the cedent’s net retained losses from multiple catastrophe events — protecting against a year with several mid-sized catastrophe events, each below the per-occurrence cat XL attachment, that collectively produce significant aggregate losses. This structure has become particularly relevant in recent years as “secondary peril” losses — severe convective storms, winter storms, wildfires, floods not meeting the cat XL per-occurrence threshold — have produced high aggregate losses that per-occurrence cat XL does not protect against.

Aggregate stop-loss treaties apply to the entire portfolio (all lines, all perils) on an annual aggregate basis — the reinsurer begins paying when the cedent’s total annual loss ratio exceeds the specified aggregate retention (e.g., 75% of earned premium), up to the treaty limit. Stop-loss provides the most comprehensive protection against adverse annual results but is expensive because it requires the reinsurer to accept the full spectrum of attritional loss risk, not just catastrophe event risk. For the relationship between reinsurance structure and catastrophe portfolio management, see Catastrophe Portfolio Management: Accumulation Control, PML Management, and Reinsurance Design.

Frequently Asked Questions