Reinsurance: Quota Share and Excess of Loss
The two basic ways an insurer can pass part of its risk to a reinsurer — sharing every claim proportionally, or handing off only the losses above a threshold — and why the choice changes what kind of risk the insurer keeps.
Prerequisites: How an Insurance Balance Sheet Works
An insurer that writes a lot of policy exposure in one place — homes along a hurricane-prone coastline, say — doesn't just carry all of that risk itself. It buys reinsurance: insurance for insurers, where a reinsurer agrees to cover part of the primary insurer's claims in exchange for a share of the premium. The two most common structures, quota share and excess of loss, transfer risk in fundamentally different shapes, and picking between them changes what kind of risk the insurer actually keeps on its own books.
Two ways to split the risk
Quota share is the simpler structure: the reinsurer takes a fixed percentage of every policy's premiums and, in return, pays that same fixed percentage of every claim, large or small. If an insurer cedes a 30% quota share, the reinsurer collects 30% of all premium and pays 30% of every single claim, from the smallest fender-bender to the largest catastrophe — proportional sharing across the board, with no threshold involved. This mainly helps an insurer that needs to write more business than its own capital comfortably supports, by handing off a proportional slice of both premium and risk.
Excess of loss works differently: the insurer keeps all claims up to a set threshold (the retention or attachment point) entirely on its own books, and the reinsurer only pays the portion of a claim above that threshold, often up to some cap. If an insurer buys excess-of-loss cover with a $5 million attachment and a $50 million limit, a $2 million claim is paid entirely by the insurer, while a $20 million claim leaves the insurer paying the first $5 million and the reinsurer paying the remaining $15 million. This structure targets tail risk specifically — the insurer is comfortable absorbing ordinary-sized losses itself and only wants protection against the rare, severe event that could otherwise threaten its solvency.
What this means in practice
Insurers typically combine both: quota share to manage overall capacity and volume, excess-of-loss layers stacked on top to cap the damage from a single catastrophic event. The choice of structure shows up directly in an insurer's combined ratio and capital requirements — a heavily reinsured book looks smoother and less capital-intensive, but a meaningful share of the underwriting profit (or loss) has already been handed to the reinsurer along with the risk.
Quota share cedes a fixed proportion of every premium and claim regardless of size; excess of loss instead caps the insurer's own exposure at a set attachment point and passes only the tail above it to the reinsurer — the first spreads risk broadly, the second targets catastrophic-size losses specifically.
A fast way to tell the two apart from an insurer's disclosures: quota share ceded losses move in lockstep with ceded premium as a fixed ratio; excess-of-loss recoveries are lumpy and appear only in years with a large individual loss or catastrophe crossing the attachment point.
Further reading
- Society of Actuaries, Reinsurance Fundamentals Study Note