Large-Line Capacity Insurance

DEFINITION of 'Large-Line Capacity Insurance'

The maximum amount of liability that an insurer can take on in a single policy. Large-Line Capacity can also be refered to as insurance coverage that protects an insurer's ability to underwrite a large amount of risk under a single policy.

BREAKING DOWN 'Large-Line Capacity Insurance'

When an insurance company underwrites a new policy, it agrees to indemnify the policyholder from a specific peril. It receives a premium in exchange for this service. The total amount of liabilities that the insurer is able to take on through its underwriting activities is referred to as its capacity. As the insurer underwrites new policies its liabilities increase, thus reducing its available capacity. Once the insurer has reached its capacity limit, it is no longer able to underwrite new policies.

The policies that insurers underwrite are most commonly associated with relatively small amounts of risk. For example, a homeowners’ insurance policy is unlikely to exceed several million dollars. In some cases, however, an insurer may want to provide a large amount of coverage in a single policy. This type of coverage is referred to as large line coverage. Because of the significant amount of liability associated with such a large line, insurers face a different set of risks than when they underwrite smaller policies.

State insurance regulators generally limit the number of large line policies that an insurance company can underwrite. This is because an event considered infrequent but severe, such as a catastrophic flood, is more likely to lead an insurer to insolvency if the insurer’s capacity is dominated by large line policies. The amount of large line coverage that an insurer is able to underwrite is typically calculated as a percentage of the insurer’s surplus.

One of the ways that an insurer can free up capacity is through reinsurance. In a reinsurance contract, the insurer cedes a portion of its liabilities to a reinsurer in exchange for a portion of the premium’s that the insurer collects. The type of reinsurance contract that an insurer pursues depends on its approach to large line capacity. A facultative reinsurance contract will allow the insurer to cede a particular risk, such as the risk associated with a large line policy. Facultative reinsurance is a more transactional approach, since it does not require the reinsurer to automatically accept additional risks, as is the case with treaty reinsurance.

The facultative reinsurance contract may be proportional or non-proportional. In a proportional contract, the insurer and reinsurer share both the premium and loss according to a predefined ratio. In a non-proportional contract, the insurer retains a portion of both the liability and risk, and the reinsurer covers losses that exceed what the insurer retains (up to a limit).