What is Aggregate Extension Clause (AEC)
An aggregate extension clause (AEC) is a reinsurance contract clause that combines separate accidents or occurrences into an aggregate loss amount. An aggregate extension clause, or AEC, is used more than loss reinsurance treaties.
BREAKING DOWN Aggregate Extension Clause (AEC)
Insurance companies use reinsurance treaties to protect themselves from potential losses from underwritten insurance contracts. Businesses use reinsurance treaties to protect themselves from liability claims. The underwritten policies are the underlying policies in the reinsurance treaty. A specific type of reinsurance treaty called an excess of loss reinsurance treaty protects against the possibility that an insurer will experience severe losses.
Aggregate Extension Clause Function
An aggregate extension clause shifts the reinsurance coverage to an aggregate basis when the underlying insurance policies also handle losses in aggregate. The clause aligns how the insurer and the reinsurer contracts treat losses. The clause is so standard in reinsurance treaties that it has standardized wording.
For example, a manufacturer produces hundreds of thousands of boxes of frozen meals each year. They know that each meal made carries a small liability risk due to packaging defects. The expectation is that some claims will happen each year, so the manufacturer buys a product liability policy to protect against the loss from claims. The liability policy protects the manufacturer from losses above a specific limit on an aggregate basis rather than on a per occurrence basis. The underwriter to the liability policy, in turn, buys an excess of loss reinsurance policy with an aggregate extension clause to protect itself from paying the manufacturer if the amount of claims exceeds the underlying policy's retention limit.
Excess of Loss Reinsurance
Excess of loss reinsurance provides coverage for individual losses exceeding a specific loss retention amount. Losses below the loss retention amount are the responsibility of the ceding company or the company that bought the excess loss reinsurance. However, losses above the retention amount are the responsibility of the reinsurer. The reinsurer limits its risk with caps written into the contract at a specific limit.
Excess of loss reinsurance treaties work well when the underlying insurance contract deals with losses on a per occurrence basis. When the underlying insurance contract deals with losses in aggregate, excess of loss reinsurance treaties encounter problems. Reinsurance is designed to provide coverage for losses above the ceding company's retention on a per occurrence basis. Reinsuring against aggregate losses is complicated since the per occurrence loss is typically lower than the ceding company's retention level. The reinsurance contract may add an aggregate extensions clause (AEC) to deal with losses in aggregate.