What Is Aggregate Stop-Loss Reinsurance?
- To ensure that insurance companies remain solvent and are able to cover their claims, many regulators require insurance companies to reduce their potential liability.
- In aggregate stop-loss reinsurance, losses over a specified amount during the contract period are covered by the reinsurer and not by the original insurer or ceding company.
- Aggregate stop-loss reinsurance caps the aggregate amount of losses for which a ceding company is responsible for at the attachment point.
- Aggregate stop-loss reinsurance attachment points are calculated from factors that influence the loss experience, policyholders' risk profiles, and demographic trends.
Understanding Aggregate Stop-Loss Reinsurance
When an insurance company underwrites a new policy, in exchange for a premium, it accepts the risk that a policyholder may file claims. State regulators limit the amount of risk that an insurer can take on and require insurance companies to set aside a loss reserve to cover potential claims.
One way that insurers can reduce their overall risk is to work with reinsurers. In exchange for a fee, reinsurers will accept the risk ceded to them by the insurer. Reinsurance is insurance for insurance companies.
Aggregate stop-loss reinsurance caps the aggregate amount of losses for which a ceding company is responsible. In essence, this is a way for an insurance company to protect itself against too many unexpected losses. This cap, called the attachment point, only applies when the value of claims occurrences reaches the attachment point. Once losses go above the attachment point, then the reinsurance company is responsible for losses.
Consider the example of an insurance company entering into an aggregate stop-loss reinsurance contract with a reinsurance company. The contract indicates that the insurance company is responsible for losses up to $500,000, while the reinsurance company is responsible for anything above that limit. If the claims total $750,000, the reinsurer would be responsible for $250,000.
Aggregate Stop-Loss Reinsurance Contracts
Reinsurance contracts often have language that limits the amount for which a reinsurer will be responsible. This may be a fixed amount or percentage of losses. The attachment point is determined by factors that influence the loss experience, such as how many losses have been incurred over a specific period, the risk profile of policyholders, and demographic trends.
The attachment point is most often determined by a process of financial modeling. Like most models run in the insurance company, ones used for calculating the attachment point for aggregate stop-loss reinsurance contracts will use historical data and predictive analysis.
Criticisms of Aggregate Stop-Loss Reinsurance
Aggregate stop-loss reinsurance contracts can be risky propositions for reinsurance companies, as it requires them to cover all losses over a certain amount. If an insurance company experiences a sharp increase in the severity of claims, such as from a catastrophe, the reinsurer could potentially cover many losses on its own, which could lead to insolvency.
Because of this risk, reinsurers typically charge a high fee for this type of coverage and are likely to set the attachment point at a multiple over an insurance company's typical loss experience. Sometimes, reinsurers will require some form of co-participation by the reinsured to be applied to the reinsurer's limit. In such a case, the reinsurance may only cover 90% to 95% of the excess loss.