DEFINITION of Combination Plan Reinsurance
Combination plan reinsurance is a form of reinsurance in which the reinsurer indemnifies the ceding company of losses in excess of a specific amount, and will also indemnify the ceding company for a fixed percentage of remaining losses after deducting any excess recoveries. Combination plan reinsurance combines features of pro rata insurance (quota share) and excess of loss coverage.
BREAKING DOWN Combination Plan Reinsurance
Businesses that use reinsurance companies to reduce risk exposure in exchange for a portion of premiums have several different options when it comes to how they share losses with the reinsurance company. Combination plan reinsurance combines pro rata insurance (sometimes called quota share) and excess of loss insurance, and is most frequently used when a company is switching from pro rata to excess of loss.
How Combination Plans Work
Reinsurance, also known as insurance for insurers or stop-loss insurance, is the practice of insurers transferring portions of risk portfolios to other parties by some form of agreement to reduce the likelihood of paying a large obligation resulting from an insurance claim. The party that diversifies its insurance portfolio is known as the ceding party. The party that accepts a portion of the potential obligation in exchange for a share of the insurance premium is known as the reinsurer.
Pro rata insurance is a form of proportional reinsurance in which the reinsurer shares losses in proportion to the percentage of premiums that it receives for its activities. For example, the reinsurance company may share 30 percent of the risk if it receives 30 percent of the premiums associated with the risks that it is covering.
Excess of loss reinsurance protects the ceding company up to a specified limit of loss. For example, an insurance company may issue a liability policy of $500,000, and plans on keeping $200,000 worth of the risk on its books. It then purchases a reinsurance policy that covers any risk in excess of $200,000 (up to the total of $500,000). If a loss occurs, the insurance company pays the first $200,000, and the reinsurance company will pay anything above $200,000 up to the maximum of $500,000.
Combination plan reinsurance uses the excess of loss feature to protect the ceding company up to a limit, while the pro rata feature limits any of the remaining losses to the portion of the premium that was not ceded to the reinsurance company. The amount of excess recoveries is deducted before the ceding company is indemnified of the final loss.