Excess Limits Premium

DEFINITION of 'Excess Limits Premium'

The premium paid for coverage above the basic liability limits in an insurance contract. Excess limits premiums are most commonly found in casualty reinsurance contracts.

BREAKING DOWN 'Excess Limits Premium'

In an insurance contract, the insured party purchases a predefined amount of coverage against a specific type of risk from the insurer. This payment is called the premium. Once the coverage limit has been reached, the insurer is no longer responsible for covering losses. This can create a scenario in which the loss from a particular risk exceeds the coverage limit, which will result in the insured potentially having to cover a large portion of the remaining losses out of pocket.

A party that purchases a casualty policy has to balance the amount of coverage desired with the amount of premium it is willing to pay. The more coverage included in the policy, the higher the premiums will be. If the insured never files claims close to the coverage limit, then the insured is likely over-insured and could realize cost savings by reducing the amount of basic coverage. However, since there still is the possibility that losses may exceed the basic coverage limit, the insured may seek excess coverage that is only triggered at high loss levels. This excess loss coverage is paid for by the excess limits premium.

The excess limits premium is calculated as a factor of the premium paid for basic coverage. Excess limits are broken into tranches, with a pre-determined factor assigned to each tranche. Typically, the factor increases the higher the excess limit tranche is. For example, a casualty insurance policy with a basic coverage limit of $1 million may include excess limits of up to $5 million in increments of $1 million. At $1 million in excess limits, the factor used to determine the excess limits premium may be 0.2 of the basic premium, increasing to 0.5 at the $5 million excess limit level.

Excess limits premiums are most commonly found in reinsurance contracts, specifically excess of loss reinsurance rather than pro rata reinsurance. In this arrangement, the ceding insurer is indemnified of losses in excess of a pre-determined retention level. This type of arrangement protects ceding companies from risks that have severity potential, meaning that the loss from an occurrence could be very high compared to most claims. The excess limits premium for this coverage is based on the reinsurer’s evaluation of the risk being ceded, the premiums for basic coverage, and how the risk is priced and covered in the market. If the reinsurer estimates a low loss severity, the lower excess limits premiums may make this a more cost-effective approach to the ceding company than paying for a higher basic coverage limit.