What Are Excess Limits Premiums?

The excess limits premium of an insurance policy agreement is the amount paid for coverage beyond the basic liability limits outlined in the policy agreement. The term is most commonly found in casualty reinsurance contracts.

Key Takeaways

  • An excess limits premium is the amount paid for coverage beyond the basic liability limits in an insurance contract.
  • If there's a possibility that losses incurred will exceed the amount of basic coverage, the insured may use an excess coverage rider, which only triggers during incidents of high damage.
  • Excess limits premiums are most prevalent in casualty reinsurance contracts, functioning to reimburse the ceding insurer for a loss beyond a pre-determined holding level.
  • This arrangement protects the original ceding company from risks that have the potential to place it into financial distress, such as a hurricane or flood.

Understanding Excess Limits Premiums

In an insurance contract, the insured party purchases a predefined amount of coverage against a specific type of risk from the insurer. Once the policyholder reaches the coverage limit, the insurer is no longer responsible for covering losses.

Coverage limitations can create a scenario in which the loss from a risk exceeds the amount of coverage. The result is the insured potentially has to cover a significant portion of the remaining losses out-of-pocket.

A party purchasing a casualty policy—a broad category of coverage against loss of property, damage, or other liabilities—must balance the amount of coverage desired with the premium amount they are willing to pay. The higher the coverage limits are in the policy, the higher the premiums will be. Premiums are the specified amount of payment required periodically by an insurer to provide coverage under a given insurance plan.

Important

Excess insurance provides additional coverage, sometimes courtesy of another insurer, ensuring that claims that would otherwise have not been reimbursed—due to inadequate limits on the original primary policy—will be paid out.

If the policyholder should never file a claim close to the coverage limit, then they are likely over-insured. The policyholder could, therefore, consider reducing the amount of coverage in order to pay less premium and realize some cost savings. In cases where there is still the possibility that losses may exceed the amount of basic coverage, the insured may use an excess coverage rider, which only triggers during incidents of high damage.

Calculating Excess Limits Premiums

The calculation of premiums for excess limits coverage is a factor of the premium paid for the basic coverage. Excess coverage limits are issued in tranches, or portions, with a pre-determined factor assigned to each level. Typically, the factor increases as the excess limit tranche increases.

For example, an engineering company holds a casualty insurance policy with a basic coverage limit of $1 million. The company purchases excess coverage for up to $5 million in damages.

The tranches of excess coverage are at $1 million increments. The engineering firm will pay 20 percent of the premium of their basic coverage for the first $1 million excess. Each section tranche increases with the $5 million excess-limit levels assessed at 50 percent of the base premium.

Special Considerations

Reinsurance Market

Excess limits premiums are most commonly found in reinsurance contracts. Reinsurance is a method for insurance providers to sell high-risk policies they hold to a secondary provider, thereby spreading the risk of loss from a catastrophic event.

Excess limit premiums are more specific to excess of loss reinsurance, rather than to pro rata reinsurance. The former is a type of reinsurance in which the reinsurer indemnifies the ceding company for losses that exceed a specified limit. The latter, on the other hand, is an agreement whereby the losses and premiums are shared between the reinsurer and the ceding company according to a fixed percentage.

Excess limits are used to reimburse the ceding insurer for a loss more than a pre-determined holding level. This arrangement protects the original ceding company from risks that have the potential to be severe and possibly place it into financial distress, like in the event of a hurricane or flood. 

The reinsurer will evaluate the possible risk to determine the cost of the excess limits coverage. If the reinsurer estimates a low-loss probability, the more economical an excess limits premiums approach may be for the ceding company.