What is 'Large-Line Capacity Insurance'

Large-line capacity insurance is a single policy that covers a potential for a large amount of loss. Often it is the maximum amount of liability an insurer can assume in a single policy. Large-line capacity is also insurance coverage that protects an insurer's ability to underwrite a large amount of risk under a single policy.

BREAKING DOWN 'Large-Line Capacity Insurance'

Underwritten policies are most commonly for relatively small amounts of risk. For example, homeowners insurance thresholds typically do not exceed several million dollars. Sometimes, however, an insurer may provide large-line coverage for a single policy. Underwriting more substantial policies introduce a different set of risks than do smaller policies.

When underwriting a new policy, the insurer agrees to indemnify the policyholder from a specific peril in exchange for a premium. An insurer's capacity is the maximum amount of liabilities it can assume through underwriting activities. Underwriting increases liabilities and reduces capacity. Once the insurer reaches its maximum capacity, it is prohibited from underwriting new policies.

State insurance regulators limit the number of large-line policies that an insurance company may underwrite. These limits are warranted because infrequent but severe events, such as catastrophic floods or hurricanes, are more likely to lead to insolvency when the majority of an insurer's policies are large-line policies. The maximum amount of large-line coverage that an insurer underwrites is typically calculated as a percent of the insurer’s surplus.

Reducing Large-Line Capacity Risk With Reinsurance

One way an insurer can reduce capacity is through reinsurance. In a reinsurance contract, the insurer cedes a portion of its liabilities to a reinsurer. The reinsurer accepts the risk in exchange for a share of the premiums collected on the policies. The type of reinsurance contract that an insurer pursues depends on its large-line capacity policy. A facultative reinsurance contract allows the insurer to cede a particular risk, like that associated with a large-line policy. Facultative reinsurance is a more transactional approach since it does not require the reinsurer to accept additional risks as it would with treaty reinsurance.

The facultative reinsurance contract may be proportional or non-proportional. In a proportional reinsurance contract, the insurer and reinsurer share both the premium and risk of loss according to a predefined ratio. In a non-proportional contract, the insurer retains a portion of both the liability and risk and the reinsurer covers losses, up to a limit, that exceed what the insurer has.

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