What is Surplus Share Treaty
A surplus share treaty is a reinsurance treaty in which the ceding insurer retains a fixed amount of policy liability and the reinsurer takes responsibility for what remains. Surplus share treaties are considered pro-rata treaties and are most commonly used with property insurance.
BREAKING DOWN Surplus Share Treaty
An insurance company typically considers a surplus share treaty when it underwrites a new policy. In writing new policies, the insurance company agrees to indemnify the policyholder up to a specific coverage limit, and in exchange, it receives a premium. In order to reduce its overall liabilities and free up capacity to underwrite new policies, an insurer may cede some of its risks (and premiums) to a reinsurer. How much risk the reinsurer accepts, and under what conditions, is outlined in the reinsurance treaty.
In a surplus share treaty, the ceding insurer retains liabilities up to a specific amount, called a line, with any remaining liability being ceded to the reinsurer. The reinsurer, thus, does not participate in all risks and instead participates in only the risks above what the insurer has retained, making this type of reinsurance different from quota-share reinsurance. The total amount of risk that a reinsurance treaty covers, called the capacity, is typically expressed in terms of a multiple of the insurer’s lines.
Surplus treaties typically have enough capacity to cover multiple lines, but in some cases, the entire amount to be insured cannot be covered under a single reinsurance agreement. If this occurs, the ceding insurer either has to cover the remaining amount itself or enter into a second reinsurance treaty. This can be accomplished by taking out a second (or third) surplus treaty.
For example, consider a property insurance company that underwrites policies with a coverage of $500,000 and wishes to retain $100,000 of liabilities as its line. The remaining $400,000 in liabilities are ceded to the reinsurer. The $400,000 represents the amount covered under the surplus share treaty.
Benefits of Reinsurance
By covering itself against excessive losses, surplus treaty reinsurance gives the ceding insurer more security for its equity and solvency and more stability when unusual or major events occur. Reinsurance also allows an insurer to underwrite policies that cover a larger volume of risks without excessively raising the costs of covering their solvency margins or "the amount by which the assets of the insurance company, at fair values, are considered to exceed its liabilities and other comparable commitments." In fact, reinsurance makes substantial liquid assets available for insurers in case of exceptional losses.