The other type of reinsurance is where the ceding company retains the responsibility for all the losses below a fixed dollar amount and the reinsurers have the responsibility for losses that are in excess of this level up to some higher agreed amount. The fixed amount that is the responsibility of the ceding company is called its retention. This type of reinsurance is called excess reinsurance. It is fairly easy to administer. The reinsurers develop a rate that is applied to all the premiums for the business that the treaty covers. In return, the reinsurers will pay for the portion of the losses that exceed the ceding company’s retention up to the limit of the treaty. The way in which excess reinsurance applies to losses is similar to an individual’s homeowners policy. A homeowner policy has a deductible and any losses below the deductible are the responsibility of the individual and the amount of the loss that is in excess of the this deductible up to the policy limits is the responsibility of the insurance company.

As is frequently the case when something seems very easy and straightforward, there always seems to be a “but” that needs to be injected somewhere. The “but” here comes in developing the rate. I won’t spend any time in today’s post talking about developing rates. I just ask you to think about the law of large numbers and inflation and how they might apply to this type of agreement.