Facultative and Treaty Reinsurance contracts can be designed utilizing pro-rata or excess of loss provisions.
Pro Rate Reinsurance: The primary insurer cedes a predetermined percentage of the risk to the reinsurer. The reinsurer shares in the losses proportional to the premiums and limits reinsured. Two major types of pro rata reinsurance are: quota share and surplus share.
• Quota share agreements require the primary insurer to cede a certain percentage of every risk within the agreement to the reinsurer (paying a proportional premium). In return, the reinsurer agrees to indemnify losses suffered by the ceding company in the same proportion. If the reinsurer agrees to reinsure 35 percent of the risk (accepting a proportional premium for that agreement); they pay 35 percent of any losses; and
• Surplus share agreements allow the primary insurer to cede a certain percentage of liabilities exceeding a pre-determined retention. The ceded amount can vary from risk to risk. Premiums and losses are received and paid by the reinsurer in the same proportion.
Excess of Loss Reinsurance: The reinsurer agrees to indemnify the primary insurer for all losses exceeding a specified retention either on a per loss basis or an aggregate loss basis. Catastrophe reinsurance, per risk reinsurance, per occurrence reinsurance and aggregate excess of loss reinsurance are all categories of excess of loss reinsurance.
• Catastrophe reinsurance contracts indemnify the ceding company for all losses in excess of a specified amount resulting from a single catastrophic event;
• Per risk reinsurance contracts apply to individual risks (most likely part of a facultative agreement) whereby the reinsurer agrees to assume losses over a pre-determined amount. The primary insurer pays all losses up to that point.
• Per occurrence reinsurance are similar to catastrophe reinsurance.
• Aggregate excess of loss reinsurance agreements stipulate that the reinsurer will pay ALL primary insurer losses that exceed a specified retention during the contract period. For example, the primary insurer contracts with the reinsurer to insure aggregate losses exceeding $500 million in the period. The primary insurer is indemnified for all loss payments above that amount (subject to the policy premium).