Excess of Loss Reinsurance

What is Excess of Loss Reinsurance?

Excess of loss (XL) reinsurance is a non-proportional reinsurance structure in which the reinsurer's liability is triggered only when a loss exceeds the cedant's agreed retention. The cedant absorbs losses up to the retention in full and the reinsurer pays the amount above that threshold, up to the reinsurer's agreed limit. For example, on a "£500,000 xs £250,000" layer, the cedant retains the first £250,000 of any loss and the reinsurer pays up to a further £500,000, capping the cedant's net exposure per event at £250,000 for losses within that range.

Unlike proportional reinsurance, there is no sharing of premium in direct proportion to losses. The cedant pays a reinsurance premium (typically calculated as a rate on line — the premium as a percentage of the layer limit) and recovers only if losses exceed the retention. This means XL protection is purely about protecting the cedant against large or catastrophic individual losses, not about smoothing the overall loss ratio on high-frequency, low-severity business.

Types of Excess of Loss Structures

XL reinsurance is structured in several ways depending on what it is designed to protect. Risk XL (or per-risk XL) applies the retention and limit to individual insured risks — each occurrence on a single policy is evaluated independently. Catastrophe XL (Cat XL) applies to the aggregate of all losses arising from a single event (such as a hurricane or earthquake) across the entire portfolio, protecting against the accumulation of many simultaneous losses from one cause. Per-occurrence XL sits between these, applying to losses from a single occurrence that spans multiple policies.

Aggregate XL (or stop loss) is a further variant where the retention is applied to the cedant's total losses for the year, and the reinsurer pays the excess over that annual aggregate. This structure protects against an accumulation of attritional losses that are individually modest but collectively damaging — a risk that per-risk or Cat XL does not address.

Pricing and Actuarial Considerations

XL reinsurance pricing is actuarially complex. The reinsurer must estimate the probability that losses will pierce the retention at all and, given that they do, estimate the expected severity above the retention. This requires detailed loss history from the cedant, exposure data, and catastrophe modelling where natural perils are involved. Rate on line (ROL) is the standard pricing metric, representing the premium as a percentage of the layer limit. A 10% ROL on a £1m xs £500k layer implies an annual premium of £100,000.

Reinstatement provisions are a standard feature of XL treaties: after a loss erodes the limit, the cedant can pay an additional premium (the reinstatement premium) to restore the full layer capacity. The number of reinstatements available is agreed in the treaty wording and directly affects the cost of protection in loss-heavy years.