What Are Proportional and Non Proportional Reinsurance Policies?

A reinsurance policy is a formal agreement that an insurer offers to cover the liabilities of an insurance provider against a significant loss. A primary insurance agency incurs such losses when multiple high-volume claims reach them simultaneously.

For example, suppose a region suffered an earthquake resulting in loss of many lives. Incidentally, most of them had life insurance policies from a particular insurer. In that case, the liability will be huge for a single company. Instruments like proportional and non proportional reinsurance policies exist to encounter these critical situations.

Let us take a look at these two types of reinsurance policies.

When availed by an insurance company, a non proportional reinsurance policy guarantees coverage of liabilities only if the loss exceeds a specific figure. For this reason, these schemes are also referred to as “excess of loss” reinsurance plans. The limit amount or sum beyond which the reinsurer is liable to pay for the rest is called “priority” or “retention”.

These instruments are ideal for insurance companies striving to concentrate better on diversifying their portfolio by consolidating their capital position.

In continuation with the formal definition of a proportional reinsurance plan here are a few things that you must know to understand the significance of a proportional reinsurance policy.

In this type of coverage, a reinsurer shares loss with a ceding company in a particular proportion as mentioned in the contract. Also, as the reinsurer is susceptible to greater risk in these types of contracts, the ceding company shall pay a higher premium. Small insurance businesses opt for these proportional reinsurance schemes as they help them to accept more insurance policy seekers without worrying about running out of operational capital.

Assume an insurance company has signed a contract with a corporate firm where they have agreed to compensate for any notable structural damage to their office space. Locking such costly deals brings enormous risks for the insurer as they become susceptible to significant losses.

Now, suppose an insured building goes through major damages such as structural collapse, loss of functionality of permanent fixtures, etc. In that case, the insurers must refurbish such significant costs all by themselves.

These scenarios will force a company to compromise its solvency to a great extent. Hence, as a better alternative, they can sign a proportional reinsurance contract, where the reinsurer may agree to pay for a greater chunk, say 60% of the losses. Then the primary insurance firm can provide the rest of the money without disturbing their finances.

In a non proportional reinsurance contract, the reinsurer promises to pay for 100% of a ceding company's liabilities if losses exceed a predefined limit. Sometimes reinsurers even agree to pay for losses that take place within the policy term irrespective of the loss retention protocol.

At times, this excess of loss reinsurance policy can also operate in a somewhat different manner. For example, a contract may specify that the reinsurer is only liable for a portion of losses beyond a specific threshold rather than requiring it to be responsible for all losses over that level.