Insurance Insights

How to Account for Stop Loss Reinsurance

Article reading time: 3 minutes

Hot Take:

Hot Take

Recently we’ve received several inquiries from insurance colleagues regarding accounting for the form of property & casualty reinsurance termed stop loss, also labeled aggregate excess of loss reinsurance. Stop-loss reinsurance falls under non-proportional reinsurance accounting, meaning the reinsurer indemnifies the ceding entity against an amount of loss in excess of contractually specified retention and is further subject to specified limits of indemnification.

While stop loss is a less common form of reinsurance, it has good uses for managing overall risk in an insurance portfolio. We suspect, given recent disasters, to see more use of stop-loss proposed by reinsurers and taken up by insurers.

So, what is stop-loss reinsurance, and how would one go about its accounting?  The comprehensive answer follows.

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With aggregate excess of loss reinsurance, the reinsurer participates over a predetermined loss amount or loss ratio. In other words, the ceding entity is indemnified against the amount by which the ceding entity’s net retained losses incurred during a specific period exceed either a predetermined dollar amount or a percentage of the entity’s subject premiums for the specific period, subject to a specified limit (SSAP No. 62R, Property and Casualty Reinsurance, para. 5b.ii.).

Stop Loss Reinsurance

Stop-loss is one of three types of excess of loss reinsurance:

  1. per risk excess of loss,
  2. per occurrence excess of loss, and
  3. aggregate excess of loss (i.e., stop loss).

Stop-loss reinsurance is one form of reinsurance that provides both horizontal and vertical protection. The aggregate excess of loss reinsurance protects the net loss ratio from an unbudgeted increase in both the frequency and severity of losses (IASA P&C Insurance Accounting). These arrangements provide for financial protection to the ceding entity for aggregate losses rather than providing indemnification for an individual policy basis. SSAP No. 62R also provides the required terms and disclosures for this type of reinsurance.

Example (IASA P&C Insurance Accounting)

An example of an aggregate excess of loss reinsurance is when a reinsurer assumes up to $100M of the net subject losses above a ceding company’s budgeted composite loss ratio of 65% for all lines of business during the current accident year. The reinsurer assumes the risk for an up-front capacity charge of $1M and an additional premium rate on line of 50% (i.e., ceded premium of $0.50 for every dollar of ceded losses).

Illustration (IASA P&C Insurance Accounting)

Illustration with the following assumptions:

  1. the ceding company incurs an accumulation of $50M unbudgeted net retained losses from a winter storm during the 4th quarter
  2. the ceding company will incur an additional ceded premium expense of $25M and record a ceded reinsurance recoverable of $50M

The aggregate excess of loss reinsurance mitigated $24M of the underwriting charge related to the unbudgeted losses.

Financial Statement Impact – Ceding Company

The ceding company will receive from the reinsurer a ceded paid loss recovery after the ceding company pays through the 65% loss ratio retention. The net financial statement impact of the aggregate excess of loss reinsurance, assuming that risk transfer has been demonstrated is as follows:

The reinsurer incurs a $24M underwriting loss under the above stop-loss cover. The reinsurer’s economic position may or may not be in a negative position depending on both the ultimate value and timing of the payment of the ceded losses (i.e. insurance risk).

Conclusion: Stop loss reinsurance in a property and casualty company is a type of excess of loss reinsurance accounted for under SSAP No. 62R.