8

Catastrophe Excess of Loss

by Gerald A. Spore*

Purposes of Catastrophe Protection

     Severity Protection. The primary purpose of catastrophe excess covers is to provide severity protection from a given event that causes an accumulation of individual net losses. While a reinsured company may be protected on a risk basis above a given retention level by a working excess cover or by a proportional treaty, the company will still need protection against the accumulation of net losses within its retention caused by the same event, such as an earthquake, windstorm, or explosion. The catastrophe excess, by definition, should not be exposed knowingly to a loss from a single risk or policy issued by the reinsured company. Therefore, the catastrophe excess cover does not increase underwriting capacity like a surplus treaty or a working excess risk cover, but it does provide protection from loss severity. Additionally, catastrophe excess protects against an inadequate distribution of risks, prevents asset depletion, and stabilizes reinsurance costs with a payback arrangement.

     Stability of Losses and Costs. A second purpose of catastrophe covers is to add stability to operating results, for both losses and costs. Loss stability is achieved by levelling the effect of large losses over time, as well as the costs of reinsurance. Given adequate catastrophe reinsurance, even a large loss from a single occurrence in a given year does not distort a reinsured company's overall financial results for that year. Cost stability is achieved by spreading reinsurance premiums over time in the form of debits (or additions) to future reinsurance prices. On the other hand, if excess losses are few over a period of years, they can be reflected in credits (or reductions) to future reinsurance costs.

     Risk Distribution. A third purpose is to help the company achieve an adequate distribution of risks, or at least to avoid the impact of inadequacy and the pain of sharply increased underwriting losses from a catastrophe. The catastrophe reinsurance underwriter must look to the . . .


* CPCU, retired Senior Vice President, Kemper Reinsurance Company, Long Grove, Illinois 60049. An autobiography follows the chapter.

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