What it means
Reinsurance is insurance bought by insurers, and quota share is the most straightforward form of it. Rather than protecting against a specific large loss, a quota share treaty splits an entire portfolio proportionally, so the reinsurer sits alongside the insurer on every single policy.
The insurer still handles the customer, sets the price and pays the claim; the reinsurer simply reimburses its agreed share. The main reason insurers buy quota share is capital relief.
Regulators require an insurer to hold capital in proportion to the risk it retains, so ceding 40% of a portfolio reduces the required capital and lets the insurer write more business with the same balance sheet. That makes quota share particularly popular with fast-growing insurers and with new entrants that have more distribution than capital.
In return for taking a share, the reinsurer typically pays a ceding commission back to the insurer. This reimburses the insurer for the acquisition and administration costs it incurred writing the business in the first place.
The size of that commission is the real negotiation, because it determines how the economics of the portfolio are divided. The important characteristic of quota share is that it is proportional, not selective.
The reinsurer takes the same slice of small routine claims as it does of catastrophic ones, which means it does not protect against a single very large loss any better than it protects against ordinary attrition. Insurers worried about a single catastrophe buy excess-of-loss cover instead, and many buy both.
The trade-off is straightforward: ceding business smooths results and frees capital, but it also gives away profit in good years. An insurer that cedes 40% of a portfolio that turns out to be highly profitable has handed 40% of that profit to someone else.
Deciding how much to cede is one of the recurring strategic questions in an insurance business.
In practice
Real-world examples.
Example
A newly licensed home insurer has strong broker relationships but limited capital. It cedes 60% of its first two years of business under a quota share, which allows it to write about two and a half times the premium its own capital would support while it builds a track record.
Example
An established commercial insurer entering the cyber market cedes 50% of the new line under a quota share because it has little claims history to price from. As the book matures and the loss experience becomes clearer, it reduces the cession to 25% at the next renewal.
Example
A specialist marine insurer uses a quota share to smooth its reported results ahead of a capital raise. The smoother earnings profile helps the pricing of the raise, though management accepts it will report lower profit in a benign claims year.
Think of it
“Quota share cedes a fixed percentage of everything-proportional sharing of risk.
Formula
Calculation
Ceded premium = quota share percentage x gross written premium. Ceded losses = quota share percentage x gross losses. Ceding commission = commission rate x ceded premium.
Suppose an insurer writes $50 million of gross premium on a motor book and cedes 40% under a quota share treaty with a 25% ceding commission. Ceded premium = 40% x $50 million = $20 million, so the insurer retains $30 million. The reinsurer pays a ceding commission of 25% x $20 million = $5 million back to the insurer, giving the insurer $30 million + $5 million = $35 million of income.
Now assume gross losses come in at $35 million and the insurer's own expenses are $12 million. Ceded losses = 40% x $35 million = $14 million, leaving retained losses of $35 million - $14 million = $21 million. The insurer's net result = $35 million - $21 million - $12 million = $2 million, compared with a gross result of $50 million - $35 million - $12 million = $3 million had it kept everything. The reinsurer's result on this treaty = $20 million - $5 million - $14 million = $1 million, which is exactly the profit the insurer gave up in exchange for the capital relief and the protection against a worse year.Case study
Seen in the real world.
Alderbay Mutual is an entirely fictional, illustrative regional insurer writing $80 million of small commercial property premium. After two calm years, its board decided the 50% quota share it had bought since inception was expensive, and it cut the cession to 20% to keep more profit in house.
The following year brought an unusually severe storm season, and gross losses on the property book ran at $68 million against the $80 million of premium. With only 20% ceded, Alderbay retained $54.4 million of those losses rather than the $34 million it would have retained under the old treaty, and its capital ratio fell close to the regulatory minimum.
In this illustration the board reinstated a 45% quota share at the next renewal, at a lower ceding commission because the reinsurer had just seen the loss experience. The point is not that reducing cession was wrong, but that quota share is bought for the bad years, and the temptation to cut it is always strongest after a run of good ones.
Watch out
Common mistakes.
- Thinking a quota share protects against catastrophes. It shares every loss in the same fixed proportion, so a single enormous claim is still enormous after cession; excess-of-loss cover is the tool for that.
- Judging a treaty purely on the ceding commission. A high commission on badly priced business still leaves the insurer with poor economics on the share it retains.
- Assuming the insurer stops being liable to its customers. The policyholder's contract is with the insurer, so if the reinsurer fails to pay, the insurer still owes the claim in full.
Questions
People also ask.
What is a ceding commission for?
It reimburses the insurer for the commissions and administration costs it spent to acquire and service the business the reinsurer is now sharing in.
How is quota share different from surplus share?
Quota share cedes the same fixed percentage of every policy, while surplus share cedes only the portion of each risk above a retention the insurer chooses, so the percentage varies policy by policy.
Does quota share reduce required regulatory capital?
Generally yes, because capital requirements are based on retained risk, though regulators will look closely at whether genuine risk has actually transferred.
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