What it means
Insurers manage their own risk by insuring themselves, and the shape of that cover matters a great deal. Stop loss is the aggregate version: it responds when the accumulated cost of many claims across a portfolio crosses a threshold, whatever combination of events produced them.
That threshold is called the attachment point, and it is generally set as a percentage of earned premium rather than a flat dollar amount. Cover then runs from the attachment point up to a stated limit, above which the insurer is exposed again unless it has bought a further layer of protection.
The commercial purpose is stability rather than extra profit. A book with stop loss cover produces a much narrower range of possible outcomes, which supports the insurer's capital position, its credit rating and its ability to satisfy regulators that one bad winter will not threaten its solvency.
The same structure appears well outside traditional insurance. Employers who self-fund their staff health plans commonly buy aggregate stop loss so that an unusually costly year does not overwhelm the budget, and captives, meaning insurance companies owned by the business they insure, use it for exactly the same reason.
Pricing turns almost entirely on where the attachment point sits. Set it low and the cover is expensive because the reinsurer expects to pay something most years; set it high and the premium is modest but the insurer keeps most of the volatility.
Stop loss is also distinct from excess of loss cover, which responds to individual large claims rather than to the annual total, and many insurers buy both.
In practice
Real-world examples.
Example
A crop insurer covering a single farming region buys aggregate stop loss before the growing season, because a drought would generate thousands of moderate claims at once rather than one enormous one. In a dry year the cover pays out and the insurer's capital is preserved for the following season.
Example
A manufacturer with 2,400 employees self-funds its health plan and adds aggregate stop loss attaching at 125% of expected claims. When an unusually severe flu season pushes claims 31% above budget, the cover absorbs the excess and the finance team's forecast holds.
Example
A small motor insurer growing quickly finds its regulator wants more capital to support the larger book. Buying stop loss reinsurance reduces the range of possible outcomes enough that the required capital falls, making the growth affordable without raising new equity.
Think of it
“Stop loss limits your total losses-protection when everything adds up to too much.
Formula
Calculation
Attachment point = Attachment loss ratio x Earned premium
Reinsurer's payment = the lower of (Actual aggregate losses - Attachment point) and the cover limit, and never less than zero
A regional motor insurer earns $50,000,000 of premium in a year. It buys aggregate stop loss cover attaching at an 80% loss ratio and running up to a 110% loss ratio, for a reinsurance premium of $3,000,000.
The attachment point is 80% x $50,000,000 = $40,000,000, and the upper point is 110% x $50,000,000 = $55,000,000, so the limit of cover is $55,000,000 - $40,000,000 = $15,000,000.
A severe hailstorm season pushes actual claims to $52,000,000, a loss ratio of 104%. The reinsurer pays $52,000,000 - $40,000,000 = $12,000,000, which is inside the $15,000,000 limit, and the insurer's retained claims cost is held at $40,000,000, an 80% loss ratio. Had claims reached $60,000,000, the reinsurer would have paid the full $15,000,000 limit and the insurer would have carried $40,000,000 + $5,000,000 = $45,000,000 itself.Case study
Seen in the real world.
Fairhaven Mutual is a fictional regional insurer created for this illustrative example. It wrote homeowner policies concentrated in a coastal county and, after several benign years, its board questioned whether the $2,800,000 annual cost of its aggregate stop loss cover was justified when it had not claimed once in four years.
The invented board decided to keep the cover but to raise the attachment point from 75% to 85% of earned premium, cutting the reinsurance premium to $1,700,000 and accepting a larger retained share of a bad year. Two seasons later a run of severe storms produced a loss ratio of 97%, and the cover paid out substantially for the first time.
The illustrative lesson is one insurers repeat often. Stop loss looks like wasted money in every year it does not pay, and the point of it is the year it does; the useful question is not whether it paid last year but whether the retained loss in a bad year would still be survivable.
Watch out
Common mistakes.
- Assuming stop loss covers any single catastrophic claim. It responds to the annual total across the book, so one very large claim is the job of excess of loss or catastrophe cover instead.
- Judging the cover by whether it paid out last year. Its value lies in reducing the worst-case outcome, which by definition will not happen in most years.
- Overlooking the upper limit of the contract. Losses above the ceiling return to the insurer, so a badly set limit can leave a large gap exactly when it hurts most.
Questions
People also ask.
What is an attachment point?
It is the level of aggregate losses at which the reinsurer's obligation begins, usually stated as a loss ratio such as 80% of earned premium.
How does stop loss differ from quota share reinsurance?
Quota share cedes a fixed percentage of every premium and every claim from the first dollar, whereas stop loss only responds after the annual total crosses a threshold.
Can a non-insurer buy stop loss cover?
Yes, most commonly employers running self-funded health plans, who use it to cap the total annual cost of employee claims.
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