What it means
Reinsurance is insurance for insurers, and proportional treaties split premiums and claims in the same ratio. A quota share cedes an identical percentage of every policy, whereas a surplus share cedes only the amount sitting above the insurer's retention.
That difference is the entire point, because it lets the insurer keep all the profit on its everyday small policies. The retention is known as a line, and treaty capacity is quoted as a number of lines.
A treaty of four lines with a $500,000 retention provides $2,000,000 of reinsurance, so the insurer can write policies up to $2,500,000 in total. Anything larger needs a facultative placement, arranged individually risk by risk.
Once the split is fixed for a policy, premium and losses follow those same proportions for the life of that policy. The reinsurer also pays a ceding commission back to the insurer, which compensates it for the acquisition and administration costs it incurred in writing the business in the first place.
The commercial appeal is that the insurer smooths its exposure without surrendering margin on small, predictable policies. Ceding risk also reduces the capital the regulator requires it to hold, which frees capacity for growth.
The trade off is administrative, since every policy needs its own cession calculation and regular bordereau reporting to the reinsurer. Surplus share suits classes where sums insured vary widely, such as commercial property, engineering and marine cargo.
It works poorly for liability lines, where the eventual loss is not capped by a stated sum insured, so quota share or excess of loss cover is normally preferred there instead.
In practice
Real-world examples.
Example
A regional property insurer with a $250,000 line and a six line treaty can offer cover up to $1,750,000. It quotes a hotel with a $1,500,000 sum insured, retaining 16.7% of the risk and ceding the rest, which wins it a client it could not previously have served.
Example
A marine cargo underwriter writes thousands of small shipments in full and cedes only the handful of high value consignments that exceed its $400,000 line. Its retained portfolio stays predictable while its published capacity looks far larger to brokers.
Example
An engineering insurer receives a $4,000,000 turbine risk that exceeds its $2,500,000 treaty capacity. It places the surplus share portion under the treaty and arranges the remaining $1,500,000 facultatively with a specialist reinsurer before confirming the quotation.
Think of it
“Surplus share covers amounts above your retention-variable percentage based on risk size.
Formula
Calculation
Reinsurer's share = (Sum insured - Retention) / Sum insured, and that same percentage is applied to the premium and to every claim
Kestrel Mutual runs a surplus share treaty with a retention, or line, of $500,000 and capacity of four lines, giving $2,000,000 of reinsurance and total capacity of $2,500,000. It writes a warehouse policy with a sum insured of $2,000,000 and an annual premium of $40,000.
Kestrel retains $500,000 of the $2,000,000 sum insured, which is $500,000 / $2,000,000 = 25%, and cedes $1,500,000, which is 75%. The reinsurer therefore receives $40,000 x 0.75 = $30,000 of the premium while Kestrel keeps $40,000 - $30,000 = $10,000. When a fire causes an $800,000 loss, the reinsurer pays $800,000 x 0.75 = $600,000 and Kestrel pays the remaining $200,000.Case study
Seen in the real world.
This is an illustrative and fictional example. Ambervale Mutual, an invented regional insurer, wrote small commercial property policies with an average sum insured of $180,000 and had a comfortable but static book. Brokers kept bringing it larger factories and distribution centres, and it kept declining them because a single $2,000,000 loss would have consumed a fifth of its annual premium income.
Ambervale arranged a surplus share treaty with a $400,000 line and five lines of capacity, taking its maximum acceptance to $2,400,000. In the first year it wrote 60 larger policies it would previously have turned away, retained only $400,000 on each, and received a 27% ceding commission on the premium it passed across.
Two years later a warehouse fire produced a $1,800,000 claim on a policy with a $1,600,000 sum insured. In this fictional case Ambervale's share of the settlement was 25% of the covered amount, an outcome its capital absorbed easily, whereas the same claim before the treaty would have wiped out most of a year's profit.
Watch out
Common mistakes.
- Confusing surplus share with excess of loss, when surplus share splits every policy proportionally and excess of loss responds only once a claim passes a stated amount.
- Assuming the number of lines includes the insurer's own retention, when a four line treaty means four times the line in addition to the line the insurer keeps.
- Overlooking the administrative burden, since every policy needs its own cession calculation and accurate bordereau reporting to the reinsurer.
Questions
People also ask.
How does a surplus share treaty differ from a quota share?
A quota share cedes the same fixed percentage of every policy, while a surplus share cedes nothing on small policies and a rising percentage on larger ones.
What happens if a risk exceeds the treaty capacity?
The insurer either declines it or arranges facultative reinsurance for the excess amount on that single policy.
Why does the reinsurer pay a ceding commission?
Because the insurer has already paid the broker commission, underwriting costs and administration on the whole policy, and the commission returns a fair share of that to it.
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