Reviewed by Sep 30, 2020| Updated on
A loss cover typically refers to a commercial reinsurance arrangement that is used to temporarily reduce holes in reinsurance coverage for an insurer. A shortfall cover is a form of optional reinsurance designed to protect the insurer if there is insufficient coverage for a reinsurance policy to cover the expected losses.
The word also applies to auto or individual insurance covering a loss in coverage, such as when an incident affects a vehicle and primary insurance only covers the car's book value, as opposed to its replacement value.
Insurance companies use deficiency covers to reinstate policies. When an insurance company subscribes to a new policy, it assumes the possibility of lawsuits against the policy and receives a premium from the insured in return. Through negotiating a reinsurance deal, the insurer will reduce its exposure to the risks generated by its underwriting activities and improve its balance sheet.
Reinsurance transfers some or all of the liability from an insurer to a reinsurer, i.e. insurance companies use reinsurers as insurance. The reinsurer earns a portion of the premiums in return for bearing the insurer's risk.
There are two reinsurance types: contractual and facultative. Under contract reinsurance, also known as portfolio reinsurance, the insurer cedes a business book to a reinsurer, such as a specific line of risk. The reinsurer accepts all these risks immediately instead of negotiating which risk it will accept. Facultative reinsurance arrangements do not require an unconditional reinsurer's acceptance but are often used to cover liabilities that may be excluded from reinsurance agreements. A cover for the shortfall is a form of optional reinsurance.
An insurer with an existing contract or portfolio reinsurance contract has a deficit cover but decides that the existing contract leaves him vulnerable to more losses than anticipated.