Introduction
Financial quota share is a type of reinsurance treaty, where the ceding company takes responsibility for a portion of loss associated with an insurance claim. If an insurance company has taken on a policy with a high level of risk, they may hire another insurance company to split part of the risk with them.
The process of shifting its risk to another insurance company, called the reinsurer, is known as ceding. This is done in exchange for a portion of the premiums received.
Insurance companies take on the process of ceding to reduce the amount of capital required, in the event of an insurance claim, especially those with high severity.
Understanding How Financial Quota Share Works
Reinsurance is structured in two ways, proportional and non-proportional. Under proportional reinsurance, the insurer and the reinsurer share a specified percentage of the premiums and losses. Under non-proportional reinsurance, the reinsurer takes on a claim if the loss exceeds a certain amount that was already agreed upon.
The excess of loss coverage becomes more economical for an insurance company to take on, in the case of high severity claims. An example of this would be loss and damage claims in earthquake-prone areas. A quota share reinsurance is considered proportional because the ceding company and reinsurer cover the same amount of claim, irrespective of the severity.
Example of a Financial Quota Share
An insurance company takes on a bunch of policies, from clients in an area prone to hurricanes. The insurance company cedes risk to the reinsurance company in the ratio of 60/40. The insurance company receives Rs.1 crore in premiums of which Rs.60 lakh is retained by it, and Rs.40 lakh is transferred to the reinsurer.
In the event of the clients facing a loss, the insurance company will only bear 60% of the damages, and the balance 40% of the damages, will be borne by the reinsurer.
