Surplus Share Treaty: Definition, Advantages, and FAQs

A surplus share treaty represents a fundamental reinsurance mechanism utilized by insurers to manage risks effectively. In this arrangement, the ceding insurer retains a predetermined portion of an insurance policy’s liability, known as a line, while transferring the surplus liability to a reinsurer. Commonly employed in property insurance, surplus share treaties fall under the category of pro-rata treaties.

Insurers often turn to surplus share treaties when underwriting new policies. In the process of underwriting, an insurer agrees to indemnify the policyholder up to a specific coverage limit in exchange for a premium. However, to mitigate overall liabilities and free up capacity for underwriting additional policies, insurers may opt to cede a portion of their risks and premiums to a reinsurer.

In a surplus share treaty, the ceding insurer retains liabilities up to a predefined amount, while any excess liability beyond this threshold is assumed by the reinsurer. Unlike quota-share reinsurance, where the reinsurer assumes a fixed percentage of all risks, surplus share treaties only involve the reinsurer participating in risks exceeding the amount retained by the insurer. The total risk covered by the treaty, referred to as capacity, is typically expressed as a multiple of the insurer’s lines.

Insurers typically determine the amount of liability to retain based on factors such as risk appetite, financial strength, and capacity to absorb losses. This decision involves a careful assessment of the insurer’s overall risk exposure and strategic objectives.

While both surplus share and quota-share treaties are types of reinsurance agreements, they differ in terms of how risks and premiums are shared between the ceding insurer and the reinsurer. In a surplus share treaty, the reinsurer only assumes risks above the amount retained by the insurer, whereas in a quota-share treaty, the reinsurer assumes a fixed percentage of all risks.

Yes, if the total amount of liability to be insured exceeds the capacity of a single surplus share treaty, the ceding insurer may choose to enter into additional treaties to cover the remaining liabilities. This approach allows insurers to diversify their reinsurance arrangements and manage risks more effectively.

Surplus share treaties enhance an insurer’s equity and solvency by providing protection against excessive losses. By transferring surplus liabilities to reinsurers, insurers reduce their overall risk exposure, thereby strengthening their financial position and ability to meet policyholder obligations.