Quota Share

Under a quota share contract, the primary insurer cedes a fixed percentage of every
exposure it insures within the class of business subject to the contract. The reinsurer shares
of the premiums written (less a ceding commission) and pays the same percentage of each
loss. The figure 1 illustrates the application of a quota share treaty with retention of 50% by
the primary insurer.
Quota share contracts are very common in property and liability insurance contracts
(with the exception of automobile insurance) because they are simple to administer and
there is no adverse selection for the reinsurer. Higher commissions and better terms are
obtainable as this type of treaty is generally profitable for the reinsurer.
Quota share is the most effective contract for the small companies to enter into a new
class of business and to reduce their unearned premium reserve. A quota share is also ideal
for reciprocal treaties between insurance companies. For example, two insurance companies
with similar volume of business and profitability could each reinsure a 50% quota share of
the other's business. This could have substantial diversification effects on each, particularly if
they are involved in different geographical areas.
DISCUSSION:
An insurance company has developed, after
six months of business, $ 1,000,000 in
unearned premium reserve for a surplus of $
500,000.
The balance sheet of the company is the following:

ASSETS LIABILITIES AND SURPLUS

Cash 750,000 Unearned premium reserve 1,000,000
Other 2,250,000 Other Liabilities 1,500,000
Surplus 500,000

Total 3,000,000 Total 3,000,000

To increase its surplus the company purchases 50% quota-share treaty.

The reinsurer agree to pay 30% commission for 50% of the actual unearned
business and all forthcoming business.

The company pays the reinsurer:

$ 500,000 - $ 150,000 ( 30 % Commission).

The new balance sheet is:

ASSETS LIABILITIES AND SURPLUS

Cash 400,000 Unearned premium reserve 500,000
Other 2,250,000 Other Liabilities 1,500,000
Surplus 650,000

Total 2,650,000 Total 2,650,000

 Figure 1
Premiums Shared under a Quota Share Treaty

Loss exposure
500

400

300

200

100

0
1 2 3 4 5 6 7 8
Number of policies

Surplus Share

Surplus share contracts, like quota share contracts, are defined as proportional reinsurance,
but the difference between them is in the manner the retention is stated. In a surplus share
contract, the retention is defined as a monetary amount rather than a fixed percentage.
As a consequence, in a surplus treaty, the percentage varies with the size of the loss
exposure. Another difference between the two contracts is the limit that is imposed by the
reinsurer on the size. This reinsurance limit is usually defined as a "n-line surplus treaty," i.e.,
the reinsurer will accept reinsurance coverage up to n times the retention amount. The
surplus can be divided among several companies.
Figure 2 illustrates the application of a surplus share treaty with retention of 50,000
monetary units and a reinsurance limit of 500,000. This would be referred to as a "ten-line
surplus treaty." In this example, the following would occur:
 Size of loss exposure Cedent's retention Surplus cession
50,000 or less 50,000 nil
80,000 50,000 30,000(37.5%)
160,000 50,000 110,000(68.7%)
400,000 50,000 350,000(87.5%)

The reinsurer would pay its share of the losses in the same proportion as its share of the
premium. The surplus treaty is particularly useful for large commercial and industrial risks. It
is superior to a quota share treaty in providing large line capacity. It is also preferable to the
quota-share because it does not require the primary insurer to share small exposures that it
is able to carry itself. On the other hand, it does not secure any unearned premium relief
that may be required by small insurers.

Figure 2
Premiums Shared under a Surplus Treaty

Loss exposure
500

400

300

200

100

0
1 2 3 4 5 6 7 8
Number of policies

In a surplus contract, only the portion of the risk exceeding the company's retention is
reinsured, leaving the company with an homogeneous portfolio. The ceding company is able
to keep more profitable business and the reinsurer receives a higher share of the less good
risks. However, administration costs are much higher and the rates of commission paid by
the reinsurer to the ceding company are less than under Quota Share treaties.