A stop loss is a type of non-proportional reinsurance, just like the excess of loss. The stop loss reinsurance is designed to protect the primary insurer, the Ceding party, from bad results.
A stop loss reinsurance provides reinsurance coverage when the total amount of claims incurred during a specific period (usually one year), exceeds either a loss ratio, either in excess which is a specified amount up to a limit.
Most of the time, the deductible is determined by a loss ratio. The loss ratio is expressed as a percentage resulting in dividing total (incurred or paid) losses by total (written or earned) premiums. That is the reason why, the stop loss reinsurance is also known as Aggregate Excess of Loss Reinsurance.
For example, a 100% stop loss means that the reinsurer covers as soon as the total claims amount are at the same level or above the premiums amount. The higher the loss ratio, the worse the results. A high loss ratio might result from 3 different reasons:First, a high frequency of small claims which are aggregated;
Second, an increase of the large claims;
And third, too low premiums due to the inaccurate quotation of the insurer.
Consequently, the Ceding party will write stop loss reinsurance mostly for catastrophic claims, such as a tempest, a typhoon, hail or crop. Stop loss reinsurance is not accurate for long tail businesses such as casualty.
With a 100% excess of 50%, stop loss reinsurance written in 2019 for its catastrophic claims incurred in 2020:
Sometimes, the stop loss is specified, with both a ratio and an amount.
To summarize: the stop loss is a non-proportional coverage protecting the insurer against bad results. The Reinsurer pays whenever the aggregate losses of the year exceed the deductible of the treaty, mostly specified as a loss ratio, up to a coverage limit.