Reinsurance tutorials #35
What is priority?
In Excess of Loss contracts, PRIORITY means the retention of the company in a reinsurance XL agreement.
The Priority is the basis of the XL Excess of Loss or of the Stop-Loss.
It is the point where the risk and/or the loss stops resting inside the retention to exceed the threshold and thus become part of the Reinsurer’s cession.
A poetic metaphor could be used to describe this – one by which the loss, obliterated by Retention, takes over PRIORITY (the edge, the doorway, the gate) to appear like dawn in the light of day, as a cession to the reinsurer (limit of the XL or of the SL).
Reality is somewhat less poetic:
Indeed, as an example, it could represent a loss of: 10m xs 5m, comparable to a deductible used in insurance.
It could also be a percentage amount like in a stop loss: 20% xs 110%.
The priority can also be defined as an Attachment Point, because the amount of a reinsured company's retained risk or loss is represented as a point at which reinsurance begins to apply.
There is also a debate on the right level of priority, whether it is HIGH or LOW will determine the level of comfort the company has with its business.
Low priority will mean a working cover protecting the company against frequency of claims. Usually, a low priority is used in contracts where the company is expecting more than one claim a year.
This is a low priority because the company wants to take special care in protecting the capital it allocates to this portfolio, because the company can take advantage of good pricing. If the pricing becomes too expensive and the need in capital is not so important, then the company can increase the level of its priority.
High priority will imply a Cat Cover protecting the company against the severity of a natural event. In such a case, the company does not expect such a regular loss to the layer. Sometimes, the probability of a loss affecting the priority can be very remote, like an event to the layer every 50 or 100 years, with pricing going low too low to the reinsurers’ taste. Whatever the level of a high priority, the capital allocated to a protection has to have a cost and has to be remunerated.
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