What is stop loss?

Reinsurance tutorials #9 • The Basics

What is stop loss?

After discussing  NP vertical covers, it is important to mention STOP LOSS (SL) covers. Although storms and floods cannot be avoided,Stop Loss covers can be bought to face such upsets.

How do Stop Loss covers work?

First, you need to assess how much of your premium income you can afford to lose on this or that line of business, the loss ratio you can bear without putting your balance sheet in danger, and then buy a protection above that level, which is the priority of the Stop Loss.

A Stop Loss cover is usually expressed as a % of your subject premium income. Here below is an example:

For a Stop Loss programme in 2 layers (90 % SL 110% and 150% SL 200%), the probability that the second layer will be affected is much less than for the first one, and the price will be reduced accordingly. Usually, it is above the % you agree on amounts with an agreed margin, as you do not know exactly at the beginning of the year what your premium income will be by the end of the year.  There are also Stop Loss covers expressed as the % of sums insured (AGRO).

Advantages/Disadvantages: 

• A Stop Loss, like a QS treaty, is a protection against a deviation of claims frequency rather than against one big event, which is the purpose of a Cat XL cover.
• A Stop Loss based on losses occurring and added along the year does not require event definition or an hours clause. You only need to be clear about the peril covered.  
• Stop Loss means that the insurance company first has to register a loss when adding up its own costs before the reinsurers intervene: a Stop Loss is not a Profit Guarantee. 
• The price depends on the level of the priority (lower priority, higher price), past experience, and expected probability of the SL to be affected, not to forget about the soft factors such as competition, global relationship, negotiations, future expectations, the reinsurers’ willingness to secure a position on a given market, LOB, company, and so on. 

Another worthy topic is that of Aggregates; there are various types: Annual Aggregate Limits (AAL) or deductibles (AAD). 

The insurance company will consider any claim below 1,000,000, for example, an that would not be an issue, not even a deviation in the number of these “petty claims”. 

For all the claims above that level, the company would buy a cover of, say, 20 million, after a priority of 5 million. 

Here is an example: 

If a first claim is 1.5 million from ground up (FGU), a second of 3 million, the cover does not come into play. If a third one is of 2 million, the Aggregate cover would take 1.5 million out of the total 6.5 million. 

Usage: Unlike Stop Loss covers, Aggregate covers quite often encompass several Lines of Business; it is a good protection for the insurance companies’ balance sheets, but is very dangerous for reinsurers, and the price should hence be quite high. 

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