Choosing Between Proportional and Excess for a Growing Book
A specialty managing general agent, Northline, writes small commercial habitational risks and has grown premium from $18M to $52M in three years. It currently buys a 50% quota share from your reinsurer. Frequency is stable and predictable; severity has one recurring problem-a cluster of total-loss fire claims in older wood-frame buildings that each run $2–4M and have produced three claims above $1.5M in the last 18 months. Northline's own retention per risk is $500K, and it wants to reduce volatility without giving up more cession, because its capacity to write new business depends on retained premium. Its underwriters have tightened construction requirements but the in-force book still carries the older risks.
1. Given the stated problem, what is the mismatch in the current structure, and what product would you propose instead of increasing the quota share?
Read the worked answer
The quota share is doing the wrong job. It shares frequency proportionally, which is stable and predictable, but it shares severity only in proportion-Northline still retains 50% of every large fire, so a $4M loss leaves it with $2M against a $500K per-risk retention appetite. The volatility is concentrated in the severity tail, not the frequency.
The right tool is a per-risk excess of loss cover sitting above Northline's retention, with a limit sized to the credible worst-case fire and a layer attachment above $500K. That removes the severity spikes while leaving the quota share to handle frequency and capacity. Increasing the quota share would dilute the good business to solve a problem the excess cover solves directly and more cheaply.
2. Northline says it cannot afford both the quota share and a new excess layer. How do you evaluate restructuring the two together?
Read the worked answer
Test whether reducing the quota share and adding excess of loss produces a better net position than the status quo. If the quota share drops from 50% to, say, 30%, Northline retains more premium-which it says it needs-but also retains more of the severity tail, which the excess layer then absorbs above $500K. The combined cost of 30% quota share plus a per-risk excess layer can be lower than 50% quota share alone if the excess is priced to the actual tail rather than to gross premium.
Run the comparison on net cost of risk transfer and on capital relief, not on gross cession. Show Northline the retained-premium gain against the excess premium and the reduced volatility, and be candid that the excess will not respond to frequency-so if their loss pick drifts upward, the quota share is still the frequency tool. The point is to match each product to the risk it actually addresses.