Financial Quota Share

A financial quota share is a reinsurance treaty in which the ceding company is responsible for a portion of the loss associated with a claim. Financial quota shares do not require the ceding company to pay a deductible before coverage begins, as the company will always be responsible for a portion of the loss. Companies, including insurers, often treat reinsurance as a form of capital. This is because a reinsurance treaty allows a ceding company to shift a portion of its risk off of its balance sheet and onto the reinsurer's, thus reducing the amount of capital it may have to employ in the case of a claim.

There are two types of reinsurance: excess of loss and quota share. Excess of loss reinsurance is considered non-proportional, as the amount of claim paid by the reinsurer and the ceding company is dependent on the claim severity. Quota share reinsurance is considered proportional, with the ceding company and reinsurer covering the same amount of claim regardless of its severity. A company choosing between these two types of coverage would have to weigh the likelihood of a high severity claim, as high severity claims are more likely to make excess of loss coverage more economical.

Financial quota share allows for surplus relief because statutory accounting requires insurers and reinsurers to immediately charge all acquisition costs to the accounting period in which the business is written, even when the premium is unearned at the end of the period. It is referred to as prepaid acquisition costs in the unearned premium reserve, or the equity in the unearned premium reserve.

For example, an insurance company is examining whether to enter into a reinsurance treaty that is either quota share or excess of loss. The quota share rate is set at 75%, and the excess of loss has 100% coverage after a $75,000 deductible. A $100,000 claim would cost the ceding company $75,000 under an excess of loss reinsurance arrangement, but $25,000 under a quota share. A $1,000,000 claim would cost the ceding company $75,000 under an excess of loss arrangement, but $250,000 under a quota share. The ceding company would prefer an excess of loss arrangement for the $1,000,000 claim because it would be paying 7.5% of the claim rather than the 25% it would pay in a quota share. For the $100,000 claim it would prefer a quota share, since that would let it pay 25% of the total claim rather than the 75% under the excess of loss option.