Chapter 7: Surplus Share Treaties

Surplus share is pro rata reinsurance used for large, complex property loss exposures.
The primary insurer determines which loss exposures are subject to the treaty and the percentage share it retains for each ceded exposure.
This arrangement restricts primary insurer liability to a consistent coverage limit amount for similar categories of loss exposures.

Premiums and losses are shared on a percentage basis that varies for each individual loss exposure.
The sharing percentage is determined by the ratio: $(\text{Ceded Loss Exposure Coverage Limit}) / (\text{Primary Insurer Retention})$ .
The treaty applies only to loss exposures with coverage limits exceeding the primary insurer's line (a specified dollar threshold).
Unlike excess of loss reinsurance, surplus share treaties share all losses from the first dollar (ground-up losses).
Primary insurers use a line guide to vary the dollar amount of the line based on the loss severity potential of an exposure.

Surplus share is frequently written in layers:
- First Surplus Treaty: Specifically the first layer of reinsurance after the primary insurer's retention.
- Second, Third, and Higher Surplus Treaties: Provide additional capacity for loss exposures with greater coverage needs.
Higher layers are triggered only when an exposure exceeds the preceding layers plus the primary insurer's retention.
A reinsurance program might provide capacity up to $500,000$ using multiple surplus share treaties, sharing a $10,000$ loss on a $450,000$ policy proportionally.
Primary insurers receive a ceding commission from the reinsurer, which typically decreases for higher layers.

Increased Large Line Capacity: Provides "automatic capacity" as the treaty expands or contracts based on the attributes defined in the line guide.
Stabilized Loss Experience: Limits the primary insurer's participation to its line and helps develop size homogeneity within exposure categories, making loss forecasting more accurate.
Surplus Relief: Provides relief similarly to quota share treaties by ceding premium and receiving commissions, though it is generally less effective because less premium is ceded.
Limitations: Does not protect against an accumulation of losses from a single catastrophe; catastrophe excess of loss reinsurance is used for that purpose.

Reinsuring Clause: Usually obligatory for both parties and contains details on the nature of cession, attachment, and policies covered.
Statement of Attachment: Often set on a "risks attaching" basis for new treaties to simplify administration, while "losses occurring" may be used for renewals.
Definitions Clause: Explicitly defines terms like surplus liability (the amount ceded), risk (e.g., all values at one location), and net retention.
Exclusions Clause: Often includes nuclear incidents, pollution, war risks, terrorism, and insolvency funds, with potential additional property-specific exclusions.
Net Retention Clause: States whether the primary insurer can use "underlying excess" (per risk excess of loss reinsurance) to reinsure its own line.
Retention and Limits Clause: Establishes the primary insurer's minimum net retention and maximum cession, often expressed as a multiple of lines with a dollar cap.
Method of Cession Clause: Addresses complexities for policies with multiple locations, sublimits, or blanket basis coverage and aims to reduce adverse selection.

Limits Profile: A categorization of policies by coverage limit used to determine the appropriate price and evaluate financial consequences of different lines.
Property Line Guide: An underwriting tool that suggests net retentions based on construction type, occupancy, and public protection.
ISO Public Protection Classification (PPC): Rates fire services on a scale of $1$ to $10$ , where Class $1$ is ideal and Class $10$ indicates no public protection.
Building Construction Factors: Includes exterior wall materials, roof/floor supports, and fire-resistive ratings.
Occupancy Hazards: Calculated using Insurance Services Office, Inc. (ISO) codes, which rank combustibility and susceptibility of contents on a scale of $5$ classifications.
Homeowners Line Guide: Public fire protection classification is the dominant factor because construction characteristics are often treated as $100\%$ subject to fire destruction ( $100\%$ PML).