Excess of loss treaty (XL)

An excess of loss treaty (XL, or XoL) is the main form of non-proportional reinsurance. The reinsurer responds only when a loss exceeds a level called the retention or priority, and its cover is capped at a defined limit above that threshold. A layer is described by its limit excess of its retention: 8 million excess of 2 million means the reinsurer takes on the part of a loss between 2 and 10 million. Put as a formula, the recovery is the lesser of the limit and the loss in excess of the retention, and nil below the retention. A quota share splits everything, premiums and claims, at the same percentage; an XL splits by monetary thresholds, and the reinsurer only sees the tail. The cedant keeps the attritional losses and transfers the peak risk, which protects its balance sheet against severe events. XL can apply per risk, per event or as catastrophe cover. It also comes as an aggregate cover, where the retention applies to the year's total losses rather than to each loss. Layers are stacked into a program, and an eroded layer is reinstated under the reinstatement provisions, often for an additional premium. Its pricing is more technical than that of proportional reinsurance, since it rests on estimating the frequency and severity of losses reaching the layer, often using burning cost and modeling. The premium is quoted as a rate on subject premium or as a rate on line. The term is also used in direct insurance, for an excess insurer sitting above a primary policy in a tower; the mechanics are the same. It is the tool of choice for covering highly volatile perils such as cyber or natural catastrophes. The short notation reads the same way: under a EUR 5m xs EUR 5m per risk treaty, an 8m loss costs the cedant 5 and the reinsurer 3; at 12m the reinsurer stops at 5 and the cedant takes back the 2m above the layer. Stop-loss, which applies to the annual loss ratio of the whole portfolio, is its widest form.