Annual stop loss reinsurance (also called stop loss) is non-proportional reinsurance (as is excess of loss). The stop loss is intended to protect the insurer, the Ceding party, from poor results.
An annual stop-loss reinsurance occurs when the total amount of claims incurred during a specific period (usually one year) exceeds either a loss-to-premium ratio or an excess (set amount with a limit).
In most cases, the deductible (or priority) is determined by a loss-to-premium ratio expressed as a percentage. This ratio is calculated by dividing the total losses (incurred or paid) by the total premiums (issued or acquired).
For example, a 100% stop loss means that the reinsurer covers as soon as the total amount of claims is at least at the same level or higher than the amount of the premiums. The higher the loss ratio, the worse the results. A high loss ratio can be due to 3 factors:
A high frequency of small aggregate claims;
An increase in serious claims;
Too low premiums due to inadequate pricing by the insurer.
Thus, the Ceding Company will take out stop loss reinsurance, mainly for losses due to natural disasters (storms, typhoons, hail or loss of crops). Annual stop loss reinsurance is not suitable for long term business, such as liability insurance.
Consider the following example: with 100% in excess of 50%, the stop loss reinsurance written in 2019 for CAT claims incurred in 2020. The results are as follows:
The premium is estimated at €10,000,000, the Reinsurer will cover as soon as the total amount of claims incurred in 2020 exceeds the threshold of €5,000,000 (and up to €15,000,000).
If the Cedant has recorded several claims incurred in 2020, amounting to €6,000,000, the Reinsurer will pay €1,000,000.
Sometimes the stop loss is determined, both with a ratio and with an amount.
To sum up: stop loss reinsurance is a non-proportional cover that protects the insurer against bad results. The Reinsurer covers when the total losses for the year exceed the deductible of the treaty, most often mentioned in the form of claims-premiums ratio, within the limit of the cover ceiling.