Quota Share Treaty Explained: Definition, Function, and Examples

What Is a Quota Share Treaty?

A quota share treaty is a type of reinsurance contract where an insurer and a reinsurer agree to share premiums and losses at a fixed percentage. Insurers use these treaties to manage risk, improve cash flow, and expand their underwriting capacity while still keeping some of the risk for themselves. There are often limits, like per-occurrence caps, to control exposure. In practice, quota share treaties are used in situations like property or casualty insurance, allowing insurers to take on more policies without bearing the full risk of large losses.

Exploring the Mechanics of Quota Share Treaties

When an insurance company underwrites a new policy, the policyholder pays it a premium. In exchange, it agrees to indemnify the policyholder up to the coverage limit. As insurers underwrite more policies, their liabilities grow until they can't underwrite additional policies.

To free up capacity, insurers can cede some liabilities to a reinsurer via a reinsurance treaty. The reinsurer receives a portion of the policy premiums for assuming the insurer's liabilities.

A quota share treaty is a reinsurance agreement in which the insurer cedes a portion of its risks and premiums up to a maximum dollar limit. Losses above this limit are the insurer's responsibility, though the insurer can use an excess of loss reinsurance agreement to cover losses that exceed the maximum per policy coverage.

Some quota share treaties also include per-occurrence limits that restrict the amount of losses a reinsurer is willing to share on a per-occurrence basis. Insurers are less willing to accept this type of agreement because it can lead to a situation in which the insurer is responsible for most of the losses from a particular occurrence of a peril, such as a catastrophic flood.

The Functionality of Quota Share Treaties Explained

A quota share treaty involves giving away part of an insurer's retention. In return, the insurer gets to increase its acceptance capacity with automatic cover.

A quota share treaty reduces financial exposure to adverse claim fluctuations. The cedent can still partake in underwriting gains at a negotiated percentage and gain expertise from a professional reinsurer.

An insurance company might seek to reduce its exposure to liabilities from its underwriting. It enters into a quota share reinsurance contract. The contract has the insurance company retaining 40% of its premiums, losses, and coverage limits, but cedes the remaining 60% to a reinsurer. This is termed a 60% quota share treaty, as the reinsurer assumes that percentage of liabilities.

The Bottom Line

A quota share treaty allows an insurer and reinsurer to share premiums and losses at a fixed percentage. This helps insurers manage risk, free up cash, and write more policies while keeping some of the profits and risk for themselves. It also allows insurers to benefit from the reinsurer’s expertise and diversify their exposure. But they still need to manage losses that go beyond the treaty’s limits. This means that in a 60% quota share treaty, the reinsurer takes on 60% of the liabilities, and the insurer keeps the remaining 40%.