how does excess of loss insurance work

What is excess of loss insurance?

Excess of loss insurance is a type of insurance policy that covers losses beyond the limits of an underlying insurance policy. Essentially, it provides additional coverage for catastrophic losses that exceed the limits of traditional insurance policies. This type of insurance is common in industries where large losses are possible, such as construction, manufacturing, and transportation.

The policyholder purchases excess of loss insurance to provide an additional layer of protection above and beyond existing insurance. For example, a construction company may have a general liability insurance policy with a $1 million limit. If a major accident occurs and the damages exceed $1 million, the excess of loss insurance would kick in to cover the remaining costs, up to the policy limit specified in the excess of loss policy.

Excess of loss insurance is typically provided on a per-occurrence basis rather than an aggregate basis. This means that each incident or occurrence that exceeds the underlying policy limit will be covered up to the limit of the excess policy.

Excess of Loss Insurance vs Reinsurance

There are different types of insurance and reinsurance, and it’s important to distinguish between them to understand how they work and what they cover. Excess of loss insurance is a type of non-proportional reinsurance that covers losses above a certain level, which is called the retention. Reinsurance, on the other hand, is insurance for insurers. It’s a way for insurance companies to transfer a portion of their risk to other companies.

  • Excess of loss insurance is a type of non-proportional reinsurance, which means that it covers losses above a certain level.
  • In contrast, reinsurance covers a portion of an insurance company’s risk across multiple policies.
  • Excess of loss insurance is usually purchased by insurance companies to protect them from catastrophic losses that exceed their retention levels.

Excess of loss insurance and reinsurance may seem similar, but they have different purposes and cover different types of losses. Excess of loss insurance is designed to protect an insurance company from large losses, while reinsurance is used to spread risk across multiple insurance policies.

While there are some similarities between excess of loss insurance and reinsurance, it’s important to understand the differences between them to make informed decisions about risk management and insurance coverage.

Below is a table summarizing the differences between excess of loss insurance and reinsurance:

Excess of Loss Insurance Reinsurance
Covers losses above a certain level Covers a portion of an insurance company’s risk
Non-proportional reinsurance Proportional or non-proportional reinsurance
Designed to protect an insurance company from catastrophic losses Used to spread risk across multiple insurance policies

Both excess of loss insurance and reinsurance play important roles in risk management and insurance coverage, but they are not identical. Understanding the differences between them is crucial for individuals and companies seeking to protect themselves from losses.

Challenges with Excess of Loss Insurance

If you are looking for a type of insurance that offers extensive risk coverage, then excess of loss insurance might be an option. Excess of loss insurance is a type of policy in which the insurer pays excess claims over the pre-established amount known as the retention. This insurance policy is common in the reinsurance market where the insurance companies look to limit their maximum loss after a catastrophic event. It is designed to protect insurers from a severe hit from major losses that could threaten the financial stability of a company. However, like with any other insurance product, excess of loss insurance has its own set of challenges.

  • High Cost: Excess of loss insurance is expensive as it provides extensive risk coverage. The higher the coverage limit, the higher the cost of the premiums. Insurers need to evaluate whether the potential cost of a catastrophic loss justifies the premium cost.
  • Complexity: The structure of excess of loss insurance can be hard to understand due to the multiple levels of coverage and retention. It requires a deep understanding of the coverage limits, retentions, and claims procedures.
  • Limited Coverages: Unlike other insurance policies, excess of loss insurance doesn’t cover every event. It only covers catastrophic losses. This means that it will not provide coverage for low-level losses. It is essential to understand what is covered and what is not before buying an excess of loss insurance policy.

Furthermore, actuaries and insurers face challenges in pricing the excess of loss policy adequately. Actuaries analyze statistical data and calculate insurance risks and premiums to make sure the insurer is charging the right amount to cover potential losses. Pricing excess of loss policies can be complicated for both the insurer and the actuary. The balance of pricing correctly is critical because low prices might lead to financial instability, while high prices could result in losing clients who are unwilling to incur significant premiums.

Finally, insurers sometimes face the challenge of accurately estimating the potential losses accurately. The accuracy of forecasting determines how much the insurer should retain, which is the amount of potential loss that the insurance company is willing to assume before the insurance policy pays. A wrong estimate could lead to an unfavorable financial situation for insurers. Even though insurers have developed complex models and algorithms to forecast potential losses, it is still a challenge to predict catastrophic events.


Excess of loss insurance is an essential insurance policy for institutions seeking to protect themselves from catastrophic loss. However, it does come with some challenges, including high cost, complexity, limited coverage, pricing difficulties, and estimating potential losses. These challenges must be addressed before purchasing an excess of loss insurance policy to ensure that you understand the coverage and can afford the premiums.