Quota Share Treaty

Definition

A Quota Share Treaty is a type of reinsurance in which the insurer and reinsurer agree to share a fixed percentage of losses and premiums. The insurer and reinsurer split risks, premiums, and returns based on the agreed-upon quota. This way, the insurer limits their potential loss scenario while benefiting from the reinsurer’s capital support.

Phonetic

The phonetics of “Quota Share Treaty” is: – Quota: KWOH-tuh- Share: share- Treaty: TREE-tee

Key Takeaways

1. Quota Share Treaty is a strategic process which allows insurance companies to protect themselves from major financial losses. They accomplish this by transferring a portion of the risk they underwrite, simultaneously, receiving a corresponding percentage of the premium.
2. It’s an effective tool for managing capital efficiently by insurance companies. The ratio of shared risk vs premium typically remains proportional, leading to sustained and stable reinsurer profits while helping the primary insurer limit its maximum possible loss.
3. This treaty allows the insurer to share larger exposures with a number of reinsurers, widening their network, and giving them an opportunity to develop relationships with other companies. It can strengthen an insurance company’s financial position by redistributing risk and increasing liquidity.

Importance

The Quota Share Treaty is an essential term in business/finance as it is a reinsurance contract where the primary insurer agrees to transfer a certain percentage of risk to the reinsurer. This arrangement is significant as it allows the primary insurer to reduce exposure to loss by sharing risks and benefits with the reinsurer. It helps insurers maintain their financial stability and solvency by protecting them from significant losses. Furthermore, it assists them – mostly new or small-scale insurers – in underwriting larger risks or expanding their business without substantially increasing their capital or reserves. Therefore, a Quota Share Treaty plays a crucial role in risk management and the growth strategy of an insurance company.

Explanation

The Quota Share Treaty is an essential cog for risk diversification and capital management in the insurance industry. Often termed as “proportional reinsurance,” the Quota Share Treaty redistributes the liability of potential financial loss between the primary insurer and the reinsurer. The primary purpose of a Quota Share Treaty is to allow the original insurer to underwrite significant quantities of risk by sharing a defined percentage of liabilities and premiums with the reinsurer. By sharing a fixed quota, or proportion of every risk insured, it reduces the exposure of the primary insurer and enhances their solvency, while providing continuous business to the reinsurer.The second significant function served by a Quota Share Treaty is a controlled growth strategy. It equips the original insurer with the capacity to secure more business without overexposing their balance sheet to potential volatility in claims. For instance, new or smaller insurers with constrained capital resources can utilize Quota Share Treaties to accommodate a higher volume of policyholders without substantially increasing their risk profile. Remunerations are then proportionately shared with the reinsurer, assisting the insurer in their ongoing mission to steadily increase their financial standing and market share, while ensuring they maintain long-term stability in their underwriting operations.

Examples

1. Insurance Industry: One of the most common real-world applications of the quota share treaty is in the insurance sector. For example, an insurance company may decide to share a percentage of its risk by entering a quota share agreement with a reinsurer. Suppose Company A writes a substantial amount of life insurance policies and, decides to cede 25% of its risk associated with these policies to Reinsurance Company B. In return, Company B will receive 25% of the premiums collected from these policies.2. Agricultural Trade Policies: Countries often use quota share treaties to control the import and export of certain agricultural products. For example, the U.S. and a country like Brazil might enter into a treaty where Brazil agrees on a quota share to export a fixed quantity of orange juice to the U.S. every year. This helps to balance trade, protect domestic industries, and manage international relations.3. Telecom Sector: The quota share treaty can be seen in the telecom industry as well. For instance, Telecom Operator A might have a quota share treaty with Tower Company B. According to the terms of the treaty, the tower company will allow the operator to use a certain percentage of its tower infrastructure in exchange for a share of the operator’s revenues.

Frequently Asked Questions(FAQ)

Related Finance Terms

• Ceding Company: This is the insurance company that passes part of the risk it has assumed to a reinsurer.
• Reinsurer: A second insurance company that assumes part of the risk from the ceding company.
• Surplus share treaty: An arrangement in which the reinsurer only takes on risks when they exceed a certain amount.
• Proportional Reinsurance: An arrangement in which the reinsurer shares losses with the ceding company in the same proportion as it shares insurance premiums.
• Risk Cession: The act of passing a risk from the ceding company to the reinsurer.

Sources for More Information

• Investopedia
• Britannica
• International Risk Management Institute (IRMI)
• The Balance