I'm doing one of the reinsurance questions at the back of the chapter and the question asks about the basis for Stop Loss. The answer is loss occurring but the notes are not great at explaining why. Is it because, stop loss lower and upper limits are normally expressed as earned loss ratios and a consistent basis for this is accident year? Thanks in advance Simz
The key question to ask is ‘What does the cedant want to achieve?’ The cedant will want to protect its loss ratio for an accounting period. Well, accounting rules dictate that companies use accident-year accounts, so the stop loss reinsurance will be written so as to protect the accident year loss ratio (ie the earned loss ratio, as you call it). The corresponding claims basis is LOD, so this will be written into the terms of the stop loss treaty. Of course, Lloyd’s Names are interested in protecting their underwriting year loss ratio. Therefore, they will be more likely to purchase reinsurance on a RAD basis. One final thing to note: Your confusion here arises because you are assuming that the stop loss Ts&Cs are set in stone and companies are forced to comply with them. This is not the case. It is the cedants (and reinsurers) who determine the stop loss Ts&Cs, not the the other way round.
Hi Katherine, This makes sense. Thank you very much. I can understand how one of the main concerns of the insurer is to protect the performance of the profit and loss account. They don't want to go to investors with a bad performing year, this is where they can use a stop loss, and the accident year is consistent with accounting principles. Thanks Asem
