Quota share reinsurance is a proportional reinsurance arrangement in which the reinsurer takes a fixed percentage of every policy in a defined portfolio, receiving that percentage of the premiums and paying the same percentage of every loss. Under a 30% quota share, the reinsurer receives 30% of the premium and pays 30% of each claim, whether the claim is $500 or $5 million.
Quota shares are almost always written as treaty reinsurance covering a whole class of business, although the same principle applies to a single risk in pro rata facultative reinsurance. The reinsurer usually pays the cedent a ceding commission to cover the cost of finding and administering the business. Quota share differs from surplus treaties, where the ceded share varies with policy size, and from excess of loss reinsurance, where the reinsurer pays only above a threshold.
Imagine two friends running a food stall on a 70/30 split. One does the cooking and serving; the other puts up money. Every evening they split the takings 70/30, and every bill, from a broken fryer to a spoiled delivery, is also split 70/30. Because the cook does all the work of finding customers, the investor hands back a slice of its share as a thank-you for that effort.
A quota share works the same way. The insurer finds the customers and handles the policies; the reinsurer takes an agreed share of everything that comes in and everything that goes out, and pays the insurer a commission for doing the legwork. Neither partner can pick and choose which days to share: good days and bad days are split in the same proportion.
Formula and worked example
With a cession percentage , the reinsurer's share of premium and losses is:
The ceding commission is a rate applied to the ceded premium:
- is the quota share percentage, written as a decimal.
- is the ceding commission rate, written as a decimal.
- The cedent keeps the remaining share, , of premium and losses.
Suppose an insurer writes $100 million of premium in a year, buys a 40% quota share with a 30% ceding commission, and suffers $65 million of losses. The reinsurer receives $40 million of premium and pays $26 million of losses and a $12 million commission, so it makes $2 million before its own expenses. The insurer keeps $60 million of premium, bears $39 million of losses and receives the $12 million commission, which helps fund the acquisition costs it paid on the full $100 million.
Ceding commissions and sliding scales
The ceding commission is the main point of negotiation. A flat commission is simple, but many treaties use a sliding scale: a provisional commission is paid during the year and later adjusted, rising if the portfolio's loss ratio is low and falling if it is high, within a set band. A profit commission may also return part of the reinsurer's profit to the cedent. These features keep the cedent's interests aligned with the reinsurer's and soften the moral hazard of handing away a fixed share of every loss.
Some quota shares cap the reinsurer's exposure with a maximum loss ratio, or include a loss corridor in which the cedent bears all losses between two loss ratios. Such features reduce risk transfer, and supervisors and auditors check that enough risk remains with the reinsurer for the contract to count as reinsurance.
- Capital relief. Ceding a share of premiums and reserves reduces the capital the insurer must hold, which can support growth or improve solvency ratios under regulatory capital rules.
- New companies and lines. A start-up or an insurer entering an unfamiliar line can rely on a reinsurer's capital and underwriting know-how while it builds a track record.
- Fronted programmes. Many managing general agents and InsurTech carriers write business on a licensed insurer's paper, with most of the risk passed on to reinsurers through quota shares.
- Financing acquisition costs. The ceding commission arrives upfront, while the corresponding expenses are paid when policies are sold, easing the strain of rapid growth.
Limitations
A quota share cedes profitable small policies as readily as large or volatile ones, so the cedent gives away good business it could have kept. It also leaves the cedent's net exposure to a catastrophe unchanged in proportion: a 30% cession cuts a $100 million storm loss to $70 million net, but does not cap it. For that reason, quota shares are usually paired with excess of loss and sometimes stop-loss reinsurance.
The cedent also takes counterparty risk on the reinsurer's share of future claims, which may be paid years later. Where the reinsurer is unauthorised in the cedent's jurisdiction, the cedent may require collateral or a funds-withheld structure, under which the cedent keeps the ceded premium and credits investment income to the reinsurer. The reinsurer's share of outstanding claims appears as a recoverable against the cedent's gross claims reserve, and it affects the reported results on the income statement each period.