Quota share (noun, adjective) Sharing is a concept generally regarded as positive.
Children are encouraged to share, while this benevolent practice is expected of adults. Reinsurers and their clients form relationships based on the concept of sharing; insurance companies share premiums with their reinsurance partners, and share out the losses as well. The most basic way to govern such interaction is through quota share reinsurance. A quota is set (say 60%); the insurer gives the reinsurer that share of the premium; the reinsurer pays that share of the losses. Unusually, such treaties can have durations of up to a decade, rather than the typical annual contract so widely used in the world of non-proportional business.
To help defray the insurer's costs of dealing with clients, the reinsurer returns a certain portion of the premium - a commission calculated as a share of the quota share. Reinsurers are not prone to see if this commission bears any relationship to the actual costs and expenses borne by the insurer.
Rather, the ceding commission is likely to be a bargaining instrument in the negotiation of the treaty, for once returned to the insurer, it is commission income rather than risk premium. It is, in fact, the only variable within the reinsurer's control under a quota share treaty.
Lately, quota sharing has not been very popular among reinsurers precisely because they have no control over the premium they receive for the risks they assume. It could, in fact, be described as the ultimate case of giving the pen away. Such sharing was extremely popular in the tariff-controlled personal motor markets of Germany and other continental European countries, when governments allowed premium rates to be fixed at levels sufficient to enrich insurers and their reinsurers through the pocketbooks of the hapless motorist, thus underpinning a burgeoning industrial society. However, competition ended all that, as insurers charged less but still made profits because reinsurers took all the losses.
Quota sharing is tangibly unattractive for reinsurers when insurers set rates which are profitable only when their ceding commissions are factored in. This has led to a nearly universal distaste for quota sharing, even in the US where they gained in popularity until the recent technical underwriting revolution. Today, quota share treaties are number one on the nasty list of reinsurers worldwide, and everyone is trying to escape from them, although almost everyone is willing to grant their core clients a bit of quota share capacity to keep the relationship sweet.
Profit and Loss
And sweeten it does, because quota sharing heavily favours the cedants' profit and loss account. Consider a portfolio with premium income of 100, losses of 50, and expenses of 30. The insurer makes a profit of 20% (100 - 80) if he retains the whole risk, losses and all. However, introduce a 60% quota share with 40% commission, and the picture changes dramatically.
The insurer retains premium of 40, pays losses of only 20, and has expenses of just 6, since of the original 30, the reinsurer reimburses 24 (40% of the ceded 60). That leaves 14 (26 - 40), or profit of 35% of premium.
With risk-based capital regulators breathing down their necks, this must look pretty good to insurers and their investors.
Consider the reinsurer, however. He has premium income of 60, but has paid losses of 30 and expenses of 24. His profit is 6, or only 10% of premium (before the reinsurer's own expenses). That's even less than the insurer would make without the treaty. In reality, however, most underwriters would fight tooth and nail for a quota share treaty that generated 10% profit (and probably get a tidy bonus for writing it). In practice these days, the profit is usually much less. Often it is negative, with the sole benefit coming from investment income on the accrued funds.
One reason for this dismal state of affairs is the practice of syndicating quota share treaties between a number of different reinsurers. When no single company is accepting a large share of the contract, the negotiating power lies entirely with the cedant. In addition, reinsurers typically accept unpriced or underpriced elements of natural catastrophe risk as part and parcel of the quota share, leaving them open to massive aggregation losses. Reinsurers have been standing their ground recently, but cedants have been incredibly reluctant to give up this cover. Meanwhile sliding-scale commissions, overriders and variable quotas all conspire to make simple sharing more complicated and costly. Little wonder then that reinsurers are retreating from the business.
Yet quota share treaties are here to stay. Withdrawing this form of support from small and regional insurance companies - the ones that use it the most - will force them either to reduce their gross premium income by the amount of the quota (and maybe out of business), to accept more risk than their capital allows, or to flee to the arms of a more cooperative reinsurer. This latter factor is surely sufficient to keep the sharing happening for a long time to come.