The type of reinsurance contract that involves two companies automatically sharing their risk exposure is called a quota share reinsurance contract.
In a quota share reinsurance agreement:
- Automatic Sharing of Risk: The primary insurer (ceding company) and the reinsurer agree to automatically share a predetermined percentage of each insurance policy or each type of risk covered by the contract. For example, if a quota share reinsurance contract covers 50% of all risks, then the reinsurer would automatically assume 50% of the premiums and losses associated with those risks.
- Proportional Basis: The sharing of premiums and losses is proportional to the agreed quota share percentage. This means that both the primary insurer and the reinsurer share in the risk and rewards of the policies covered under the contract in a fixed proportion.
- Simplicity and Certainty: Quota share reinsurance is often used for its simplicity and predictability, as it allows the primary insurer to cede a fixed percentage of risk without having to individually negotiate each reinsurance arrangement.
- Risk Diversification: It helps the primary insurer to diversify its risk exposure across multiple reinsurers, thereby reducing the potential impact of large losses on its financial stability.
Quota share reinsurance contracts are common in the insurance industry, especially for spreading risk and stabilizing underwriting results.