Financial Quota Share
Categories: Metrics, Accounting, Banking
Lawyers occasionally need their own lawyers. Accountants sometimes hire other accountants to do their accounting.
Along the same lines, insurance companies will often hire their own insurance companies. These firms are known as reinsurers.
If an insurance company thinks they've taken on too much risk (meaning they don't want to be on the hook for all their clients losses if some terrible event should occur), they would pass some of that to a reinsurance firm.
One method of reinsurance goes like this: an insurance company takes out a policy from a reinsurance firm, pays them periodic premiums, and files a claim if the terrible event happens. Basically, it echoes the relationship you have with your insurance company.
A financial quota share represents a different model. It acts as more of a partnership, a splitting of the burden. Instead of paying premiums, the companies agree to split any losses by a predetermined ratio. Meanwhile, any premiums that come in get shared.
An insurance company has a bunch of clients in an earthquake zone. They want to lower their exposure to the risk that The Big One will wipe out all their clients' houses. So, they engage a reinsurer and set up a financial quota share.
The insurance company collects $1 million a month in premiums from the earthquake-zone customers. It agrees to divide this with the reinsurance firm on a 70/30 split. So the insurance company keeps $700,000 per month and sends $300,000 per month to reinsurer. If an earthquake hits, the insurance company will pay 70% of all claims and the reinsurer will pay 30%.