Surplus Share Treaty: Overview and Advantages

Julia Kagan is a financial/consumer journalist and former senior editor, personal finance, of Investopedia.

Khadija Khartit is a strategy, investment, and funding expert, and an educator of fintech and strategic finance in top universities. She has been an investor, entrepreneur, and advisor for more than 25 years. She is a FINRA Series 7, 63, and 66 license holder.

What Is a Surplus Share Treaty?

A surplus share treaty is a reinsurance treaty in which the ceding insurer retains a fixed amount of policy liability and the reinsurer takes responsibility for what remains. Surplus share treaties are considered pro-rata treaties and are most commonly used with property insurance.

Key Takeaways

• A surplus share treaty is a reinsurance agreement whereby the ceding insurer retains a fixed amount of an insurance policy's liability while the remaining amount is taken on by a reinsurer.
• When engaging in a reinsurance treaty, the insurer shares its risks and premiums with the reinsurer.
• Entering into such an agreement reduces the insurer's liabilities and frees up capacity to underwrite more policies.
• The reinsurer does not participate in all of the risks in a surplus share treaty; only if the amount of the claim is above the limit set in the treaty.

Understanding a Surplus Share Treaty

An insurance company typically considers a surplus share treaty when it underwrites a new policy. In writing new policies, the insurance company agrees to indemnify the policyholder up to a specific coverage limit, and in exchange, it receives a premium. In order to reduce its overall liabilities and free up capacity to underwrite new policies, an insurer may cede some of its risks (and premiums) to a reinsurer. How much risk the reinsurer accepts, and under what conditions, is outlined in the reinsurance treaty.

In a surplus share treaty, the ceding insurer retains liabilities up to a specific amount, called a line, with any remaining liability being ceded to the reinsurer. The reinsurer, thus, does not participate in all risks and instead participates in only the risks above what the insurer has retained, making this type of reinsurance different from quota-share reinsurance. The total amount of risk that a reinsurance treaty covers, called the capacity, is typically expressed in terms of a multiple of the insurer’s lines.

Surplus treaties typically have enough capacity to cover multiple lines, but in some cases, the entire amount to be insured cannot be covered under a single reinsurance agreement. If this occurs, the ceding insurer either has to cover the remaining amount itself or enter into a second reinsurance treaty. This can be accomplished by taking out a second (or third) surplus treaty.

For example, consider a property insurance company that underwrites policies with a coverage of $500,000 and wishes to retain $100,000 of liabilities as its line. The remaining $400,000 in liabilities are ceded to the reinsurer. The $400,000 represents the amount covered under the surplus share treaty.

Advantages of Reinsurance Under a Surplus Share Treaty

By covering itself against excessive losses, surplus share treaty reinsurance gives the ceding insurer more security for its equity and solvency and more stability when unusual or major events occur. Reinsurance also allows an insurer to underwrite policies that cover a larger volume of risks without excessively raising the costs of covering their solvency margins—the amount by which the assets of the insurance company are greater than its liabilities and other similar commitments. In fact, reinsurance makes a substantial amount of liquid assets available for insurers in case of exceptional losses.