Loss Occurrence Clause in Reinsurance

Most reinsurance treaties are structured in an excess of loss format. This means that the reinsurer is liable to pay the ceding insurer only when losses exceed a certain amount. For example, the reinsurer is liable to pay the ceding insurer all losses which are above $1 million. If the losses are below $1 million, then the ceding insurer is expected to manage such losses on their own.

Now, it is important to note that the ceding insurance company faces several small losses. These small losses need to be aggregated together to make a single claim to the reinsurance company. The manner in which these losses are aggregated can cause a huge impact on payout which is expected from the reinsurance policy. This is because as mentioned above, reinsurers only pay if the losses go above a certain limit. Hence, most reinsurance companies try to clarify which losses can be aggregated in their reinsurance contract. If the ceding insurance company is allowed to aggregate several unrelated losses, then it could cause extensive loss to the reinsurer.

The clause which lists down the rules related to such aggregation of claims is called the loss occurrence clause. In this article, we will explain how the loss occurrence clause works as well as the various features of this clause.

What is a Loss Occurrence Clause?

As explained above, a loss occurrence clause is a legal clause in the reinsurance treaty which defines how the losses occurring at the individual policy level should be aggregated by the insurer while making a reinsurance claim.

The loss occurrence clause is deeply influenced by the type of reinsurance policy. Some reinsurance policies only capture a single risk. For example, some reinsurance treaties might only cover losses arising from a single natural event such as a hurricane, earthquake, etc. On the other hand, there are other reinsurance treaties that cover all risks which occur above a certain amount regardless of how these risks arose. The loss occurrence clause in both these types of policies is expected to be very different.

How is an Event Defined?

In reinsurance treaties, a single claim i.e. a single loss occurrence corresponds to a single event. Hence, it is important for the loss occurrence clause to clearly define what is meant by an event in the context of that particular reinsurance policy. The definition of an event may seem to be pretty obvious and it seems futile to clearly define what it means. However, the inability to define it clearly is one of the main reasons for disputes in many such contracts.

Also, when reinsurance companies are expected to pay out huge claims, it is likely that they may be motivated to legally dispute what seems obvious.

For the purpose of reinsurance, an event is defined by clearly describing certain parameters about the same.

  • The geographical boundaries related to a reinsurance event must be clearly defined. However, different types of events have different boundaries. For instance, it is common for certain storms to have geographical boundaries exceeding thousands of miles! It is for this reason that the reinsurance company needs to define the geographical boundaries depending upon the type of event which has occurred.

  • The event must have the same proximate cause. This means that if an earthquake in one region also leads to a tsunami in another region, then they should be grouped together as a single event since they have the same proximate cause. Grouping these claims together can be beneficial to the ceding insurer since fewer deductibles will apply to them and a higher claim amount will be received.

  • Also, most reinsurance companies will set time boundaries related to different catastrophic events. The reinsurer will try to make this list as comprehensive as possible since the legal principle is that ambiguity in the contract benefits the party which has not drawn up the contract. In such cases, it will usually be the ceding insurer who will benefit from any ambiguity in the contract.

How are Units of Time Defined?

A single loss occurrence is defined based on the unit of time which has been mentioned in the reinsurance contract. For instance, if the reinsurance contract mentions that for a storm, a single loss occurrence will be for 72 hours, then all damages that occur up to 72 hours will be handled by a single claim. However, if the damages continue to occur for more than 72 hours, then two separate loss occurrences may have to be created. The deductible limits might apply differently to these two loss occurrences. There are other details mentioned in the loss occurrence clause as well. For instance, the occurrence of a loss contract may clearly define that two occurrences should not overlap with regard to time.

The fact of the matter is that a loss occurrence clause is a very important part of the insurance policy contract. The ability to define this clause in a clear and unambiguous manner is what differentiates a good reinsurance policy from one that will be mired in litigation. It is important for both parties to ensure that their legal teams carefully consider this legal clause and its implications before signing a reinsurance contract.

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