Rate on Line: Meaning in Reinsurance, Profitability

What Is Rate on Line?

Rate on line (ROL) is a measure for evaluating reinsurance costs. It's the ratio of premium to loss recoverable in a reinsurance contract, showing how much money an insurer pays for coverage.

ROL indicates coverage cost implications. A higher ROL signals that the insurer must pay more for coverage, while a lower ROL means an insurer must pay less for that same level of coverage.

Factors like exposure and historical losses are taken into consideration when reinsurers price contracts.

ROL helps reinsurers determine contracts' potential profitability.

How Rate on Line Influences Reinsurance Contracts

Reinsurance lets insurance companies increase their capacity to underwrite new policies by transferring some of their liabilities to reinsurers. In exchange, reinsurers receive part of the premiums that insurers collect on these additional policies.

To price a contract, reinsurers consider factors like the insurer's exposures and recent industry losses. Reinsurers study market benchmarks, focusing on the frequency and severity of claims. When there's a limited number of reinsurers and significant historical losses, insurers can expect higher costs for reinsurance.

In such cases, insurers may adjust their underwriting activities by charging higher premiums or by altering the way they invest in premiums in order to maintain excess capacity.

Consider a property insurance company that seeks to shift some of its risk to a reinsurance company, in a concerted effort to mitigate its exposure to losses from potentially catastrophic flood activity. In this hypothetical scenario, both the reinsurer and the insurer examine the severity and frequency of past claims and collectively decide on a contract in which the reinsurer will assume up to $20 million in liabilities.

In exchange, the insurer agrees to pay the reinsurer $4 million in premiums. The rate on line for this contract is calculated by dividing the premium by the coverage, equaling 20%. The payback period would be five years.

Assessing Reinsurance Profitability Using Rate on Line

Rate on line helps reinsurers assess contract profitability, though this gets complex with factors like reinstatement provisions, past expenses, and carry-forward provisions.

Calculations become even more difficult when additional premium and profit commission percentages change for each year or if coverage is canceled. Fortunately, using a frequency distribution can help insurers and reinsurers visualize this data, because the mean of the distribution relates to the payback period for traditional risk covers. This payback period can be compared to the results of catastrophe models or other pricing analyses.

The Bottom Line

Rate on line (ROL) is a key metric in reinsurance. It's the ratio of premium paid to loss recoverable in reinsurance contracts.

ROL indicates how much an insurer pays to obtain coverage. Higher ROL means more cost to secure reinsurance coverage, while lower ROL means paying less.

A well-calculated rate on line can help insurers manage their underwriting activities and reinsurers gauge their contracts' profitability. ROL analysis considers factors like an insurer’s exposure, recent industry losses, and market conditions, all of which can significantly affect reinsurance costs.

Understanding rate on line helps insurers and reinsurers make informed decisions about entering contracts and managing financial risk.