Spreading of Exceptional Claims by Means of an Internal Stop Loss Cover

Assurance companies usually divide their portfolio into a series of tariff groups. This division is necessary for a comparison between the claims and the available premiums in the different tariff groups. By comparing these figures the company is able to verify if the tariff is appropriate or if a modification in line with the empirical data is to be recommended. Apart from this technical argument companies are sometimes compelled to make such a division because of their constitution (e.g. mutual companies) or because it is prescribed by the supervisory authorities. Companies underwriting in various countries are under the obligation, as a rule, to keep special accounts for different countries and currencies. All these reasons lead to a division of the whole business into more or less independent subdivisions which quite obviously have not as much capacity to equalize the risk fluctuations as the whole portfolio.In every tariff group an exceptional fluctuation may occur either from a large individual claim or from claims under number of policies. This leads to a substantial loss in the relevant profit and loss statement at the end of the year. If this debit balance is carried forward to the new account every year, the account of such a tariff group may show a loss over a number of years. It is obvious that a company will endeavour to avoid such an awkward situation.This sort of problem is usually dealt with by means of reinsurance and, to some extent this will be the right solution. However if every tariff group should be able to meet its own liabilities, a rather extended reinsurance is necessary. The capacity of the whole portfolio then would be of no importance, which suggests that a solution through reinsurance alone is not entirely satisfactory.