What does a surplus-share treaty entail regarding policy retention limits?

A surplus-share treaty represents an arrangement where the primary insurer (ceding company) retains a certain amount of each risk, known as the retention limit, while the reinsurer covers the portion of the risk that exceeds this limit, up to a specified maximum. This allows the insurer to manage its risk exposure effectively by only taking on a manageable amount of liability.

In this type of treaty, when a claim occurs that exceeds the retention limit set by the insurer, the reinsurer steps in to pay the difference, providing financial protection for the insurer and enabling it to write larger policies without taking on excessive risk. This mechanism helps stabilize the insurer's financial performance by reducing the potential impact of large claims on their liquidity and reserves.

The other options do not accurately reflect the mechanics of surplus-share treaties. For example, one option suggests the reinsurer pays the full amount of each claim, which contradicts the nature of a surplus-share treaty since it only comes into play for amounts above the retention limit. Another option implies coverage is restricted to catastrophic losses, which is not a defining characteristic of this type of treaty. Lastly, the idea that the insurer retains all risks above a certain amount also misrepresents how these treaties function, as they do provide some level of