SPECIALTY LINES · 6 MIN READ

Reinsurance, Captives, and Surplus Lines

Reinsurance transfers risk from a ceding insurer to a reinsurer, in two contract styles. Treaty reinsurance is obligatory: the reinsurer agrees in advance to accept a defined book of business on pre-negotiated terms - the cedent must cede, the reinsurer must accept. Facultative reinsurance is negotiated risk by risk, and either party may decline. Both styles can be written pro rata or excess of loss. Pro rata splits premium and losses by formula: quota share cedes a fixed percentage of every risk, while surplus share cedes only amounts above the cedent's retained line. Excess of loss pays the reinsurer's share of ultimate net loss above an attachment point, with an hours clause aggregating catastrophe losses occurring within a defined window into one occurrence. Supporting machinery includes fronting (a licensed carrier issues the policy and cedes most or all risk, while remaining directly liable to insureds), cut-through endorsements (giving policyholders direct rights against the reinsurer, typically on cedent insolvency), the insolvency clause (reinsurance is payable to the receiver even if the insolvent cedent never paid the claim), and retroactive structures like loss portfolio transfers and adverse development covers. Captives are insurer subsidiaries formed to insure their owners' risks: pure single-parent captives, group captives, risk retention groups, reciprocals, and protected cell companies renting segregated cells. Domicile selection weighs minimum capital, premium and self-procurement taxes, regulatory responsiveness, available structures, and the local service ecosystem. The federal tax hook is IRC 831(b): a qualifying small captive may elect to be taxed only on investment income - not underwriting income - if net written premium stays under an inflation-indexed ceiling ($2.65 million for 2026) and it satisfies diversification and reporting requirements; abusive micro-captives have drawn IRS transaction-of-interest scrutiny. Risk distribution among enough exposures is essential for the arrangement to count as insurance for tax purposes. Surplus lines is the nonadmitted market for risks the licensed market will not write. A surplus lines broker generally must document a diligent effort to place the risk with admitted insurers, then use an eligible nonadmitted insurer - domestic insurers on the state's eligibility list, alien insurers typically confirmed through the NAIC International Insurers Department Quarterly Listing (the White List). Stamping offices receive, review, and stamp broker filings for compliance and tax support - they do not underwrite, adjust, or license. Under the NRRA, the insured's home state exclusively regulates and taxes the placement, and exempt commercial purchasers can skip the diligent search.