catastrophe reinsurance (cat XL)
/ cat XL = cat ex-ell /
Most of an insurer's claims are independent: your kitchen fire has nothing to do with your neighbour's car crash, so the law of large numbers smooths them out. A catastrophe shatters that comfort. An earthquake, a hurricane, a wildfire, or a flood strikes thousands of policies at the same instant, turning a book of small independent risks into one gigantic correlated loss. Catastrophe reinsurance, almost always written as an excess of loss on a per-occurrence basis, is the cover built specifically to absorb these rare, massive, all-at-once events.
A cat XL responds to the cedant's total losses from a single catastrophic event. The cedant retains losses up to an attachment point set well above any ordinary loss, and the reinsurer pays the aggregate above that, up to the layer limit. For example, a cat layer of 100 million excess of 50 million means the cedant absorbs the first 50 million of any single catastrophe and the reinsurer pays the next 100 million; a hurricane causing 120 million of total losses would see the cedant keep 50 million and the reinsurer pay 70 million. Because one season can bring several events, cat covers usually include reinstatements, and the 'hours clause' defines what counts as a single occurrence (for example, all losses within 72 hours of a windstorm).
Catastrophe reinsurance is where actuarial science meets the limits of historical data. Big catastrophes are so rare that past losses alone cannot price them, so the market relies on catastrophe models — physical-statistical simulations of hazards like quakes and storms across millions of synthetic years — to estimate how often and how severely an event of a given size occurs. These models are powerful but uncertain, and climate change is shifting the very frequencies they estimate, so honest practitioners treat their outputs as informed estimates with wide error bars, not precise truths. Cat XL is the backbone of the property reinsurance market and the reason a single mega-disaster does not bankrupt the world's insurers all at once.
An insurer buys a cat XL of 200 million excess of 50 million with one reinstatement. A magnitude-7 earthquake causes 180 million of losses across its book. The cedant keeps the first 50 million; the reinsurer pays 130 million. Because of the reinstatement, the layer is refilled for any later quake or storm in the same year.
Cat XL absorbs a single event's aggregate losses above a high attachment, with reinstatements for the season.
Cat pricing leans on catastrophe models, not just history, because the worst events are too rare to observe. Those models carry large uncertainty and are being unsettled by climate change — their numbers are estimates, not facts.