What does "excess of loss" reinsurance primarily cover?

"Excess of loss" reinsurance is designed to cover losses that exceed a predetermined amount, known as the retention limit or attachment point. This type of reinsurance is beneficial for insurers as it helps them manage risk by limiting their exposure to significant claims. In practice, when an insurer experiences losses that surpass this specified limit, the excess of loss reinsurer steps in to cover the additional costs up to a predetermined cap. This ensures that the insurer can stabilize its financial position in the event of large claims while still being responsible for losses up to the retention limit.

This mechanism is particularly critical for protecting insurers from significant, potentially catastrophic losses, thus enhancing their ability to maintain solvency and continue operations. Consequently, the correct answer reflects the fundamental principle of how excess of loss reinsurance functions within the insurance market.