The reinsurance limit in an excess of loss reinsurance agreement reflects the amount of losses and loss adjustment expenses the Reinsurer is willing to accept in exchange for ceded premium paid by the Insurance Company. The contract may include a provision that requires the limit to be reinstated, either free of charge or for a reinstatement premium.
To determine if a reinstatement premium needs to be recorded, the Insurance Company compares estimated ultimate losses for a contract period to the amount of reinsurance limit that has been reduced or exhausted by ultimate loss. Any reduction of limit will require an accrual of reinstatement premium. This calculation is performed at each financial statement measurement date to re-evaluate the reinstatement premium based on the revised estimate of ceded ultimate losses, until all claims covered under the reinsurance contract are closed.