Assessing the Impact of Excess of Loss Reinsurance on a Worker's Compensation Portfolio

In Portugal, workers’ compensation (WC) insurance is mandatory and must be secured through private insurance companies. The law states that employers must provide insurance coverage to all employees, irrespective of the nature of their employment contracts, to ensure protection against work-related injuries and occupational diseases. Reinsurance is an essential tool to help insurers manage capital and mitigate exposure to large or unpredictable losses, particularly in long-tail lines such as WC. Given the growing complexity and cost of covering long-duration liabilities like disability pensions, the need for efficient and well-structured reinsurance arrangements has become increasingly important. This study evaluates the effectiveness of a non-proportional excess of loss (XL) reinsurance treaty in mitigating risk and improving efficiency for a WC insurance portfolio. The analysis is motivated by the high cost of long-term annuity payments, which impose sustained financial obligations on the insurer and must be protected by adequate mathematical reserves. We explore whether the current treaty structure appropriately balances retained risk and ceded premium. Using actuarial modelling techniques, including Generalized Linear Models (GLMs) to analyse claim frequency and severity, and the Generalized Pareto Distribution (GPD) to capture tail behaviour, we assess the treaty’s risk transfer performance. We apply Loss Elimination Ratios (LERs) and capital-based metrics to compare various attachment points and layers of reinsurance under real-world constraints. The results indicate that the current treaty structure provides minimal reduction in retained losses, largely due to high retention thresholds and steep ceded premium loadings. While lowering the attachment point offers limited benefit in terms of reducing expected losses, given the high cost imposed by reinsurers, it would contribute more significantly to reducing retained volatility. This suggests that although the current structure is not particularly efficient in terms of risk transfer, adjustments could enhance protection against large claim variability.