how facultative reinsurance works
an insurance company that enters into a reinsurance contract with a reinsurance company also known as a ceding company does so in order to pass off some of their risk in exchange for a fee this fee may be a portion of the premium the insurer receives for a policy the primary insurer that cedes risk to the reinsurer has the option of either ceding specific risks or a block of risks reinsurance contract types determine whether the reinsurer is able to accept or reject an individual risk or if the reinsurer must accept all the specified risks facultative reinsurance allows the reinsurance company to review individual risks and determine whether to accept or reject them the profitability of a reinsurance company depends on how wisely it chooses its customers in a facultative reinsurance arrangement the ceding company and the reinsurer create a facultative certificate that indicates that the reinsurer is accepting a given risk insurance companies looking to cede risk to a reinsurer may find that facultative reinsurance contracts are more expensive than treaty reinsurance this is because treaty reinsurance covers a book of risks this is an indicator that the relationship between the ceding company and the reinsurer is expected to become a long term relationship versus if the reinsurer only wants to cover a single risk in a one off transaction while the increased cost is a burden a facultative reinsurance arrangement may allow the ceding company to reinsure specific risks that it may otherwise not be able to take on treaty reinsurance vs facultative reinsuranceboth treaty and facultative reinsurance contracts can be written on a proportional or excess of loss basis or a combination of both treaty reinsurance is a broad agreement covering some portion of a particular class or class of business such as an insurer s entire workers compensation or property business reinsurance treaties automatically cover all risks written by the insured that fall within treaty terms unless they specifically exclude certain exposures while treaty reinsurance does not require review of individual risks by the reinsurer it demands a careful review of the underwriting philosophy practice and historical experience of the ceding insurer facultative reinsurance is usually the simplest way for an insurer to obtain reinsurance protection these policies are also the easiest to tailor to specific circumstances facultative reinsurance contracts are much more focused in nature they cover individual underlying policies and they are written on a policy specific basis a facultative agreement covers a specific risk of the ceding insurer a reinsurer and ceding insurer must agree on terms and conditions for each individual contract facultative reinsurance agreements often cover catastrophic or unusual risk exposures because it is so specific facultative reinsurance requires the use of substantial personnel and technical resources for underwriting activities benefits of facultative reinsuranceby covering itself against a single risk or a block of risks reinsurance gives the insurer more security for its equity and solvency and more stability when unusual or major events occur reinsurance also allows an insurer to underwrite policies covering a larger volume of risks without excessively raising the costs of covering their solvency margins the amount by which the assets of the insurance company at fair values are considered to exceed its liabilities and other comparable commitments in fact reinsurance makes substantial liquid assets available for insurers in case of exceptional losses example of facultative reinsurancesuppose a standard insurance provider issues a policy on major commercial real estate such as a large corporate office building the policy is written for 35 million meaning the original insurer faces a potential 35 million in liability if the building is badly damaged but the insurer believes it cannot afford to pay out more than 25 million so before even agreeing to issue the policy the insurer must look for facultative reinsurance and try the market until it gets takers for the remaining 10 million the insurer might get pieces of the 10 million from 10 different reinsurers but without that it cannot agree to issue the policy once it has the agreement from the companies to cover the 10 million and is confident it can potentially cover the full amount should a claim come in it can issue the policy 