Treaty reinsurance is among the most common types of reinsurance, but it should not be confused with facultative reinsurance, as the two are different types of contracts.
Insurers will sometimes lack a sufficient level of capital to underpin their policies. They may also want to reduce their risk on policies they offer to their customers. In both cases, reinsurance offers a solution.
Treaty reinsurance involves covering a portion of risk that may cover an array of assets, and facultative reinsurance insures a specific asset or risk. We outline this in more detail below.
Treaty vs. facultative reinsurance
Treaty reinsurance is a much broader type of reinsurance than facultative insurance, covering multiple policies and risk. Facultative reinsurance involves the insurance of a particular asset or very specific risks which are determined on a case-by-case basis.
The primary advantage of facultative insurance is that insurers can limit their exposure for very specific risks that they identify. It offers much more flexibility for the ceding company to choose which policies to reinsure.
Treaty reinsurance is more of a consistent, long-term arrangement. It can even cover policies that have not been written yet. This is not the case for facultative insurance, which envisages a much shorter relationship between the reinsurer and ceding company due to the specific nature of the risks.
Treaty reinsurance explained:
Treaty reinsurance is where an insurer (often referred to as a “ceding company”) secures reinsurance coverage for a portion of its policies rather than a specific individual asset.
Consider an insurer with $60 million worth of policies but a desire to underwrite $120 million. There is a shortfall of $60 million. This creates a demand for treaty reinsurance.
The primary advantage of this type of reinsurance is that the ceding company (i.e. the primary insurer) will retain greater control over their underwriting process.
Types of treaty reinsurance
Treaty reinsurance is usually categorized by reference to two main types of contracts: proportional and non-proportional contracts.
In proportional treaty reinsurance, the ceding company and the reinsurer share both premiums and losses in agreed-upon proportions.
By way of example, if a proportional treaty stipulates a 50-50 sharing arrangement, the reinsurer will cover 50% of premiums and absorb 50% of losses for all policies covered under the treaty.
Proportional contracts are typically used for stable, predictable risks and can help ceding companies manage their exposure while sharing the burden of losses with reinsurers.
Non-proportional treaty reinsurance is designed to protect the ceding company against catastrophic or unpredictable losses. Under this type of treaty, the reinsurer only steps in when the losses exceed a predefined threshold, known as the “retention.”
The reinsurer covers losses that surpass the retention, which generally occurs in the event of something severe.
Non-proportional contracts provide ceding companies with a safety net for unexpected or high-impact claims but do not share premiums.
Learn more about treaty reinsurance from the experts
Understanding the intricacies of treaty reinsurance is an important tool for any insurance company who wants to limit their risk or increase their capital to underwrite more policies.
The team at Axxima can help your organization determine the best way for you to achieve the level of capital you need and reduce your risk appropriately. Visit their website if you’re looking to review your reinsurance and are specifically interested in understanding the implications of treaty and facultative reinsurance on your business.