Facultative reinsurance

Definition

Facultative reinsurance is a type of reinsurance where the primary insurer has the option to cede individual risks to a reinsurer for coverage. Unlike treaty reinsurance, which automatically covers a portfolio of risks, facultative reinsurance is negotiated on a case-by-case basis. This method allows insurers to transfer specific high-risk policies or large exposures that they deem necessary, ensuring that they maintain an optimal risk profile while managing their capital effectively.

5 Must Know Facts For Your Next Test

1. Facultative reinsurance is primarily used for unique or high-value risks that fall outside the normal underwriting guidelines of the insurer.
2. Insurers can choose whether to accept or decline offers for facultative reinsurance based on their own risk assessment and capacity.
3. This form of reinsurance provides flexibility and allows insurers to tailor their coverage according to specific risks they face.
4. Facultative reinsurance can help insurers manage their solvency by reducing their exposure to catastrophic losses on particular policies.
5. Reinsurers often use facultative reinsurance as an opportunity to evaluate and price unique risks before deciding whether to provide coverage.

Review Questions

• How does facultative reinsurance differ from treaty reinsurance in terms of risk coverage and negotiation?
  • Facultative reinsurance differs from treaty reinsurance in that it covers individual risks rather than an entire portfolio. Each facultative agreement is negotiated separately, allowing the primary insurer to choose specific high-risk policies to cede. In contrast, treaty reinsurance automatically covers a broad range of risks without individual negotiation. This distinction means that facultative reinsurance provides more tailored solutions for specific exposures.
• Discuss how facultative reinsurance can influence the underwriting practices of insurance companies.
  • Facultative reinsurance can significantly influence underwriting practices by allowing insurers to manage their risk more effectively. By using facultative agreements, insurers can cede particularly challenging or large exposures to reinsurers, which encourages them to take on additional risks that they might otherwise avoid. This flexibility helps insurers maintain a balanced portfolio while improving their ability to compete in the market by offering coverage on unique or high-value risks.
• Evaluate the strategic advantages and potential drawbacks of using facultative reinsurance for both primary insurers and reinsurers.
  • The strategic advantages of facultative reinsurance for primary insurers include improved risk management, enhanced capital efficiency, and tailored coverage for unique risks. However, potential drawbacks may involve increased costs associated with negotiation and the possibility of reinsurers declining coverage on specific risks. For reinsurers, the ability to assess individual risks allows for informed pricing and selection, but it may lead to a fragmented portfolio if not managed properly. Thus, both parties must weigh these factors when considering facultative arrangements.

Related terms

Treaty Reinsurance:

A type of reinsurance where a reinsurer agrees to accept all risks from a primary insurer under a specified agreement, without the need for individual negotiations.

Underwriting:

The process of evaluating and selecting risks to determine whether to provide insurance coverage and at what terms.

Capacity: The maximum amount of insurance or reinsurance a company is willing or able to underwrite, often influenced by its financial strength and risk appetite.