Primary insurers and reinsurers negotiate contracts of reinsurance (insurance for the insurance company) utilizing facultative agreements and/or treaty agreements; usually these are used in combination. Each of these agreements serves a particular purpose as follows:
Facultative Reinsurance: Can be defined and easily recalled using the term "facilitative." Facultative insurance is reinsurance for a single risk or a defined package of risks. The ceding company (the primary insurer) is not compelled to submit these risks to the reinsurer, but neither is the reinsurer compelled to provide reinsurance protection. Each risk under a facultative contract is individually underwritten by the reinsurer. Agreement to provide reinsurance "facilitates" the primary insurer's desire to write the business; without the reinsurance, the primary insurer may be unable to provide coverage for the agent.
A good example of the use of facultative reinsurance is a property risk with a very high total insurable value (TIV, or Maximum Possible Loss). The primary insurer does not have the capacity itself to provide the requested limits. To provide the coverage, the primary insurer submits to the risk to the reinsurer to facilitate (allow) the coverage. If the reinsurer agrees, coverage is written and a facultative reinsurance contract is created.
Treaty Reinsurance: A pre-negotiated agreement between the primary and the reinsurer. The primary insurer agrees to cede all risks within a defined class or classes to the reinsurer. In return, the reinsurer agrees to provide reinsurance on all risks ceded without individual underwriting. "Underwriting" is done during negotiation of the treaty contract, thus none is done at the time of cession.
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To provide the coverage, the primary insurer submits to the risk to the reinsurer to facilitate (allow) the coverage
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This is a bit confusing. Underwhat circumstances is the ceding company every complelled to submit risks (or do you mean details about the nature of the risks?). Also under what circumstances is the reinsurer ever complelled to provide reinsurance protection? I'm not sure why these statements are being made.
"Both the facultative and treaty reinsurance agreements require an initial agreement to be struck. The reinsurer approves the agreement with the insurer through an application process similar to when we apply for insurance.
A facultative agreement allows the reinsurer and insurer to agree on each individual risk. So if the insurer receives an application for a risk and they decide that they don’t have the financial capacity or appetite to retain the risk, they send it to their reinsurer for facultative consideration. If the reinsurer agrees, they will accept either a percentage, losses above a certain dollar amount, or the whole risk.
For example, Wells insurance receives an application for a $20 million condominium in Tampa. They might use their facultative agreement to reinsure $10 million of the risk. This allows them to write more business.
A treaty reinsurance agreement lets the insurer and the reinsurer agree in advance that a percentage or all of certain risks fall under the reinsurance agreement. It may be that the agreement allows risks that exceed a certain dollar amount or all risks of a certain class to be transferred to the reinsurer.
For example, Wells insurance agrees with their reinsurer that they will take all coastal buildings over $1 million for wind only.
Reinsurance agreements can allow an insurer to grow their book of business without having traditional surplus available to cover the risks."
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