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.