Facultative Reinsurance

Dated: September 8 2022

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Facultative Reinsurance

 

A primary insurer purchases facultative reinsurance to cover a single risk or a group of risks held in the primary insurer's book of business. One of the two forms of reinsurance is facultative reinsurance (the other type of reinsurance is called treaty reinsurance). Facultative reinsurance is normally a one-time transaction, while treaty reinsurance is usually part of a long-term coverage agreement between two parties.

 


Facultative reinsurance enables the reinsurance firm to evaluate specific risks and accept or reject them. The success of a reinsurance firm is contingent on its prudent client selection. In a facultative reinsurance contract, the ceding firm and reinsurer issue a certificate indicating the reinsurer's acceptance of a certain risk.

 


Insurers seeking to relinquish risk to a reinsurer may discover that facultative reinsurance contracts are more costly than treaty reinsurance. Because treaty reinsurance covers a book of risks, this is the case. This is a sign that the connection between the ceding firm and reinsurer is anticipated to be long-term versus if the reinsurer only wants to cover a single risk in a one-off transaction. Although the higher cost is a burden, a facultative reinsurance agreement may enable the ceding business to reinsure certain risks that it would not be able to assume otherwise.

By insuring itself against a single risk or a group of risks, reinsurance provides the insurer with more protection for its equity and solvency, as well as greater stability in the case of exceptional or significant occurrences. Reinsurance also enables an insurer to underwrite policies covering a greater volume of risks without excessively increasing the costs of covering their solvency margins — the amount by which the insurance company's assets are deemed to exceed its liabilities and other comparable commitments at fair value. In reality, reinsurance provides insurers with large cash assets in the event of catastrophic losses.

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