Treaty reinsurance is where an insurer enters into an agreement with a reinsurer to cover a “book” of risks. The book of risks is generally quite broad in that it will stipulate the various risks it will cover, i.e. motor, aviation, business, immovable property, etc. Treaty insurance is a long term contract that covers the primary insurer for various types of risk.
Facultative reinsurance is where an insurer wants to cover a specific type of risk or a block of risks with a reinsurer/s. It is generally a one-off specific type of insurance.
The Treaty reinsurance provides cover to the primary insurer over a period of time as stipulated in the agreement. This allows the primary insurer to enter into a multitude of policies that are covered in the agreement and the insurer is covered almost immediately for the risk. In a Treaty reinsurance, the reinsurer cannot choose whether to reinsure or not individual policies as it will be bound by the agreement
The Facultative reinsurance allows the primary insurer to spread the risk of a specific policy for part or all of the risk. The reinsurer is at liberty to accept or refuse the offer of facultative reinsurance. Where the reinsurer accepts the risk, generally an agreement is entered into between the primary insurer and the reinsurer setting out the terms of their relationship.
An agreement for treaty reinsurance is negotiated between the primary insurer and the reinsurer and, besides the terms and conditions of the cover, a period of time will be agreed with a clause providing for review of the agreement at certain intervals.
The facultative reinsurance is a one-off transaction that can involve one or more reinsurers. The primary insurer considers the risk it is willing to take and then for the remaining percentage puts a slip on the facultative market and reinsurers will confirm their acceptance by initialling the slip and indicating the percentage risk it is willing to offer. There can be responses from various insurers who may accept different levels of risk so it is possible to have many reinsurers involved covering specific percentages up to the level of risk the primary insurer intends to carry.
As stated above treaty reinsurance covers a range of risks through a single agreement. The result, besides the convenience as stated above, is that many policies can be written over a period of time on a single agreement. The further advantage is that such an agreement not only protects the primary insurer but provides it with substantial liquid assets so it does not have an issue reaching its solvency ratio requirement.
Facultative insurance provides comfort to the primary insurer who can consider the exposure and decide on the amount of cover they can provide and seek facultative reinsurance for the balance. This type of reinsurance allows the primary insurer additional cover than what may be on offer through the treaty insurance. This has the benefit of protecting the primary insurer and assisting it with its solvency margin.
The obvious disadvantage of the facultative reinsurance is that it requires more costly administration and other costs; there are also inconveniences in the procedure including negotiating a one-off agreement and the insured is not covered during the process.
However, the main advantage of facultative reinsurance which frequently outweighs the disadvantages is that it allows the primary insurer to choose the type of policy they are prepared to enter into and the percentage level of risk and then put the balance of the risk out to facultative reinsurers.