Facultative Reinsurance: How It Works And Example!

Facultative Reinsurance How It Works And Example

Reinsurance is an agreement that is not a contractual basis. In this type of reinsurance, the insurer secures the coverage from his reinsurer for unwanted loss. The loss must be due to the reasons that come under the insurance policy. In other words, you can describe it as insurance that the insurance companies apply for. There are two different methods that the company’s use for reinsurance. One is facultative and another is a treaty. Here, the article gives you details of the facultative one.

Read Also: Difference Between Facultative and Treaty Reinsurance!



What Exactly Is Facultative Reinsurance?

Facultative reinsurance is coverage that comes with limitations. The primary insurer purchases it to cover a list of risks or even a single risk. These risks are one of those that come under the primary insurer’s book of business. In other words, you can describe it as a one-off transactional deal. Treaty insurance, on the other hand, is a long term arrangement. Insurance companies find facultative reinsurance simplest to obtain protection. In fact, the policies are easy to tailor to certain specific circumstances.



How Does Facultative Reinsurance Work?

The insurance company that signs a reinsurance contract with a reinsurance company is a ceding company. The ceding does choose reinsurance in order to reduce the amount of risk in exchange for a fee. The fees could be a portion of the premium that the customers pay to the insurer for a policy. The primary insurer or insurance company has the power of ceding specific risks. They can select a list of risks or a single risk. Reinsurance contract types help in analyzing whether the reinsurer accepts or rejects a risk. Another thing that comes under it is whether the reinsurer must accept all the risks or not.

Facultative reinsurance allows the companies in the reinsurance business to review risks. They can determine whether they should accept or reject them. Reinsurance companies need to choose wisely in order to gain profits. The customers and contracts influence profitability in the near future. The reinsurer and the ceding company create a facultative certificate. This certificate will clearly state whether the reinsurer is accepting risks or not.

Insurance companies want to cede risks to the reinsurer that’s the main purpose. To serve it, the facultative reinsurance method seems to be more expensive than treaty reinsurance. That’s because treaty reinsurance doesn’t cover limited risks. It covers a book of risks. This clearly indicated that the relationship is going to be long-term. We do understand the risk that comes with increased costs. Facultative reinsurance is going to allow the insurer to shift its risks to the reinsurer. These risks may or may not be easy to handle by the insurer.



Advantages Of Facultative Reinsurance

By providing coverage against individual or group of risks, reinsurance is itself an advantage. The insurer gets more security against the risk for its equity and solvency. Another advantage is the company’s stability as the risk factor is lower even after unwanted events. It gives the right to the insurer to underwrite policies. These policies cover a large number of risks without excessive financial burden. It could be for the assets of the insurance company that exceeds its liabilities. With reinsurance, the insurers get access to substantial liquid assets.



Example Of Facultative Reinsurance

Consider insurance provider A issues a policy on major commercial real estate. It could be for a corporate office building or a manufacturing company. The contract reads that the policy is written for $25 million. If there is damage to the manufacturing company then the original insurer is liable for $25 million. The insurer believes it cannot handle the financial liability of more than $18 million.

Before signing the insurance contract, the original insurance company goes for facultative reinsurance. It goes for in search of reinsurance companies that can help it out. The taker should be able to handle the remaining $7 million. It may happen that a single company offers reinsurance for the full amount. Another condition could be that multiple companies offer bits of $7 million. Without finding the reinsurer it is not possible for the company to issue the policy.

Once the insurer has the reinsurance agreement ready to cover $7 million the insurer becomes confident. The insurer knows that it can potentially handle the full $25 million with the help of reinsurer. It then proceeds to issue the policy.



Does It Have Some Disadvantages?

Yes, it comes with a few disadvantages. The facultative reinsurance involves formalities that are quite expensive. Also, the whole procedure of obtaining coverage is inconvenient. It’s better you opt for an agent that can help you out with it. They use their contacts to make your experience stress free. You are left insecure during the time period in which you are arranging for the facultative cover. We never know about the future so any mishap can happen. In such a situation, you may even lose your business to a competitor. It’s important to note that there are multiple disadvantages you cannot neglect the advantages. You can analyze them to come to a conclusion.



Final Words

Reinsurance is definitely something the insurance companies look up to. It allows insurance companies to remain solvent by handling the financial burden with ease. Reinsurance reduces the liability of insurance companies. It provides catastrophe protection from multiple types of losses. Ceding companies get the chance to increase their underwriting capabilities. Isn’t that wonderful? Facultative reinsurance is definitely going to help you out with risks. You can even choose to reduce a single risk. It may happen that the company needs help with a single problem so it is definitely great.

Each and every exposure that the ceding company wishes to reinsure is offered to the reinsurer. A single transaction helps them with it. It is important to note that submission and acceptance are needed for each risk factor. It means ceding companies negotiate for individual reinsurance agreement for all the policies. However, the reinsurance company is not responsible for accepting all the submissions.

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