What is Facultative Reinsurance?

Facultative reinsurance is when a primary insurer buys coverage for a specific risk or a group of risks in their portfolio. It is one type of reinsurance, with the other type being treaty reinsurance. Facultative reinsurance is usually a one-time deal, while treaty reinsurance involves a long-term agreement between two parties.

How Facultative Reinsurance Works

A reinsurance company, also called a ceding company, is contracted by an insurance company to transfer some of their risk in return for a fee. This fee can be a part of the premium the insurer gets for a policy. The insurer can choose to transfer specific risks or a group of risks to the reinsurer. The type of reinsurance contract determines if the reinsurer can accept or decline individual risks, or if they have to accept all the specified risks.

Facultative reinsurance enables the reinsurance company to assess each risk separately and decide whether to approve or decline it. The profitability of a reinsurance company relies on its prudent selection of clients. Under a facultative reinsurance agreement, the ceding company and the reinsurer establish a certificate confirming the reinsurer’s acceptance of a specific risk.

Insurance companies seeking to transfer risk to a reinsurer might discover that facultative reinsurance contracts are pricier compared to treaty reinsurance. The reason behind this is that treaty reinsurance covers a portfolio of risks, indicating a long-term relationship between the ceding company and the reinsurer. On the other hand, if the reinsurer only wants to cover a single risk in a one-time transaction, it would be more costly. Despite the higher cost, a facultative reinsurance arrangement could enable the ceding company to reinsure specific risks that it wouldn’t be able to handle otherwise.

Benefits of Facultative Reinsurance

Reinsurance provides additional protection to the insurer’s financial stability and solvency by covering a specific risk or a group of risks. This helps to ensure the insurer’s equity and provides stability during unexpected or significant events.

Reinsurance enables insurers to write policies that cover a greater number of risks without significantly increasing the costs of maintaining their financial stability. This is because reinsurance provides insurers with a significant amount of liquid assets that can be used to cover unexpected losses.