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Chapter 2 Different types of reinsurance 2/3

Key terms
This chapter features explanations of the following terms and concepts:
Alternative risk Capital market Catastrophe bonds Faculative obligatory Chapter
transfer (ART) reinsurance

Facultative reinsurance Finite risk Industry loss warranties Limits of liability 2
Retrocession Retrocessionaire Severity Treaty reinsurance

A Main types of reinsurance

A1 Facultative reinsurance

Consider this…
Before you move on, what do you know about facultative reinsurance?

Facultative reinsurance was the earliest form of reinsurance. If an individual risk was too large for an
Facultative was the
insurer to accept, it would look to reinsure a share of the risk with another insurer or reinsurer and a earliest form of
reinsurance contract was made. The fundamental features of facultative contracts are as follows: reinsurance
• Facultative means optional, so both parties to the reinsurance of an individual risk have a choice as to
whether to enter into the contract or not: the original insurer in determining whether it wishes to buy
cover and the reinsurer in determining whether it wants to accept the risk and at what terms.
• Each risk is a separate reinsurance contract and this is important to note when considering treaty
reinsurance later.
Be aware
Although most risks today are ceded to reinsurance in the form of treaties which provide automatic coverage, there
is still a place for facultative reinsurance, particularly where the risks have to be considered individually on their own Reference copy for CII Face to Face Training
merit because of their size or nature. For example, a very large electronics factory would be a risk for which
facultative reinsurance could be considered because the original insurer wants to give 100% cover to its client but
does not have enough automatic capacity available from its treaty reinsurers.

Question 2.1
What other type of risk might be a suitable proposition for facultative reinsurance?

A1A Uses of facultative reinsurance
Facultative reinsurance could be used in the following circumstances:
• Where the insurer requires capacity beyond its treaties providing automatic underwriting capacity.
Insurers do not want
An insurer would not want to turn away a good risk because it was too large, so it may attempt to to reject good risks
obtain facultative reinsurance to cover the excess capacity. because they are
too large
• Where the risk is excluded from the insurer’s treaty reinsurance. Treaty reinsurances generally have a
list of exclusions of business that the reinsurer does not wish to cover. These might be hazardous
risks, risks not fitting the reinsurer’s risk appetite, or areas of business in which they had particularly
bad experience in the past. For example, some liability reinsurance treaties exclude directors and
officers cover, more so during difficult economic times. Other problem areas may be geographical, for
example, risks may be excluded that emanate from the USA. Insurers may wish to obtain cover for
these risks, in whole or in part, which are not otherwise covered and so seek facultative protection.
• Where the insurer does not want to cede the risk to its reinsurance treaty or where a particular risk,
although covered under the treaty reinsurance, might lead to losses that could affect the amount the
reinsurer would charge as premium for the entire treaty. A facultative reinsurer would be able to judge
the potential of the individual risk and charge an appropriate premium. For example, an insurer has a
courier firm as a risk under its motor account. It realises that the potential losses from this firm could
lead to the entire reassessment of its motor account by its treaty reinsurers and so it looks to reinsure
this particular risk on a facultative basis. The insurer must be certain that it is not in breach of an
obligation to compulsorily reinsure such risks under its treaty and should seek the agreement of the
treaty reinsurer before obtaining separate facultative cover.