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Chapter 3 Features and operation of facultative reinsurance 3/5

Various levels of loss would be allocated as follows:
• A loss of $750,000 would be retained by the insurer in its entirety.
• A loss of $3m would be retained $1m by the insurer with the remaining $2m recovered from
reinsurer A.
• A loss of $7m would be retained $1m by the insurer with $4m recovered from reinsurer A and the
remaining $2m recovered from reinsurer B.
• A loss of $16m would be retained $1m by the insurer with $4m recovered from reinsurer A, $5m
recovered from reinsurer B and the remaining $6m recovered from reinsurer C.
Another factor which results in an increasing use of facultative excess of loss reinsurance is the Chapter
development of captive insurance company business. As we have already seen in chapter 1, section B6
and chapter 2, section C1, a captive is a riskbearing company operated primarily for the purpose of 3
underwriting in whole or in part, directly or indirectly, the insurances of its parent company. This implies
that the parent company’s primary business is not that of insurance.

Be aware
There is an increased tendency for powerful multinational organisations to form their own insurance subsidies,
due to:
• some aspect of their risk exposures having predictable loss patterns;
• a preference for their risks to be rated on their own experience, rather than that of the wider market; and
• the inability to achieve the insurance products they require at an acceptable price through traditional insurance
markets.

Captives have the advantages of making best use of the parent group’s risk control programme and Captives are
discussed in detail
avoidance of the frictional costs and overheads associated with doing business with a conventional in chapter 9,
insurer, by having direct access to reinsurance markets. section C
Reinsurance is purchased to limit the captive’s exposure to a tolerable level. Given the nature of a
Limits the captive’s
captive’s portfolio where the spread and balance of the account is limited, maintaining an acceptable exposure to a
level of exposure is usually best achieved through the use of excess of loss reinsurance. tolerable level Reference copy for CII Face to Face Training
It is important to remember that a facultative excess of loss is a placement where the insurer retains a
greater share of the original premium income compared to proportional reinsurance, but if its
assessment of the likely loss pattern proves inaccurate in frequency and severity terms, this will be
small compensation for the level of losses retained.
Facultative excess of loss reinsurers might also be able to offer more capacity, since they would not be
involved in any loss frequency at an attritional, or low, level. Additional capacity could be provided at a
reduced premium if the excess of loss exposure was considered to be remote. If the profile of the
account is such that only a few risks provide an unacceptable level of additional exposure, the insurer
may elect to reinsure them separately as facultative excess of loss risks.
Consider this…
In what situations might this be the case?

Facultative excess of loss reinsurance is appropriate when:

• additional capacity is required to handle risks exceeding its existing treaty limits; or
• no automatic cover is currently in existence for the particular class of business concerned; or
• the insurer does not want to expose its treaties to a certain risk; or
• certain risks are specifically excluded by the treaty reinsurers.
However, when opting for the use of the facultative excess of loss method, the reinsured must still
consider the disadvantages we looked at in chapter 2. Treaty excess of loss with its automatic protection
and simplicity of operation may still be a more attractive option.

A3B Application of facultative non-proportional reinsurance

We have already seen that business can be placed facultatively on either a proportional or non-
proportional basis and the factors influencing the decision of any insurer to opt for either type of
protection are very similar.