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Chapter 3 Features and operation of facultative reinsurance 3/11

Key points

The main ideas covered by this chapter can be summarised as follows:
Main types and operation of facultative reinsurance
• It is important to establish exactly the coverage under both the original insurance policy and the facultative
reinsurance policy since the latter is usually designed to follow the terms, conditions and exclusions of the original
insurance policy on a ‘back to back’ basis.
• ‘As original’ terms under facultative reinsurance could cover all aspects of the original policy and can lead to
disputes between insurers and reinsurers if all terms and conditions, including exclusions and warranties, are not
clearly defined and understood at the time of the facultative placement. Chapter
Facultative proportional reinsurance 3
• Facultative proportional reinsurance allows the insurer to pass on a fixed share of a risk by ceding to one or more
reinsurers. The ceding insurer pays a share of the premium less commission and in return recovers the same share
of the original claim from the reinsurer in the event of a loss.
• The premium for the risk is shared between the parties concerned in the same proportion as the liability, so if a
reinsurer assumes 50% of the liability, it will receive 50% of the premium and pay 50% of claims up to the
policy limit.
Facultative obligatory reinsurance
• Facultative obligatory reinsurance combines some of the features of both facultative and treaty methods of
reinsurance.
Facultative non-proportional reinsurance
• Facultative non-proportional reinsurance is otherwise known as facultative excess of loss reinsurance.
• The ceding insurer chooses a fixed monetary amount, otherwise known as the excess or deductible, to retain on a
particular risk and arranges facultative excess of loss reinsurance to pay any claim amounts exceeding that fixed
monetary amount up to a further defined monetary amount which serves as the limit of cover.
• The ceding insurer may also decide to buy ‘common account’ protection if it wants to protect the cession made to
its proportional treaty reinsurers too. This benefits both the reinsured and its proportional treaty reinsurers to the full
sum insured potential of the original risk, so long as the limit of the reinsurance is sufficient. Reference copy for CII Face to Face Training
• Captive insurance companies purchase facultative excess of loss reinsurance as a means of achieving acceptable
levels of exposure.
• Facultative excess of loss reinsurance allows the ceding insurer to retain more of the original premium income
compared to facultative proportional reinsurance.
• Facultative excess of loss reinsurance is suitable when:
– additional capacity is required to handle risks exceeding existing treaty limits; or
– no automatic cover is currently in existence for the particular class of business concerned; or
– the ceding insurer does not want to expose its treaties to certain risks; or
– certain risks are specifically excluded by the treaty reinsurers.
• EML is important in determining the premium and deciding how much of the risk to accept and retain.
Calculation of reinsurance premiums and claims recoveries
• The reinsurance premium is the price of the cover charged by the reinsurer in consideration for offering to
underwrite the risk.
• Premiums for facultative excess of loss reinsurance are not proportional to values at risk because the potential
distribution of losses is unlike that found under facultative proportional reinsurance.