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Chapter 4 Features and operation of proportional reinsurance treaties 4/13

If the risk does not fall within the scope or capacity of the treaty arrangements, the insurer must still
resort to the facultative method of reinsurance or retain the risk net.
• As with a quota share, where a risk falls within the scope of the treaty arrangements, the company is
bound by the treaty terms. The insurer has to fix its retention in accordance with its table of limits or
its underwriting practice and cede the risk to the reinsurer. It cannot deal with the risk in any other
way, for example, by making a new relationship with a different reinsurer, unless there is an
agreement in the treaty that further reinsurance can be sought and used for the benefit of the
reinsured.
• From the reinsurer’s point of view, the surplus treaty can result both in a widely fluctuating loss
experience and less desirable business, particularly in periods of intense competition. On the other
hand, lower rated or more hazardous business may be available in larger quantities and passed on to
the surplus treaty.
• The ceding commission is usually lower than if the treaty were a quota share. Also, second, third and
fourth surplus treaties have lower ceding commissions than first surplus.
• As discussed above in quota share, surplus treaties generally provide useful protection in the event of
natural catastrophes, but still leave the insurer with aggregate exposures in its net account. Chapter
Reinforce 4
Before you move on, make a note of some of the key differences between quota share treaties and surplus treaties.

A4 Facultative obligatory treaties

Facultative obligatory reinsurance is a form of treaty for the placing of a number of individual cessions. Refer to chapter 3,
section A2
You may recognise the commonly used abbreviation of ‘fac/oblig’. This type of treaty combines some of
the principles of both facultative and treaty methods of proportional reinsurance. Facultative obligatory
reinsurance is for
As with all treaties, the contract is made in advance but once the treaty is in place the insurer has the placing a number of
individual cessions
option whether or not to cede a risk to it. The obligatory element falls upon the reinsurer, who must
accept such cessions once the insurer has decided to cede a risk. In summary, the insurer may cede
risks of a specified agreed class which the reinsurer must accept if ceded. Reference copy for CII Face to Face Training

The reinsuring clause in a facultative obligatory contract wording can look like this:
The Company has the option to cede to the Reinsurer and the Reinsurer hereby agrees to accept
obligatorily by way of reinsurance, up to the limit of lines and the maximum amount set out in the
Schedule, a share of insurances underwritten direct by the Company, or accepted in coinsurance or by
way of facultative reinsurance from local companies, in the lines of business covered at the terms and
conditions and within the territorial scope set out in the Schedule.

Such arrangements provide considerable flexibility to the insurer and you can see that a high degree of
trust must exist between the parties so that the reinsurer receives a reasonable spread of risks.

A4A Operation of facultative obligatory treaties

The capacity provided by a facultative obligatory treaty can, like a surplus treaty, be expressed as a
multiple of the reinsured’s gross retention, that is, its line or the part it retains for its own account, but is
often simply a monetary limit, so this type of treaty can be described as lined or unlined.
As with other types of proportional treaties, once a risk has been ceded, premiums and claims will be
allocated in the same proportion that the original liability was apportioned. We have already seen that
there is no obligation to cede business on the part of the reinsured, and so risks attaching to such an
agreement are likely to be fewer and larger than those ceded to the surplus treaty. Consequently, they
are more likely to produce an unbalanced portfolio for reinsurers.

Consider this…
Why do you think reinsurers are likely to allow lower rates of commission for facultative obligatory than surplus
business?