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A4B Use of facultative obligatory treaties
A facultative obligatory treaty may be needed purely to provide additional capacity to allow for the
May be needed to
provide additional expansion and development of an existing account. It may also be used to allow an insurer to maintain
capacity sufficiently high acceptance limits on large or target risks or where it is perceived that an accumulation
of risk problems may arise. Alternatively, it may be used to protect certain specific types or categories of
risks where the insurer deems it prudent to limit its own retention due to the degree of hazard
associated with the original business. For example, an insurer has automatic capacity to accept risks up
to £100 m. This is sufficient to enable it to write the risks that it is usually offered. In favourable market
conditions, the insurer sees opportunities to write more business on a selected number of larger risks
but it needs more gross capacity if it is to be able to take them on. In order to offer its clients the
capacity they seek, the insurer may choose to establish a facultative obligatory treaty.
A4C Advantages of facultative obligatory treaties

These arrangements are useful for risks which have already been allocated to existing quota share and
surplus treaties but where additional capacity is needed, without the expense and uncertainty of the
4 single risk facultative method being used. They represent a further source of additional cover for the
Chapter insurer, once other options have been exhausted.

A4D Disadvantages of facultative obligatory treaties
The obligatory element falls upon the reinsurer who must accept such cessions once the insurer has
decided to cede a risk. These treaties tend to generate small income for large capacity and so are not
always popular with reinsurers. This is not simply because results can often be poor, but also because
small premiums relative to high exposures mean that a single claim may have a significant impact upon
profitability.

It follows that in market conditions that favour reinsurers, these arrangements tend to be in short supply
and, where provided at all, offer commission rates and associated terms which are of no great advantage
to insurers. They present a less attractive rate of commission to the reinsured due to the level of anti-
selection present. Reference copy for CII Face to Face Training

Activity
Obtain placing slips or contract documents for two or three fac/oblig treaties, either for an actual placement or a
specimen text. Note whether the treaty limit is expressed on a lined or an unlined basis and compare it with the
underlying surplus treaty or treaties.

B Main accounting methods

This section looks at common ways in which the transactions under a proportional treaty are accounted
by the reinsured to the reinsurer.
In this type of business the reinsured provides an account at stated intervals, generally quarterly but
Reinsured provides
an account at stated sometimes half-yearly, which sets out the remittance due to and by the reinsurer for the activity during
intervals each period. In essence, the reinsurer is credited with the premiums ceded and is debited with the
commission allowed under the treaty, any taxes and charges for which it is liable, together with the
losses paid. Other items, such as premium and loss reserve deposit movements, and any portfolio
transfers are also credited or debited and a balance is struck for the period. After the statement of
account has been rendered and agreed, payment is made by the debtor, who could be the reinsured or
the reinsurer, to settle the balance.

B1 Underwriting year accounting

When a proportional treaty is put in place by a ceding insurer, the treaty takes cessions of policies
incepting during the period of the reinsurance. The inception date of each policy issued by an insurer
determines to which treaty year that policy is ceded. The reinsurer shares liability with the insurer for the
duration of the original policy by the reinsurer receiving its ceded portion of the policy premium and
paying its ceded portion of all losses from that policy. Irrespective of when a claim occurs and is settled,
the reinsurer which receives the written premium on the underwriting year basis is the one which pays
the claims. With this ceding and accounting method, the year of origin of the cession of the policy has
particular importance.