Facultative reinsurance is a form of reinsurance where there’s a contractual agreement between the reinsurer and the ceding insurer to share a specific risk or policy on a case-by-case basis. This type of reinsurance is designed to help insurers manage complex risks that go beyond their capacity and risk appetite. By doing so, they are able to protect themselves against financial ruin and other risks.
The primary benefit of this form of reinsurance is that it allows an insurer to transfer a portion of their risk to a reinsurer, ultimately helping to stabilize their financial standing and enhance the effective management of their portfolio.
How Does It Work?
The process of placing facultative reinsurance involves several steps. The first step before engaging in it is to identify the risk of the policy that you need coverage for. The ceding insurer is in the right position to identify the risks that require this form of reinsurance and the potential impact it would have on their portfolio.
Once the risks have been identified, the insurer and reinsurer will then engage in a negotiation process where they agree on the terms and conditions of the facultative reinsurance. The two parties determine the scope of the overage and premium rates, including the loss-sharing arrangements.
Once there’s a contractual agreement between the ceding insurer and the reinsurer, the facultative reinsurance will be formally placed with the reinsurer, who will assume a portion of the risk specified in the reinsurance agreement.
If the need ever arises to file a claim, the ceding insurer and reinsurer will work together to manage the claim and resolve further issues based on the terms and agreement of the facultative reinsurance.
Types of Facultative Reinsurance
Based on the structure of the reinsurance agreement, there are two major types of facultative reinsurance, which include;
- Proportional facultative reinsurance
- Non-proportional facultative reinsurance
Proportional facultative reinsurance is typically when the ceding insurer and reinsure come to an agreement about sharing the premiums and losses of the risk insured in accordance with their respective shares in their policy.
Here, the reinsurer’s share is being determined by a quota share or a fixed percentage, where the reinsurer assumes a specific percentage of the risks involved.
On the other hand, non-proportional facultative reinsurance, otherwise known as excess of loss reinsurance, offers coverage to the ceding insurer for the risk and losses that exceed a stipulated limit. This type of reinsurance implies that the liability of the reinsurer is not proportional to its share of the premiums but rather based on the amount of loss that exceeds the specified limit.
Pros
There are several benefits attached to this form of reinsurance. Both the ceding insurers and reinsurers get to enjoy these benefits.
- Improved risk management.
- Capacity Expansion.
- Access to expertise and resources.
- Financial Stability.
Through the transfer and sharing of risk portfolios among reinsurers, insurers are able to improve their risk management, expand their capacity, and gain access to a myriad of resources, including financial stability. All of these are essential to maintaining a strong market presence and development.
Cons
Although facultative reinsurance offers loads of benefits, it also has its own downsides and challenges. Some of its drawbacks are highlighted below:
- It is complex.
- It is costly.
- It is a time-consuming process.
- There’s potential for disputes.
- Counterparty risk.
What Type of Risk Does Facultative Reinsurance Cover?
It is designed to cover a wide range of risks that could pose a danger or threat to the lives of policyholders. Specifically, it covers risk under life, property, and liability insurance. However, insurers should review the terms of the reinsurer in order to get a better understanding of the types of risks they provide coverage for.
How Are Premiums Calculated Under Facultative Reinsurance?
Typically, premiums for facultative reinsurance are calculated based on the type of coverage you seek, the risk involved, and the insurer’s underwriting standards. Also, there are other things that could affect the premiums, such as market conditions, the insurer’s claim history, and the reinsurer’s financial stability.
Therefore, it is important to understand that these factors have an adverse effect on your premiums. It is now left to the insurer and reinsurer to come to an agreement on how the premiums will be calculated and settled.
