Key takeaways
– Facultative reinsurance is a reinsurance arrangement in which the reinsurer reviews and either accepts or declines individual risks or specific policies presented by the primary insurer (the ceding company).
– It is highly customizable and typically used for large, unusual, or catastrophic exposures that fall outside the scope of an insurer’s treaty programs.
– Facultative reinsurance can be more expensive and administratively intensive than treaty reinsurance but lets the ceding insurer write business it otherwise could not retain.
– Both facultative and treaty reinsurance may be structured on a proportional (share-the-premium/share-the-loss) or excess-of-loss (losses above a retention) basis.
What is facultative reinsurance?
Facultative reinsurance is a one-off reinsurance placement for a single underlying policy or a narrowly defined block of policies. The reinsurer has the option (i.e., the “faculty”) to accept or decline each submission. If the reinsurer accepts, the two parties execute a facultative certificate that sets out the terms, premium, and limits for that specific risk.
Why insurers use facultative reinsurance
– To place large individual risks beyond the ceding insurer’s retention or capacity.
– To obtain cover for unusual or high-severity exposures not adequately addressed by treaty programs.
– To reduce volatility from a single catastrophic exposure.
– To access specialist underwriting or pricing expertise from reinsurers on complex risks.
How facultative reinsurance works (mechanics)
1. Identification: The primary insurer identifies a risk (e.g., a $35 million property policy) that exceeds its desired retention.
2. Submission: The ceding insurer prepares a submission packet—policy wording, exposure data, engineering reports, valuation, loss history—and sends it to potential reinsurers.
3. Underwriting review: Each reinsurer evaluates the submission independently and decides whether to offer terms, and if so on what basis (limit, premium, attachment, exclusions).
4. Placement: The ceding insurer pieces together the required capacity, which may involve several reinsurers each taking a portion of the risk.
5. Documentation: Accepted arrangements are recorded in facultative certificates or slips that specify coverage, premium, conditions, and claims procedures.
6. Claims: If a covered loss occurs, claims are processed according to the negotiated terms; reinsurers pay their agreed share.
Facultative vs. treaty reinsurance — key differences
– Scope: Treaty covers a defined class or portfolio automatically (subject to treaty terms). Facultative covers individual policies on a case-by-case basis.
– Underwriting: Treaty relies on review of the cedant’s underwriting philosophy and historical results; facultative requires submission and review of each risk.
– Cost and resources: Facultative placements are generally costlier per-unit of capacity and require more underwriting resources. Treaties spread cost across many risks and involve less per-risk overhead.
– Use cases: Treaties supply ongoing, predictable capacity for a class of business. Facultative fills gaps—large single risks, new products, or non-standard exposures.
Advantages of facultative reinsurance
– Tailored coverage: Terms can be customized to the particular exposure and policy wording.
– Capacity flexibility: Enables ceding insurers to write larger risks without exceeding solvency/retention limits.
– Specialist expertise: Reinsurers with technical knowledge can price or structure coverage for complex risks.
– Risk selection: Reinsurers can decline risks they judge unsuitable, potentially improving the overall quality of reinsured exposures.
Limitations and costs
– Higher cost per unit of cover compared with treaty placements.
– Time-consuming underwriting and negotiation for each submission.
– Administrative burden: More documentation, certificates, and claims coordination.
– Placement risk: If sufficient capacity cannot be found, the ceding insurer may have to decline the original policy.
Illustrative example (conceptual)
A primary insurer is asked to write commercial property insurance with a $35 million limit on a major corporate headquarters. The insurer’s internal policy retention is $25 million. To be comfortable issuing the policy, the insurer seeks facultative reinsurance for the excess $10 million. It prepares a detailed submission and approaches reinsurers. Several reinsurers agree to take slices of the $10 million (e.g., three reinsurers each take $3.33 million). After terms are agreed and faculties issued, the insurer issues the policy knowing the potential $35 million exposure is reinsured.
Practical steps for an insurer considering facultative reinsurance
1. Assess need
– Identify exposures above retention or outside treaty scope.
– Quantify the maximum probable loss and capital impact.
2. Prepare high-quality submissions
– Include policy wording, valuation, engineering/inspection reports, loss history, risk controls, occupancy/use details, and any loss-prevention measures.
– Present clear limits requested and proposed retention.
3. Target appropriate markets
– Approach reinsurers with expertise in the relevant class (e.g., terrorism, catastrophe, energy).
– Consider brokers who have market access and can manage multilateral placements.
4. Structure the placement
– Decide proportional vs excess-of-loss or hybrid approaches.
– Negotiate premium, retentions, sub-limits, exclusions, and facultative slips/certificates.
5. Obtain documentation and internal approvals
– Secure signed facultative certificates or binding agreements.
– Obtain board or underwriting authority approvals per internal governance.
6. Integrate administratively
– Update policy records, accounting entries, and reinsurance tracking systems.
– Ensure claims teams know reinsurer notification and reporting requirements.
7. Monitor performance
– Track profitability, loss development, and reinsurer creditworthiness.
– Use facultative experience to inform treaty negotiations and pricing.
8. Post-loss management
– Follow agreed claims procedures, provide required documentation promptly, and coordinate loss adjustment with reinsurers.
Operational and regulatory considerations
– Credit risk: Reinsurer insolvency risk should be evaluated (ratings, collateral, trust accounts).
– Solvency and capital: Regulatory treatment of reinsurance for solvency margin and capital relief depends on jurisdiction and admissibility rules.
– Documentation: Facultative certificates should clearly spell out scope, premium, exclusions, and claims procedures to avoid disputes.
– Confidentiality and data sharing: Manage sensitive exposure data per privacy and regulatory norms.
When to prefer facultative over treaty
– Large single risks that exceed treaty limits or are excluded.
– New lines of business or entering unfamiliar territories.
– Unique or highly volatile risks where reinsurers need to price individually.
– Short-term or one-off transactions where treaty coverage is not practical.
Bottom line
Facultative reinsurance is a precise, case-by-case tool insurers use to manage outsized, unusual, or excluded risks. It offers customizable protection and access to specialist capacity but requires more underwriting effort and can be costlier than treaty reinsurance. Insurers should balance the flexibility and targeted protection of facultative placements against administrative burden and cost, using clear submission documentation, careful market selection, and disciplined claims and credit management.
Source
– Investopedia, “Facultative Reinsurance,” https://www.investopedia.com/terms/f/facultative-reinsurance.asp (accessed via user-provided link).