The 3 Main Methods of Reinsurance: Treaty, Facultative, and Hybrid

Reinsurance is a critical risk management tool for insurance companies. It allows them to transfer a portion of policy risks to a reinsurer. There are three primary methods of reinsurance used – treaty, facultative, and hybrid. Each has advantages and disadvantages to consider.

Overview of Reinsurance Methods

  • Treaty reinsurance covers a predefined group or book of business through an ongoing agreement. The reinsurer automatically accepts all risks within the treaty scope.

  • Facultative reinsurance covers individual policy risks on a one-off negotiated basis. The reinsurer assess and accepts or declines each risk separately.

  • Hybrid reinsurance combines elements of treaty and facultative approaches. The insurer cedes certain risks meeting set criteria, which the reinsurer can review and accept or reject individually.

  • Most reinsurance arrangements use treaty or hybrid methods for efficiency. Facultative is used selectively for unique, complex or high-value risks.

  • The approach used depends on factors like portfolio size, risk diversity, ceding company preferences and capital resources.

What is Treaty Reinsurance?

Treaty reinsurance is the most common arrangement. It involves a standing agreement covering a specified book of business:

  • Reinsurer accepts all risks within scope without individual risk assessment.

  • Scope defined by line of business, geography, policy limits or other criteria.

  • Typically 12-month contracts renewed annually.

  • Premiums and claims shared on an ongoing proportional basis.

  • Administration is simple with little risk evaluation required.

  • Allows insurers to easily grow business volume and diversify risks.

  • Very common for high-volume, small-to-medium sized risk portfolios.

Advantages: Broad coverage, simple administration, portfolio diversification

Disadvantages: Reinsurer has limited underwriting control, high ceding commissions

What is Facultative Reinsurance?

With facultative reinsurance, risks are assessed and reinsured individually:

  • No pre-defined covered risk group. Applies to specific policies.

  • Ceding insurer offers risks, reinsurer evaluates and accepts/declines each one.

  • Typically used for large, unusual or complex risk exposures.

  • Reinsurer has full underwriting control to limit adverse selection.

  • Each policy reinsured is separately negotiated.

  • Higher administration costs but reinsurer retains selectivity.

  • Vital where treaty reinsurance capacity is unavailable.

Advantages: Flexibility, risk selectivity, covers unique exposures

Disadvantages: High administrative costs, less diversification

What is Hybrid Reinsurance?

Hybrid reinsurance combines elements of treaty and facultative:

  • Reinsurer automatically accepts risks meeting set underwriting criteria.

  • For risks exceeding criteria, reinsurer can individually assess and accept or decline.

  • Provides efficiencies of treaty approach with selectivity of facultative.

  • Simplified administration for risks meeting guidelines.

  • Individual risk evaluation when ceding insurer’s limits exceeded.

  • Balances ceding insurer’s portfolio needs with reinsurer’s risk management.

  • Also called facultative-obligatory or treaty-facultative reinsurance.

Advantages: Blends risk selectivity with administrative efficiency

Disadvantages: Complex to administer, still cedes some marginal risks

Detailed Overview and Comparison of Reinsurance Methods

Treaty Reinsurance Facultative Reinsurance Hybrid Reinsurance
Description Standing agreement covering a book of business matching predefined underwriting criteria. Covers individual risks separately on a negotiated basis for each specific policy.
Contract Duration Typically 12 months with annual renewal. Risk-by-risk basis. No defined contract term.
Risk Evaluation No individual risk underwriting. Automatically accepts all risks within treaty scope. Reinsurer evaluates and prices each risk individually, retaining underwriting control.
Premiums & Claims Proportional sharing of premiums and claims for all policies in scope. Premiums and claims handled on a policy-by-policy basis.
Administration Simple with minimal

What are the different types of reinsurance?


What is reinsurance and its methods?

Reinsurance, or insurance for insurers, transfers risk to another company to reduce the likelihood of large payouts for a claim. Reinsurance allows insurers to remain solvent by recovering all or part of a payout. Companies that seek reinsurance are called ceding companies.

What is the most common form of reinsurance?

The most common is called proportional treaties, in which a percentage of the ceding insurer’s original policies is reinsured, up to a limit. Any policies written in excess of the limit are not to be covered by the reinsurance treaty.

What is reinsurance and briefly explain 3 reasons why it is used?

Several common reasons for reinsurance include: 1) expanding the insurance company’s capacity; 2) stabilizing underwriting results; 3) financing; 4) providing catastrophe protection; 5) withdrawing from a line or class of business; 6) spreading risk; and 7) acquiring expertise.

What are the methods of treaty reinsurance?

Treaty reinsurance contracts can be both proportional and non-proportional. With proportional contracts, the reinsurer agrees to take on a specific percentage share of policies, for which it will receive that proportion of premiums. If a claim is filed, it will pay the stated percentage as well.

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