As the individuals pay for risk transfer in the everyday life the insurance companies do it too. When they do not posses financial capacity for covering the mathematically expected losses they transfer the risk to reinsurers.
There are variances in contractual agreements between insurance companies and reinsurers. So what are the differences between facultative and treaty reinsurance?
Treaty reinsurance represents a contract between the ceding insurance company and the reinsurer who agrees to accept the risks of a predetermined class of policies over a period of time.
By signing a contract for reinsurance, the reinsurer and the ceding insurance company demonstrate that the business partnership is expected to be long-term. The long-term nature of the contract enables the reinsurer to plan how to earn a profit because it accepts the types of risk it assumes and is acquainted with the ceding company.
The usual reinsurance treaties are usually negotiated once per year and usually are one year long.
The ethimlogy of the word Facultative in the reinsurance sense comes from the late 14 century French faculte . It ment – “ability, opportunity, means, resources,” . So Facultative treaties are usually ad-hoc treaties which are created out of the planned yearly scope.
So usually the Facultative treaties are on one time basis.
There are Reinsurers which are specialized in Facultative treaties.
Definitivates (and moreover facultative reinsurers) generally focus on contingent risks while treaty reinsurers generally focus on compulsory risks. Indeed, both types of reinsurers also have complementary capabilities and specialisations. These are often gained through combining traditional commercial reinsurance with new or specialised reinsurance opportunities.
Concerning automatic rather than contingent risks, contingent risk can be classified into contingent (class 3) or involuntary (class 1).
Definitivites bear risks that other parties are generally not obliged to assume, and issuers of contracts expose themselves to additional expenses as a result of known high-risk contracts. Contingent risks are similar and extend beyond the provision of contracts. By contrast, involuntary risks are obligations of an insurer or insurer operating in an EU country to accept a payment by the issuer as a result of known high-risk contracts.
In attaining the highest possible returns, either treaty or facultative reinsurance tends to have a high cost. Also they are linked closely to the investment risk appetite and profit margins of the actual or potential client. Thus, price competition among reinsurers is often a key determinant of actuarial ability to provide superior reinsurance service.
Andrea Miteski, PhD and MD in the field of reinsurance. Long term senior insurance executive with specialization of reinsurance optimization.