What Are the Three Types of Reinsurance?

Insurance companies seeking reinsurance to mitigate large payouts related to individual risks or catastrophe coverage are known as ceding companies.

Reinsurers who assume risk are known as reinsurers, while arrangements to transfer that risk are known as reinsurance treaties – single or multiple contracts can form these arrangements.

Proportional

Proportional reinsurance is one of the most prevalent forms of reinsurance. This method involves an agreement between insurers and reinsurers to share risks and premiums on an agreed percentage basis, providing advantages such as reduced exposure, improved loss control, and enhanced financial security for both sides.

Proportional reinsurance allows insurers to expand their underwriting capacity, enabling them to take on more extensive policies or new lines of business. Furthermore, reinsurers offer their expertise and resources as tools that help insurers improve risk evaluation and underwriting practices.

As with other forms of reinsurance, proportional agreements depend on effective communication and cooperation among the parties involved. Insurance and reinsurer must establish precise loss allocation mechanisms and dispute resolution processes while keeping abreast of market developments to make necessary changes to their arrangements accordingly.

Proportional reinsurance can be complex and resource-intensive to manage. Furthermore, it may tie up capital that could otherwise be utilized elsewhere – leading a ceding insurance company to increase capital reserves or post collateral to secure the transaction. Achieving an optimal balance between capital efficiency and risk transfer should be struck for proportional reinsurance benefits to outweigh associated capital requirements.

Facultative

Facultative Reinsurance is the easiest and least complex way for insurers to secure reinsurance protection. Under this strategy, an insurance agency, known as a ceding company, arranges individual reinsurance agreements with reinsurers for each risk it surrenders; each of these reinsurance contracts contains specific terms and conditions that allow reinsurers to accept or reject each risk individually; these can either be approached directly by ceding company representatives or through brokers; these deals tend to be cheaper than treaty reinsurance agreements yet can become transaction-driven over time.

At times, primary insurers will seek facultative reinsurance for one policy in their portfolio to allow the reinsurer to evaluate each risk individually and determine whether to take on it. This practice often occurs when ceding companies (i.e., primary insurance companies) wish to transfer a large portion of risk from policies that have yet to be priced by ceding company and ceded back directly.

Treaty reinsurance occurs when the ceding company transfers all risks within an individual business book to a reinsurer, often for large and expansive group policies such as all of a primary insurer’s commercial auto or homeowners business.

Treaty

Treaty reinsurance occurs when an insurance company agrees with a reinsurer to cover multiple policies simultaneously. It typically involves larger volumes than facultative reinsurance and often operates non-proportionally; hospitals often utilize this form of cover.

Once the terms of an agreement have been agreed upon, any new policy that meets them is automatically reinsured by the reinsurer until its agreement has been canceled – an advantage over quota systems where individual insurance companies retain complete decision-making control for each policy they cede to them.

There are various treaty reinsurance policies, but they all share similar fundamental benefits for insurance companies, such as risk sharing and capital relief. This can include quota share treaties, surplus treaties, and excess of loss treaty contracts – these options provide unique advantages to insurance firms looking to strengthen and stabilize their finances.

Treaty and facultative reinsurance differ primarily by treating each policy individually while covering multiple risks in one package of policies. Treaty reinsurance involves longer-term relationships and is more costly; however, facultative coverage offers more excellent coverage against catastrophic losses than treaty options.

Excess

Excess reinsurance is essential to the insurance industry, protecting insurers against significant losses that could threaten their financial security and solvency. Excess reinsurance also helps stabilize the financial results of insurance companies and enables them to continue paying claims to policyholders.

Pricing and negotiating excess reinsurance contracts involve several considerations and variables. An insurer’s historical loss experience and exposure profile play an integral part in setting the terms of their contract and reinsurers’ capacities and willingness to accept more risk, which can affect pricing.

Under an excess of loss agreement, the primary company retains a certain liability amount for losses and pays a fee to their reinsurer for coverage above this retention. This arrangement tends to be more cost-effective than proportional reinsurance while protecting from frequent and severe losses.

Some reinsurance agreements are also negotiated on an asymmetrical basis, rather than a pro-rata basis, such as catastrophe bonds and side-cars which take an alternative approach to spreading risk than treaties. Such arrangements can be more complex than their counterparts and pose regulatory, legal, and commercial concerns for insurers.