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What Is Facultative Reinsurance?

An insurer might be more likely to take out facultative reinsurance for areas prone to natural disaster.
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  • Written By: Mary McMahon
  • Edited By: O. Wallace
  • Last Modified Date: 16 August 2014
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Facultative reinsurance is a form of reinsurance in which a contract is negotiated for a specific insurance policy. This type is purchased when a policy is unusual or large and the original insurer is concerned about the liability risks. The policyholder is not informed that reinsurance has been taken out, in contrast with coinsurance, in which multiple insurers take on the risk of a policy together. The other type is treaty reinsurance, in which a group of policies or risk categories are covered together.

Reinsurance is essentially an insurance policy on an insurance policy. When an insurance company takes on risks in the form of policies, it may be concerned that it will have difficulty covering those risks, or that the company could experience financial hardship if a large group of claims happened at the same time, as might occur in a natural disaster. The company mitigates its risks by taking out a reinsurance policy with another insurance company. This policy is used to cover the original policy.

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In facultative reinsurance, the terms of the contract are negotiated for a specific policy. The reinsurer has the right to evaluate the risks involved, unlike in treaty reinsurance, when it cannot evaluate individual risks. The company proposes a price that it believes to be reasonable, and if the insurance company agrees, then the policy is written. Periodically, the terms are reviewed, giving both parties a chance to walk away from the contract if they feel that it is no longer necessary, that the policy is too risky for the reinsurer, or that the terms need to be renegotiated.

This type of reinsurance is generally used for tricky policies that may require some special coverage, with large policies as the obvious candidates. For the reinsurer, the advantage of such a policy is that it allows the company to develop a customized policy that will meet the needs of the specific situation, and the situation is less risky for them, because they have a chance to assess the individual risks and determine a rate for the reinsurance which they deem reasonable.

Facultative reinsurance is highly specialized and offered only by a small number of insurance companies. Along with treaty reinsurance, it is designed to ensure that insurance companies have the ability to cover their policies.

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anon335471
Post 4

Facultative Reinsurance provides coverage for a special single risk that cannot fit into a cedant's treaty due to its nature or even size. It therefore provides the capacity for insurance companies to underwrite most of the businesses, which would otherwise not have coverage.

We also need to note very well that reinsurance companies buy covers from other big reinsurance companies, a process called retrocession. This assists in reducing the risk of going under. I think this makes sense and makes insurance a sensible venture. Leonard C., Nairobi, Kenya

anon252562
Post 3

If the reinsurer goes into run-off the liability of the initial insurer remains; it must meet the policy holder's claim. As was posted below, fac resinurance improves the security of the original insurer.

Of course, if the insurer simply cannot meet the claim then the entire company will become insolvent and its capital will have to be divested amongst all stake holders, including shareholders. Insurance is risk transfer, but you never release yourself from the risk in its absolute entirety due to the varying financial strength of the insurer.

anon196820
Post 2

I would hope that the policy holder would choose an insurance company that has a solid, credible financial rating. The reinsurance is creating less of a risk for the policy holder than anything.

PBJ
Post 1

Sounds like a lot of legal mumbo-jumbo to me. I guess I just get frustrated when insurance companies go into things like this because it seems like it could turn out really badly for the policy holder.

For example, what if one of the companies that was covering part of the policy went out of business? What would happen to that part then, would it just not be covered any more?

I'm definitely not an expert on insurance policies, but I can just really see the potential for this to go wrong. Anybody else?

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