Ultimate Guide to Treaty Reinsurance
There may come a time when an insurance company does not have enough working capital to back all the policies they want to underwrite. Or, an insurance company may wish to purchase reinsurance to help minimize their risk on a certain policy or book of business.
In these situations, an insurance company could consider purchasing reinsurance. Reinsurance is where an insurance company will transfer portions of their risk portfolios to other parties through some form of agreement.
There are different forms of reinsurance available, but one of the most common types is known as treaty reinsurance.
This article will outline the nature of treaty reinsurance in detail. We will explain what it is, how it works and outline some considerations for an insurance company looking to purchase it.
What is Treaty Reinsurance?
Treaty reinsurance refers to an agreement between an insurance company (the “ceding company”) and a reinsurer or group of reinsurers (the “cedant”). Under this agreement, the cedant will accept the risks of a portfolio of policies underwritten by the ceding company. These risks are typically documented in a reinsurance contract, in return for the payment of a premium.
Reinsurance effectively transfers a portion of a ceding company’s liabilities to a cedant. As a result, the insurance company can protect itself with assurance that the risks falling within the terms of the treaty agreement will be reinsured by the cedant. So once an insurance company has established a treaty reinsurance agreement with a reinsurer, they can free up capital to allocate elsewhere such as underwriting new policies, or expanding to a new market.
Treaty reinsurance is sometimes called obligatory insurance as reinsurers do not underwrite each individual policy themselves, but all risks as defined by the parameters of their contract with the insurance company.
Treaty reinsurance contracts are typically long-term relationships. This is because, unlike faculty reinsurance, the reinsurer has agreed to assume the risks for a swathe of policies and not simply a specific risk.
Practical example: Superstorm Sandy, USA
In 2012, Superstorm Sandy (a post-tropical cyclone) caused a tremendous amount of destruction across more than 20 U.S. states. Tens of thousands of insurance claims were made, with the total amount claimed exceeding US $20 billion.
Many insurance companies who met these claims were able to do so because they had reinsurance. Swiss Re, a Zurich-based reinsurance company, reported that Superstorm Sandy would cost them approximately US $900 million. Bermuda-based Arch Capital Group also reported that 60% of its losses from Superstorm Sandy came from its reinsurance operations.
Types of Treaty Reinsurance
There are two types of treaty reinsurance contracts that are normally available. These are proportional and non-proportional contracts.
- Proportional contracts (also known as pro rata contracts) are where a reinsurer agrees to take a share of insurance policies and pay a specific percentage if a claim is then filed. In return, the reinsurance company receives a corresponding proportion of premiums. For example, a reinsurer may agree to accept the risk of 20% of an insurance company’s D&O insurance policies, meaning they would then pay out 20% of all claims on those policies. In return, they’ll collect 20% of the ceded premiums on those policies.
- Non-proportional contracts, in contrast, are where a reinsurance company will agree to pay out claims only if they exceed a certain amount during a period. For example, a reinsurer may agree to pay out 40% of claims on an insurer’s cyber insurance policy if the claims exceed $200,000 in the first three years.
Benefits of Treaty Reinsurance
- Opportunity to grow – reinsurance allows insurance companies to scale their operations by expanding their book of business and offering a greater number of insurance policies to their customers.
- Greater stability – reinsurance allows an insurance company to limit their claims volatility with respect to the policies they have underwritten. This is particularly so in the event of a major event.
- Control of underwriting – unlike facultative reinsurance, treaty reinsurance allows the ceding company to retain a greater level of control over their policy underwriting.
- Cheaper than other forms of reinsurance – treaty reinsurance is generally more affordable than other forms of reinsurance, such as facultative reinsurance.
- Long-term relationship – this type of reinsurance allows an insurance company to develop a long-term relationship with a reinsurance company, who will get to understand their business and their product offerings. They will therefore be in an ideal position to help them find solutions to potential future challenges.
Treaty reinsurance versus facultative reinsurance
While treaty reinsurance only requires entering into a single contract to cover a class of risk, facultative reinsurance is more specific with the insurance company purchasing reinsurance only on certain particular risks. Facultative reinsurance agreements are negotiated separately and may involve the drawing up of several different contracts so the expenses involved are typically higher.
You can read more specifically about the differences between treaty and facultative reinsurance here.
Wondering if treaty reinsurance is right for you?
There are a number of considerations to take into account when looking to enter into a reinsurance agreement.
If your insurance company is looking to expand its capital or minimize its risk on existing policies, then treaty reinsurance may be a cost-effective option for you to select.
Before you make the decision, it is important that you discuss your options with an experienced insurance broker to determine how reinsurance can help support your insurance company’s operations.
Axxima specializes in crafting tailored reinsurance options that help you achieve your organizational objectives. Using our expertise in the reinsurance market, we help our clients navigate their risks and exposures, ultimately selecting the best reinsurance option to help them minimize their losses and grow their business.
Get in touch with the team at Axxima today to discuss your reinsurance options.