Reinsurance is an arrangement in which an insurance company transfers some or part of its risk to another insurance company. In other words, the insurance company purchases its own insurance coverage to minimize its exposure.
Reinsurance generally comes in two forms: facultative reinsurance and treaty reinsurance.
Facultative reinsurance covers specifically identifiable risks, while a treaty reinsurance arrangement means the primary insurer wants the reinsurer to cover all of its risks. The primary insurer and the reinsurer agree to a facultative reinsurance policy that covers specific risks, not the primary insurer’s entire book of business. The reinsurer has the right to accept or reject each risk on its own merits.
What’s an Example of Facultative Reinsurance?
Company A is an insurance company that insures commercial and residential properties in Florida. All of the properties it has insured to date are relatively low-value; however, it has an opportunity to insure a new building project (Building Project X) that is substantially greater in value than anything it has insured before. Company A is concerned that it does not have enough reserves to pay a potential claim on Building Project X, so Company A approaches Company B, a Bermuda-based reinsurer, for a facultative reinsurance policy on this specific building project only. The reinsurance agreement would not apply to Company A’s other insured risks.