What Is Reinsurance ?- Facultative Reinsurance and Treaty Reinsurance

Sunday, March 05, 2017

Reinsurance is insurance that is obtained by an insurance company (referred to as the insurer) from another insurance company (referred to as the re insurer) as a means of risk management. The main function of procuring reinsurance is to transfer risk from the insurer to the re-insurer. The re-insurer and the insurer enter into a reinsurance agreement which specifics the conditions upon which the re-insurer would pay the insurer's losses in terms of excess of loss or proportional to loss. The re insurer is therefore paid what is termed as a reinsurance premium by the re-insurer.

Illustration:

Assume an insurer sells 1000 policies, each with a $1000 policy limit. In theory, the insurer could lose $1000 on each policy – totaling up to $ 1,000,000. It may be better to pass some of the risk to a re-insurance company ie re insurer as this will minimize the insurer's risk. Reinsurance essentially occurs when multiple insurance companies segment risk by purchasing insurance policies from other insurers in order to limit the total loss the original insurer would otherwise experience in case of disaster. By spreading the risk, an individual insurance company can take on clients whose coverage would be too great of a burden for a single company to handle alone. When reinsurance happens, the premium paid by the insured is classically shared by all of the insurance companies involved.

Reference cases

• Nasser mohamed omer v prudential assurance co ltd [1966]1 ea 79
• Corporate insurance co ltd v wachira [1995-1998]1 ea 20
• General accident insurance co (k) ltd v mutuma [1995–1998]1 ea 65
• Kariuki v irungu [2004]2ea 108
• Kasereka v gateway insurance co ltd [2003]2 ea 502
• Madison insurance co ltd v kinara and another [2005]1 ea 240

There are two basic methods of reinsurance, Facultative Reinsurance and Treaty Reinsurance

1. Facultative Reinsurance

Facultative reinsurance is a form of reinsurance in which a contract is negotiated for a specific insurance policy. This type of reinsurance is acquired when a policy is unusual or large and the original insurer is concerned about the liability risks. The policyholder is not cognizant that reinsurance has been taken out, in comparison with coinsurance in which multiple insurers can take on the risk of a policy together.

2. Treaty Reinsurance

Treaty reinsurance means that there is an agreement between the Re-insurer and a direct company occasionally called ‘ceding company’ where the re-insured undertakes or agrees to cede and the re-insurer reach agreement to accept all insurances offered within the limit of the agreement.

The treaty arrangement can be on any of the following:-

Quota Share:
Under this type of agreement, every business is shared on an agreed proportion and the ceding company cannot alone retain the business even if he has the capacity to retain that business.

Surplus:
The direct company only places on the treaty excess of the business that are above its retention. The direct company's retention is referred to as a line whereas the treaty capability is a multiple of that line.

Excess of Loss:
Here an insurer elects the maximum amount he/she is prepared to bear in the event of loss and thus buys re-insurance under an agreement that will make the re-insurer accountable for the losses in excess of the amount that is above the deductible of the ceding company. This is usually arranged in stratum.

Stop Loss or Excess of Loss Ratio:
This is for academic purpose only as we do not have any agreement arranged on this basis. This is a distinction of excess of loss whereby the loss ratio of the ceding company on particular accounts for example fire insurance is clogged at an agreed percentage and if the loss ratio has exceeded the agreed percentage the re-insurer bears the difference.

Tags : Insurance Law