day 8: types of reinsurance contracts – facultative reinsurance
TRANSCRIPT
Day 8: Types of Reinsurance
Contracts – Facultative
ReinsuranceTARIQ AL-BASHA
[email protected] – 00962 7 9767 7418
Index
Introduction to reinsurance contracts
About Tariq Al-Basha
Introduction
Relations between direct insurance companies (cedants) and reinsurers areformalized in writing by means of a document called a reinsurance contract.
In general, the legal parameters that have to be taken into account in areinsurance contract are as follows:
Enacted laws, both public and private.
Court judgments
The contract itself as applicable law
Reinsurance custom and practice
Practice has shown that the provisions agreed in the contract and internationalcustom and usage in reinsurance transactions tend to have priority over thepossible applicable legislation and jurisprudence.
Introduction (cont.)
In addition to the rules normally imposed by mercantile law (ability to contract,intention to create a legal relationship, etc.), reinsurance contracts must alsosatisfy the minimum conditions prevailing for any insurance contract:
1. Insurable interest: insurable and, in this case reinsurable, interest must exist and
commences when it is applicable for the direct insurer; in this way, the interest for the
reinsurer, and also its liability, commences from the time the direct insurer issues the
policy, and is limited by the amount and liability that it accepts under the contract.
2. Utmost good faith: as this is the principle upheld in the insurance profession, it has to be
one of the principles maintained by reinsurance. In this business, utmost good faith is
absolutely essential and must be very observed, since it is a relationship between
professionals of the same level, one of which, the reinsurer, on accepting a contract,
virtually hands the ceding company a blank check. The implicit trust can only be
achieved, in practice, through the cedant’s observance of this principle over time.
Introduction (cont.)
This principle is manifested in various ways in the course of the reinsurance relationship:
Information: the cedant has to provide the reinsurer with complete and reliable informationon the circumstances of the business ceded. This information is especially valuable as thereinsurer will decide on its participation, rates to be applied and share to be written. Thereinsurer should be informed of increases in risk, those that the cedant decides to cover forcommercial reasons (covers granted as a favor) any deviations from the provisions of thecontract.
Another way in which the principle of good faith is manifested is when the cedantexcludes from its policies those risks which, although accepted, can be construed asinappropriate for the risks for which the contract was created; special risks, etc.
As regards general information on accepted business, the cedant must provide reliableinformation on claims estimates, outstanding losses reserves, reliable and clear statistics,etc.
Introduction (cont.)
3. Indemnity: reinsurance contracts are contracts of indemnity. Contracts based ona purely speculative interest do not make sense.
4. Solidarity of interests (follow the fortunes): it is generally accepted that the
reinsurer’s and reinsured’s fortunes go hand in hand which means that, when a
circumstance arises that benefits one of the parties, it must also benefit the other. In
other words, the reinsurer and the reinsured must share equally any profits or claims
that arise. Although the principle of following the fortunes applies to all types of
reinsurance, in excess of loss contracts, situations can arise that favor just one of the
parties.
Introduction (cont.)
This principle in invaluable when interpreting dubious cases that can often
arise in view of the need for flexibility in reinsurance contracts and it is
related to the principle of continuity commented on below.
5. Risk transfer: an actual transfer of risk must take place in the business reinsured (in
the case of proportional contracts), or an actual risk must be covered (in the case
of non-proportional contracts and facultative excess of loss reinsurance) between
the cedant and the reinsurer.
6. Principle of continuity: closely related to the principle of following the fortunes,
this principal enables the parties to stabilize the results obtained over time,
compensating the other for claims transferred or, alternatively, paying back part of
the profits obtained.
Introduction (cont.)
By maintaining the reinsurance relationship over time, the reinsurer and the
cedant can participate in the results generated by the reinsurance
transactions
7. Arbitration: in the event of dispute between the cedant and the reinsurer, arising
from the interpretation of the reinsurance contract, instead of taking legal action
through the courts of justice, differences are usually resolved by arbitration, the
arbitrators being professionally recognized reinsurance experts.
8. Reinsurer’s solvency: since reinsurance cession transactions involve an
undertaking of future payment by the reinsurer, the reinsurer is required to have a
high level of solvency to cover the liabilities it accepts. A reinsurer’s insolvency is
very damaging for a cedant that is not released from its liabilities towards its
insureds.
Introduction (cont.)
Obviously, a reinsurance contract, in the same way as an insurance policy, has to be set out in awritten document, signed by both parties, setting out the characteristics of the risk transfer:
Period of cover
Class of business reinsured
Territorial limits
Type of risk transfer (cession) and its characteristics
However, and as happens in any commercial transaction, there are many different ways ofestablishing this reinsurer/reinsured relationship.
One basic difference and, therefore, general classification is the one that lists the parties’contractual obligations depending on whether they are irregular and sporadic (facultativeplacements) or whether they are permanent and fully binding obligation for both the insurerand the reinsurer for whole groups of business, whether by insurance class or entire portfolios(obligatory treaties).
Obligatory reinsurance is also known as automatic reinsurance.
Introduction (cont.)
Classification according to the reinsurer’s and the insurer’s “positions”
Reinsurer’s position
Has to accept the
risk
Free to accept the
risk
Insurer’s position
Obligation to cede
the risk
Obligatory (or
automatic)
reinsurance
Obligatory-
facultative
reinsurance
Free to cede the
risk or not
Facultative
obligatory
reinsurance
Facultative
reinsurance
Introduction (cont.)
Classification of Reinsurance
Obligatory treaties
Proportional (based on sum insured or PML)
Quota Share treaties
Surplus treaties Other types
Non-Proportional (based on
amount of claims)
Per-risk XL Per-event XLExcess of Loss or
Stop Loss
Obligatory treaties
Facultative Proportional
Facultative Non-Proportional
Classification by type
About Tariq Al-
Basha• Promoting entrepreneurship and innovative SMEs
in MENA Market.
• Business & Financial Modelling Consultant atseveral consulting firms in the Middle East.
• Independent business planning & feasibilitystudies specialist.
• Business management graduate from theUniversity of Greenwich, London – UK.