DEFINITION of 'Facultative Reinsurance'
A type of reinsurance contract that covers a single risk. Facultative reinsurance is one of the two types of reinsurance contract transaction, with the other type being treaty reinsurance. Facultative reinsurance is considered to be more transaction-based than treaty reinsurance.
BREAKING DOWN 'Facultative Reinsurance'
Companies that enter into a reinsurance contract with a reinsurance company do so in order to pass off some of the risk that they face in exchange for a fee. In the case of an insurance company using a reinsurer, that fee may be a portion of the premium that the insurer receives for underwriting a policy. The company that cedes the risk to the insurer has the option of ceding a specific risk or a block of risks. Reinsurance contract types determine whether the reinsurer is able to accept or reject an individual risk, or if the reinsurer must accept all risks.
Facultative reinsurance allows the reinsurance company
to review individual risks and determine whether to accept or reject the risk. How profitable the reinsurance company is in this type of contract arrangement depends on which of the risks the reinsurer decides to take on.
In a facultative reinsurance arrangement, the ceding company and the reinsurer create a facultative certificate that indicates that the reinsurer is accepting a specific risk.
Companies looking to cede risk to a reinsurer may find that facultative reinsurance contracts are more expensive than treaty reinsurance. This is because treaty reinsurance covers a “book” of risks, which is an indicator that the relationship between the ceding company and the reinsurer is expected to be more long-term than if the reinsurer only dealt with one-off transactions covering single risks. While the increased cost is a burden, a facultative reinsurance arrangement may allow the ceding company to reinsure a risk that it may otherwise not be able to do, given a block of risks.Source: www.investopedia.com