Insurance

Advantages And Disadvantages Of Facultative Reinsurance

Broadly, there are two main ways through which reinsurance may be distinguished. These are, Facultative reinsurance, and Treaty reinsurance. Both types of reinsurance are having their Advantages And Disadvantages. Here I am discussing the major Advantages And Disadvantages Of Facultative Reinsurance along with how this Reinsurance works. I will discuss relative Advantages And Disadvantages Of Treaty Reinsurance later.

How Facultative Reinsurance Works:

Facultative Reinsurance is the original form of reinsurance. Participation by reinsurer in a risk is not prearranged through a standing treaty contract. Reinsurance has to be arranged by the insurer after getting a proposal of insurance from the company would be insured and preferably before giving any cover to the proposer. Generally, after getting a proposal for insurance, the insurer decides as to how much he can retain on that particular risk. If there remains a balance after retention, he goes to facultative market with the request to make reinsurers interested in the risk.

This request is usually made through a slip detailing the particulars of the risk. If a reinsurer is interested in the risk then he initials the slip clearly indicating the percentage or amount of risk he is willing to subscribe in this way the insurer goes from re-insurer to reinsurer unless 100% of the risk is absolved. It is only then that the insurer is theoretically safe in issuing a cover to the insured for full amount. It should be known by the students that reinsurers are not bound to accept a risk when approached.

Example : Insurance company XYZ has received a proposal for USD 1,00,00,000 from a jute mill. For a jute mill the company’s retention is USD 10,000,00. The company has no standing treaty arrangement.

This means that if company XYZ has to accept the full risk, it must go for facultative reinsurance and try the market until the full USD. 1 crore is absolved. After trying ten companies, say by the names A, B, C, D, E, F, G, H, I and J, the final closure of the business may look as follows

Company     Percentage of acceptance          Amount of acceptance.

A                     20%                                                        USD 20,00,000

B                     15%                                                        USD 15,00,000

C                     15%                                                        USD 15,00,000

E                      10%                                                        USD 10,00,000

G                     10%                                                        USD 10,00,000

H                     10%                                                        USD 10,00,000

J                      10%                                                        USD 10,00,000

10%                                                                                USD 10,00,000

XYZ (Retention) 100%                          USD 1,00,00,000

In this way the whole amount has been absolved and there is no difficulty of the XYZ Insurance Company in assuming the whole risk of USD 1 crore from the jute mill. The readers should realize from the above example that companies D, F and I were also tried but they refused to participate in the risk as reinsurers.

My readers should also appreciate that if the ceding company (XYZ), after trying all possible sources, could only manage up to 90% (including its retention) then, in theory, it would not have been possible on its part to assume the risk from the jute mill for the full amount, since such an attempt would create an undesirable additional pressure on its fund to the extent of USD 10,00,000, for which there is no provision there. It should be borne in mind by the visitor that in case of a loss, it will also be paid by the reinsurers in the same proportion.

Advantages And Disadvantages Of Facultative Reinsurance

Advantages Of Facultative Reinsurance:

i. This type of reinsurance is advantageous to ceding company since it can pick and choose as to which risks are to be reinsured and which risks are not.

ii. It is advantageous to reinsurers because they can apply underwriting judgment case by case and may accept o reject. This is not so in treaty arrangements.

Disadvantages Of Facultative Reinsurance:

i. The formalities involved in obtaining cover is much more expensive in comparison to treaty.

ii. Lot of inconvenience is envisaged in the procedure involved.

iii. The insured is left insecure during the time required for the arrangement of facultative reinsurance cover. Any mishap may take place during this period.

iv. Such a situation arising out of (iii) above may cause the business to be lost to a competitor who might have automatic treaty cover. The readers should, however, note that even though the demerits outweigh the merits, nevertheless, such a practice is still there for necessity and shall remain, howsoever advantageous the treaty arrangements might be.

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