Facultative Reinsurance: A Pillar of Trust and Judgment
CA Chandrasekaran Ramakrishnan
Technical Consultant, Reinsurance Practitioner, Member, Reinsurance Advisory Committee of IRDAI
Facultative reinsurance is one of the oldest and most straightforward forms of risk transfer in the insurance and reinsurance industry. Despite its simplicity, it remains a critical component of reinsurance practices, deserving continued attention and analysis. This essay explores the core characteristics and nuances of facultative reinsurance, emphasizing its reliance on trust, underwriting judgment, and the interplay between insurers and reinsurers.
Defining Facultative Reinsurance
Facultative reinsurance refers to the arrangement where a cedant (the original insurer) transfers a portion of an individual risk to a reinsurer. This is done on a case-by-case basis, allowing the cedant to cede risks that exceed their retention capacity. Importantly, there is no obligation for the cedant to offer a particular risk to the reinsurer, nor is there any compulsion for the reinsurer to accept it. Each transaction is negotiated independently, highlighting the discretionary nature of facultative arrangements.
The cornerstone of facultative reinsurance is the reinsurer’s ability to evaluate the risk independently. Acting as a direct underwriter, the reinsurer assesses the information provided by the cedant before deciding to accept or reject the offered risk. This underscores the necessity for comprehensive and transparent underwriting information to facilitate informed decision-making.
The Role of the Cedant’s Judgment
A distinguishing feature of facultative reinsurance is that the cedant has already exercised its underwriting expertise by accepting the original insurance risk. This initial underwriting decision implies that the cedant’s judgment carries significant weight. For a reinsurer, this means the cedant’s evaluation forms the basis of the offered risk, provided that the cedant demonstrates sound underwriting practices and retains a reasonable share of the risk on their own account.
When the reinsurer trusts the cedant’s underwriting acumen and perceives that the cedant has retained an appropriate portion of the risk, the reinsurer may adopt a "follow the fortunes" approach. In such cases, the reinsurer might accept the risk without requiring exhaustive underwriting details, relying instead on the cedant’s judgment and expertise.
Balancing Trust and Due Diligence
While facultative reinsurance is inherently built on the principle of trust, this trust is not blind. A prudent reinsurer must assess not only the technical aspects of the risk but also the motives of the cedant in offering the risk for reinsurance. A reinsurer’s experience often allows them to discern whether a cedant is attempting to offload an undesirable risk. This evaluation hinges on several factors:
By carefully analyzing these elements, a skilled reinsurance underwriter can identify potential red flags and make informed decisions.
The Dual Principles of Facultative Reinsurance
Facultative reinsurance is underpinned by two key principles:
The Principle of Trust: Effective facultative reinsurance depends on mutual trust between the cedant and the reinsurer. This trust enables streamlined decision-making and fosters long-term partnerships.
The Principle of Underwriting Judgment: Reinsurance is not solely about assessing risks but also about evaluating the entities presenting those risks. This requires reinsurers to exercise their judgment in underwriting both the risk and the cedant.
Conclusion
Facultative reinsurance, though simple in concept, encapsulates profound aspects of the reinsurance industry. It exemplifies the art of balancing trust with meticulous judgment, requiring reinsurers to evaluate not only the technical merits of a risk but also the motives and reliability of the cedant. As such, facultative reinsurance is as much about underwriting people as it is about underwriting risks. In a world of ever-evolving insurance needs, the enduring relevance of facultative reinsurance lies in its flexibility, transparency, and the indispensable role of professional judgment.
National Head Liability Underwriting & Claims at The New India Assurance Co. Ltd.
8moVery informative
Reinsurance Specialist | Global Market Development | Legal & Compliance Acumen. M.B.A ,LL.M. , LL.B.
8moInsightful Insights on Facultative Placements Sir. Very much a underwriters judgment game.
Technical Consultant Worked with Cholamandalam Ms Gen Insurance, New India Assurance co. Ltd
8moThe candid presentation on the fundamentals of Facultative reinsurance cannot be explained better.Your emphasis of how important is trust transparency and judgement of cedant is very well understand in many cases now. The lack of the same results in Fac reinsurers doing multiple post loss inspection and protracted correspondence with loss assessors and cedants claim managers post loss.
General Manager
8moFacultative placement is frequently sought to augment underlying treaty capacity either as Fac/Obligatory or individual risk. In soft market phases, facultative reinsurers tend to set risk premiums in line with their assessment which may not be aligned with primary rates. Negotiations are leveraged by business volume shared with the cedant for accommodation. Single risks on a random basis are non-preferred due to anti-selection concerns.
Advocate, Supreme Court of India, New Delhi
8moVery well explained shorn of hyper-technicalities. Very impressed. Similar writeup on treaties is solicited.