Introduction
Facultative reinsurance is a type of reinsurance where coverage is purchased by a primary insurer on a specific, individual risk or contract basis. Unlike treaty reinsurance, which covers entire portfolios of risks, facultative reinsurance provides underwriters with the ability to secure reinsurance for particularly large or hazardous risks that are not adequately covered under their existing treaties.
Concept of Facultative Reinsurance
Facultative reinsurance serves as a critical tool for insurance companies to manage their risk exposure on a case-by-case basis. It allows insurers to write policies that exceed their individual risk thresholds or retention limits by transferring the excess risk to a reinsurer. This arrangement is particularly important for large or unusual risks where the potential losses could significantly impact the insurer’s financial stability.
Scenario Overview
Imagine “SafeInsure”, an insurance company based in India, which has been approached to insure a new, state-of-the-art shopping mall in Mumbai. The total insured value of the project is Rs.200,00,00,000, a sum that greatly exceeds SafeInsure’s single risk retention limit of Rs.50,00,00,000.
Event Description
SafeInsure evaluates the risk and decides to insure the property but realizes that retaining the full risk exposure is not feasible due to its internal risk management policies. Therefore, it decides to seek facultative reinsurance to cover the excess value.
Facultative Reinsurance Process
Identification of Excess Risk:
- Total Insured Value: Rs.200,00,00,000.
- SafeInsure’s Retention Limit: Rs.50,00,00,000.
- Amount Needing Reinsurance: Rs.150,00,00,000.
Reinsurance Arrangement: SafeInsure approaches various reinsurance companies to secure a facultative reinsurance agreement for the Rs.150,00,00,000. After negotiations, a reinsurance company, “ReinsureGlobal,” agrees to take on the risk.
Premium and Reinsurance Terms:
- Facultative Reinsurance Premium: Calculated at a rate agreed upon based on the risk assessment of the shopping mall, let’s say 0.75%.
- Total Reinsurance Premium: 0.75% of Rs.150,00,00,000 = Rs.1,12,50,000.
Key Points to Keep in Mind:
- Risk Analysis: Detailed risk assessment is crucial to determine adequate coverage and fair premium rates.
- Reinsurance Contract Specifics: Clear terms regarding the extent of coverage, exclusions, and the duration of the reinsurance agreement.
- Regulatory Compliance: Ensuring all reinsurance arrangements comply with local insurance regulations.
Underwriting Scenario and Claim Payout
Underwriting Scenario: SafeInsure underwrites the policy with specific terms and conditions reflecting the large value and complex nature of the shopping mall. The policy includes a variety of covers such as property damage, business interruption, and public liability.
Claim Event: Two years into the policy term, a major fire damages a significant portion of the shopping mall, leading to a claim of Rs.80,00,00,000.
Claim Payout Process:
- SafeInsure’s Liability: Up to its retention limit of Rs.50,00,00,000.
- ReinsureGlobal’s Liability under Facultative Reinsurance: The remaining Rs.30,00,00,000.
Outcome The claim is settled with SafeInsure paying ₹50,00,00,000 and ReinsureGlobal covering the additional Rs.30,00,00,000. This distribution ensures that SafeInsure does not bear an overwhelming loss, which could impact its financial stability.
Conclusion This case study demonstrates the importance of facultative reinsurance in managing high-value or unusual risks. By utilizing facultative reinsurance, SafeInsure was able to accept a lucrative opportunity that exceeded its retention limits, while effectively managing its risk exposure. Facultative reinsurance not only provides a safety net for insurers but also enables them to expand their market presence and capability to underwrite more diverse and significant risks.
