What is 'Obligatory Reinsurance'
A reinsurance treaty in which the ceding insurer agrees to send a reinsurer all policies which fit within the guidelines of the reinsurance agreement. An obligatory reinsurance treaty, also called an automatic treaty, requires the reinsurer to accept these policies.
BREAKING DOWN 'Obligatory Reinsurance'
Insurers looking to shift the risks created by their underwriting activities can enter into a reinsurance arrangement with a reinsurer. There are two primary types of reinsurance arrangements: facultative and treaty. In a facultative reinsurance arrangement the reinsurer is able to choose which of the ceding insurer’s risks it wants to accept, while in a treaty reinsurance arrangement the reinsurer is obligated to accept all risks provided that they fall within the terms of the contract.
Obligatory reinsurance is a type of treaty reinsurance in which an insurer is required to cede and a reinsurer required to accept all risks that meet a set of predetermined conditions. This allows the insurer and reinsurer to develop a long-term relationship, as the insurer does not have to find a new reinsurer for every new risk. Each risk is automatically accepted under the terms of the arrangement, even if the insurer has yet to notify the reinsurer.
Because obligatory reinsurance features automatic acceptance, both the insurer and reinsurer need to be certain that the terms of the agreement include an accurate description of the type of risks that the treaty covers. This is an important step in removing ambiguities that, if left unaddressed, may require the arrangement to be canceled. If the ambiguities are discovered too late, it may be difficult to unwind the arrangement since risks may have already been exchanged.
Automatic acceptance also increases the risk of insolvency. Each party will want to make sure that the other is being managed properly, and that the interests of the ceding insurer align with those of the reinsurer.