What is 'Cut-Through Clause'

A cut-through clause is a reinsurance contract provision that allows a party, other than the ceding company and reinsurance company, to have rights under the agreement. Cut-through clauses are often triggered by specific events, such as when a ceding company becomes insolvent.

BREAKING DOWN 'Cut-Through Clause'

The relationship between the ceding company and reinsurer changes when a cut-through clause is present. A reinsurance contract is made between a ceding company, such as an insurance company, and a reinsurance company. In exchange for a portion of the premiums generated by the ceding company’s underwriting activities, the reinsurance company agrees to indemnify the ceding company from claims made. This contractual relationship is strictly between the ceding company and the reinsurer, not between parties not included in the contract, such as policyholders. However, this changes in the presence of a cut-through clause.

Cut-through clauses are most commonly attached to reinsurance agreements when the ceding company is not in good financial shape, as the insured parties obtaining rights under the clause are most in need of protection when the insurance company is insolvent or cannot make payments on claims, or is liquidated by insurance regulators.

Policyholders like the added protection provided by cut-through provisions. Rather than having to work with insurance regulators to make claims against an insolvent insurer, policyholders can work directly with the reinsurer. Ceding insurers find the clause useful in that it makes the reinsurance company guarantee claims payments, which allows a company that may not typically be able to attract larger commercial clients to seem more stable and thus more attractive. Reinsurers find the clause useful because it can allow them to provide services in areas where it may not be licensed.

From the reinsurer’s standpoint, a cut-through clause functions as a competitive tool that enables the company to capture a certain type of reinsurance business. However, a reinsurer may be caught between conflicting demands for reinsurance recoverables from receivers, as well as from insureds and loss payees.  As a result, there is a significant effort to obtain specific statutory protection against double payments with respect to cut-throughs and guarantees is critical to reinsurers, insurers, insureds and loss payees in order to achieve the intended outcomes.

Cut-through clauses differ from cut-through endorsements. The latter is a side agreement between the policyholder and the reinsurer, and can be used in other circumstances such as when a reinsurer is not licensed to provide reinsurance in a particular area.

 

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