What is Franchise Cover

Franchise cover is a type of reinsurance plan in which the claims from a number of policies are aggregated together to form a reinsurance claim. Franchise covers are also known as loss trigger covers. Other types of non-proportional reinsurance with aggregate covers are aggregate stop loss reinsurance and catastrophe covers.

BREAKING DOWN Franchise Cover

One type of threshold used in reinsurance contracts is the franchise cover, which is used to limit the amount of reinsurance that is provided to a ceding insurer. Insurance contracts often require the insured to retain losses up to a certain threshold, with the insurer only covering losses that exceed this threshold. The amount of losses that the insurer will ultimately pay for is set by the policy’s coverage limit. Reinsurance contracts can have similar features, meaning that the reinsurer is not responsible for losses until a certain threshold is met.

Franchise determines minimum threshold of the insurance companies' financial responsibility. Some Insurers feel that to totally exclude an amount from a claim is a little harsh and adopt a different approach by applying a franchise. A franchise will apply to the policy in the same way and for the same reasons as an excess-of-loss, but in the event that a claim exceeds the franchise the full amount of the loss will be paid. If a claimant has a very small claim that is below the policy franchise then there will be no difference in the way that the two systems are applied – in neither case will any amount be paid. However, if the loss is above the franchise limit the amount will be paid in full.

When Franchise Covers Are Triggered

Franchise covers are triggered when a loss benchmark exceeds a predetermined threshold, at which point the reinsurer will cover the ceding insurer’s losses. The benchmark may be set to losses experienced by a particular line of business ceded by the insurer, or it may be set to losses experienced by the broader market. If the threshold is set to the experience of the broader market, the reinsurer and ceding insurer will agree on the exact benchmark to use and indicate this in the reinsurance contract.

For example, a property insurance company enters into a reinsurance contract with a franchise cover. The trigger is based on losses experienced by the broader market, with the reinsurer indicating that it will cover the ceding insurer’s losses if the market experiences $15 million in losses. The attachment point – the point at which the insurer will first pay – is set at $10,000. If the market experiences $20 million in losses the reinsurer will cover the ceding insurer’s losses in excess of $10,000.