What Is a Franchise Cover?

A franchise cover is a reinsurance plan whereby the claims from several policies are aggregated 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.

Key Takeaways:

  • A franchise cover, or trigger cover, is a reinsurance plan in which the claims from several policies are aggregated to form a reinsurance claim.
  • The franchise cover limits the amount of reinsurance provided to a ceding insurer. 
  • Franchise covers are triggered when a loss benchmark exceeds the predetermined threshold set according to a line of business or the experience of the broader market.

Understanding Franchise Covers

The franchise cover is a type of threshold used in reinsurance contracts to limit the amount of reinsurance 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 and Excess of Loss

Franchise determines the 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 small claim that is below the policy franchise, there is no difference in the way the two systems are applied—in neither case will any amount be paid. However, if the loss is above the franchise limit, the amount is paid in full.

Franchise Covers in Practice

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.

Example of Franchise Covers

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.