What is 'Obligatory Reinsurance'

Obligatory reinsurance is reinsurance 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'

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.

Types of Reinsurance

Facultative coverage protects an insurer for an individual or a specified risk or contract. If several risks or contracts need reinsurance, each is negotiated separately. The reinsurer has all rights for accepting or denying a facultative reinsurance proposal. Treaty reinsurance, meanwhile, is effective for a set time period rather than on a per-risk or contract basis. The reinsurer covers all or a portion of the risks that the insurer may incur. Both of these types of reinsurance may be classified as obligatory if the reinsurance contract mandates all policies that fall within the scope of the contract are transferred.

By contrast, an obligatory-style contract isn't available for some types of reinsurance. Those types of reinsurance include proportional reinsurance and non-proportional reinsurance. Proportional reinsurance is where the reinsurer receives a prorated share of all policy premiums sold by the insurer. When claims are made, the reinsurer bears a portion of the losses based on a pre-negotiated percentage. The reinsurer also reimburses the insurer for processing, business acquisition, and writing costs. With non-proportional reinsurance, the reinsurer is liable if the insurer's losses exceed a specified amount, known as the priority or retention limit. As a result, the reinsurer does not have a proportional share in the insurer's premiums and losses. The priority or retention limit may be based on one type of risk or an entire risk category.

RELATED TERMS
  1. Reinsurer

    A reinsurer is a company that provides financial protection to ...
  2. Treaty Reinsurance

    Treaty reinsurance is a type of reinsurance in which the reinsurance ...
  3. Reinsurance Credit

    Reinsurance Credit is an accounting entry made by an insurer ...
  4. Following Reinsurer

    A following reinsurer is a reinsurance company that signs onto ...
  5. Spot Reinsurance

    Spot Reinsurance is a reinsurance agreement that covers a single ...
  6. Schedule F

    Schedule F is a section in an annual insurance statement in which ...
Related Articles
  1. Insurance

    The Business Model of Reinsurance Companies

    Learn about the business of reinsurance, a hidden industry that underpins the entire financial and insurance structure around the globe.
  2. Tech

    The Reinsurance Industry: An Inside Look (BRK.A)

    Warren Buffett has a major influence on the global reinsurance market, which has seen momentum in 2016 for higher revenue.
  3. Insurance

    How Does Reinsurance Work?

    Reinsurance is a practice in which insurers transfer portions of portfolios to other parties in order to reduce their exposure to claims.
  4. Taxes

    2 Ways Hedge Funds Avoid Paying Taxes

    Learn about two strategies hedge funds use to minimize their tax liabilities. Read why some hedge funds are in the reinsurance business in Bermuda.
  5. Trading

    Are Derivatives A Disaster Waiting To Happen?

    They've contributed to some major market scandals, but these instruments aren't all bad.
  6. Small Business

    Berkshire Hathaway Stock: Analyzing 5 Key Customers (BRK)

    Discover how Berkshire Hathaway began as a failing textile company and grew into the fifth-largest company worldwide with help from its key customers.
  7. Insurance

    The 5 Big Names in Canadian Insurance

    These Canadian companies are known around the world for their products. The big five include Manulife, Power Financial, Sun Life, Fairfax, and iA Financial Group.
  8. Tech

    How Big Data Has Changed Insurance

    No longer confined to technology, big data has become integral to providing solutions to the insurance industry's long standing challenges.
  9. Insurance

    Why Health Insurance Premiums Will Rise in 2017

    To battle the costs and challenges of the Affordable Care Act, many health insurances are raising their premiums in 2017.
  10. Insurance

    What If Your Long-term Care Insurance Carrier Goes Bust

    When a long-term care insurance carrier goes bust, what happens to policyholders?
RELATED FAQS
  1. What is the main business model for insurance companies?

    Read about the most important components of an insurance company business model, such as risk pricing, investing and claims ... Read Answer >>
  2. What is the financial services sector?

    The financial services sector consists of a diverse group of companies that goes beyond banks and credit unions. Read Answer >>
  3. What are the most popular mutual funds that invest primarily in the insurance sector?

    Understand why investors may be interested in investment opportunities in the insurance sector, and learn which mutual funds ... Read Answer >>
  4. Can an Insurance Company Deny Coverage?

    Insurance isn't always as straightforward as other products, and insurers can deny coverage in many different instances. ... Read Answer >>
Trading Center