What is Treaty Reinsurance
Treaty reinsurance is a type of reinsurance in which the reinsurance company accepts all of a particular type of risk from the ceding insurance company. Treaty reinsurance is one of the three main types of reinsurance contracts, the others being facultative reinsurance and excess of loss reinsurance. Treaty reinsurers are obliged to accept all risks outlined in the treaty reinsurance contract.
BREAKING DOWN Treaty Reinsurance
When insurance companies underwrite a new policy, they agree to take on additional risk in exchange for a premium. The more policies that an insurer underwrites, the more risk it takes on. One way an insurer can reduce its exposure is to cede some of the risk to a reinsurance company in exchange for a fee. Reinsurance allows the insurer to free up risk capacity and to protect itself from claims of high severity.
Treaty reinsurance represents a contract between the ceding insurance company and the reinsurer, in which the reinsurer agrees to accept all risks of a predetermined class over a period of time. It differs from facultative reinsurance, which allows the reinsurer to accept or reject individual risks. Treaty reinsurance involves a single contract covering a type of risk, and does not require the reinsurance company to provide a facultative certificate each time a risk is transferred from the insurer to the reinsurer.
By signing a treaty reinsurance contract, the reinsurer and the ceding insurance company indicate that the business relationship is more likely to be a long-term one. The long-term nature of the agreement allows the reinsurer to plan out how to achieve a profit because it knows the type of risk it is taking on, and it is familiar with the ceding company. This type of contract is also less expensive than facultative reinsurance because it is less transactional and less likely to involve risks that would have otherwise been rejected from reinsurance treaties.
Benefits of Treaty Reinsurance
By covering itself against a class of predetermined risks, treaty reinsurance gives the ceding insurer more security for its equity and solvency and more stability when unusual or major events occur. Reinsurance also allows an insurer to underwrite policies that cover a larger volume of risks without excessively raising the costs of covering their solvency margins or "the amount by which the assets of the insurance company, at fair values, are considered to exceed its liabilities and other comparable commitments." In fact, reinsurance makes substantial liquid assets available for insurers in case of exceptional losses.