Insurers will often strategically seek reinsurance to manage risk and expand their capacity to underwrite policies.
Reinsurance allows them to transfer portions of their risk portfolios to another party, ensuring financial stability and freeing up capital for growth.
One of the most common forms of reinsurance is treaty reinsurance
In this article, we’ll explain the basics of what treaty reinsurance involves.
What is treaty reinsurance?
Treaty reinsurance, also known as obligatory insurance, is an agreement between a primary insurer (referred to in industry as the ceding company) and a reinsurer (also known as the cedant) in which a cedant will accept the risks of a portfolio of policies.
It is different from the alternative facultative reinsurance, which is purchased for individual risks. Instead, treaty reinsurance applies to a predefined class of policies, offering automatic coverage under the terms of a reinsurance contract.
This arrangement enables insurers to transfer liability for a segment of their policies, ensuring that claims within the treaty’s scope are covered by the reinsurer.
The primary benefit of treaty reinsurance for insurers is that they can stabilize their operations, mitigate their risk effectively and allocate resources toward expansion.
How treaty reinsurance works in practice
Under a treaty reinsurance contract, a reinsurer – a cedant – will assume responsibility for a portfolio of risks in exchange for a premium. This provides financial protection to insurers, particularly in large-scale events where claims might otherwise overwhelm their reserves.
For example, in 2012, Superstorm Sandy caused billions in damages across the United States. Many insurers met claims obligations due to reinsurance agreements. Swiss Re absorbed nearly $900 million in losses, while Arch Capital Group reported that 60% of its losses stemmed from reinsurance operations.
The two types of treaty reinsurance
There are two primary types of treaty reinsurance.
There is proportional (a.k.a pro rata) reinsurance. This is where a reinsurer shares a percentage of the policies and claims. For example, if a reinsurer takes on 20% of a portfolio, they receive 20% of premiums and pay 20% of claims.
There is also non-proportional reinsurance. This is where the reinsurer covers claims only if they exceed a specified threshold. For instance, they might agree to cover 40% of cyber insurance claims exceeding $200,000 within three years.
Benefits of treaty reinsurance
The core benefit of treaty reinsurance is that it allows an insurer to underwrite more policies and expand their market reach, since they can comfortably navigate the future without being burdened by too much risk.
This isparticularly so during catastrophic events, which lead to large claims that may drain out reserves.
Is treaty reinsurance right for you?
If your insurance company seeks to enhance its capacity or mitigate risk on existing policies while still growing its business, treaty reinsurance could be a strategic option.
Consulting an experienced insurance broker is crucial to understanding how reinsurance can support your company’s financial objectives.
Axxima specializes in tailored reinsurance solutions designed to safeguard your business. Contact their team today to explore how reinsurance can optimize your risk management strategy.