Treaty reinsurance is a type of reinsurance where a re-insurer agrees to cover specific risks of the ceding company over a period of time.
It is an reinsurance contract where the reinsurer agrees to accept all or some portion of the risk of the primary insurer provided it meets specific criteria based on ceding company underwriting and issue requirements.
That is, treaty reinsurance covers all of the primary insurer’s policies in a given area that meets certain standards.
In treaty reinsurance, certain groups or classes of insurance risk are reinsured under a single contract.
Instead of having to place each risk individually with the reinsurer and having the possibility that each separate one could be accepted or rejected, treaty reinsurance was created to allow the insurer to cede a fixed amount of its business to the reinsurer.
The chief characteristic of treaty reinsurance is that, once the reinsurance conditions are agreed upon for a particular type of operation, the insurer is required to cede them and the reinsurer is required to accept them.
Treaty reinsurance is considered an obligatory contract because the reinsurer cannot decline risks falling within the scope of the agreements and the insurer must allow all risks coming within the scope to be covered.
In the insurance industry, treaty reinsurance is commonly used to manage risk and protect against large losses.
Features of Treaty Reinsurance
1. Written agreement: In treaty reinsurance, there is always a written agreement between the reinsurer and the insurer.
The agreement will contain the types of risks covered, the premium paid, and the retention of the ceding company.
The agreement serves as a legally binding contract between the two parties, and it helps provides clarity and certainty about the terms of the treaty reinsurance arrangement.
2. Pre-agreed coverage: In treaty reinsurance, the coverage and terms of the agreement are pre-agreed upon, rather than negotiated on a case-by-case basis as in facultative reinsurance.
This means that the reinsurer and the insurer agree on the terms of the reinsurance agreement even before any specific risks are ceded to the reinsurer.
The terms of the agreement typically cover a specific class or category of risks, such as all property risks or all automobile risks, rather than individual policies or claims.
3. Premium sharing: In treaty reinsurance, the reinsurer shares in the premiums collected by the ceding company, in exchange for assuming a portion of the risk associated with the policies underwritten by the ceding company.
4. Automatic coverage: Treaty reinsurance provides automatic coverage for risks that fall within the scope of the agreement, without the need for the ceding company to seek approval from the reinsurer before underwriting a policy.
The automatic coverage is typically provided for a specified period, known as the treaty period, which is usually one year.
During this period, the ceding company can underwrite policies that fall within the scope of the treaty reinsurance agreement without seeking approval from the reinsurer.
However, if the ceding company wants to underwrite policies that fall outside the scope of the agreement, it must seek approval from the reinsurer before doing so.
Advantages of Treaty Reinsurance
1. Quicker administration of policy: In treaty reinsurance, a large number of losses are covered under a single contract.
The terms and conditions of the reinsurance contract are agreed upon by the reinsurer and the insurer upfront and the reinsurer assumes a predetermined percentage of the risks associated with all policies underwritten by the insurer within the agreed-upon parameters.
Because the percentage of risk assumption is predetermined, the reinsurer doesn’t need to evaluate each policy individually, which saves time and reduces the need for clerical work.
As a result, the administration of treaty reinsurance is quicker and easier than facultative reinsurance, which can be more complex and time-consuming due to the need to evaluate each policy on a case-by-case basis.
2. Automatic coverage: Treaty reinsurance allows the ceding company to automatically reinsured some or all of its risks.
For example, if an insurance company has a treaty reinsurance agreement with a reinsurer that covers all of its property insurance policies, any property insurance policy that the insurance writes will automatically be covered by the reinsurer.
Since the reinsurer is obligated to cover any cession of the insurer that falls within the scope of the reinsurance contract, treaty reinsurance allows the insurer to automatically cover his risk exposures.
3. Predictable: Another advantage of treaty reinsurance is the predictable nature of the contract.
Treaty reinsurance is predictable because the reinsurer is obligated to accept any risks that fall within the scope of the treaty agreement, as long as they meet certain conditions.
The predictable nature of treaty reinsurance allows the insurer better understand his risk exposure and the cost of transferring that risk to a reinsurer.
Disadvantages of Treaty Reinsurance
1. Limited Control: When a ceding company transfers its risks to reinsurance, the reinsurer assumes responsibility for managing and handling any claims that arise from the insured events
By automatically transferring risk to the reinsurer, the ceding company gives up some control over the management of the risk and the claims handling process.
As a result, the ceding company may have limited input into how claims are handled and how the risk is managed.
2. Limited flexibility: Since the terms of a treaty reinsurance agreement are pre-agreed upon, It may be very difficult to make changes to the agreement or negotiate different terms.
The limited flexibility of the treaty means that unexpected events or changes in market conditions may make the original terms of the agreement no longer plausible
3. Higher premium: When an insurer cedes a portion of its risks to a reinsurer through a treaty, the reinsurer will typically charge a premium( which is usually a percentage of the original premium received by the insurer) for assuming those risks.
However, in some cases, the premium charged by the reinsurer may be higher than the actual cost of the risk, especially for smaller and less risky policies.
This means that the insurer may end up paying more for the coverage than they would if they had retained the risk themselves.
In other words, too much premium can be ‘lost’ to reinsurers on small good risks that an insurer would otherwise retain net for their own account.
Summary
To conclude, treaty reinsurance is a reinsurance contract where a reinsurer agrees to cover specific risks of the ceding company over a period of time based on certain criteria.
Treaty reinsurance covers all of the primary insurer’s policies in a given area that meets certain standards. It covers a certain group or class of insurance risks under a single contract.
Features of treaty reinsurance include a written agreement, pre-agreed coverage, premium sharing, and automatic coverage.
The advantages of treaty reinsurance include quicker administration of policy, automatic coverage, and predictability.
The disadvantages of treaty reinsurance include limited control, limited flexibility, and higher premiums.
