Facultative or Treaty and Why the Need for Hybrid Solutions: Part I

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Insurers face challenges in managing underwriting, capital protection, risk and risk profiling as they navigate underwriting guidelines based on their gross and net risk underwriting appetite. Against these challenges, companies utilize various forms of reinsurance, traditionally facultative or treaty, to buy risk protection, shore up capital and satisfy rating agencies, according to Jeff Fleming, Managing Director, Guy Carpenter.

"Increasingly, insurers need alternative solutions that draw on the provisions of both facultative and treaty," Fleming says. "These alternatives meet insurers' evolving needs and align with the coverage they offer insureds: free and unlimited reinstatements, no occurrence caps, pay-as-you-go premium, exposure rated pricing and the potential to improve treaty terms and to utilize facultative purchasing strategies more efficiently. The solutions that sit between facultative and treaty reinsurance should also enable insurers to expand the limits on their programs."

Facultative and treaty reinsurance offer a host of benefits, but each can be burdened with a number of inflexibilities that limits the utility to many insurers, particularly for those insurers lacking economies of scale for treaty purchasing.

"One of the reasons insurers choose facultative over treaty reinsurance is that facultative offers insurers the freedom and flexibility to cede risk based on their overall risk management strategies," continues Fleming. "Facultative purchasing habits typically are cyclical, with companies shifting their purchasing strategies to reflect changing market environments and risk appetite. Over the past two years, facultative requests have experienced a resurgence, rising 20 to 30 percent year-over-year."

In the casualty market, facultative purchasing increased across all the lines, and particularly in auto, general liability, umbrella and professional lines. In the property market, the events of 2017 and the deterioration of attritional loss ratios helped drive buyers back into the market. Market trends show that insurers increasingly utilize facultative reinsurance to narrow their net risk scope, increase capacity on desired risks and protect themselves against weakening factors and the potential for severe losses in property and casualty.

"Facultative reinsurance is a strong solution for coverage on individual risks, but there are intrinsic inefficiencies associated with facultative purchasing including the administrative burden of resource requirements for studying the minutiae of each risk; the risk of not having coverage for an unexpected event; cost uncertainty related to fluctuating pricing in facultative; and the need to determine required capacity," according to Fleming.

"Increased demand for facultative reinsurance purchases may create scenarios where companies are purchasing similar or like-for-like facultative across either entire portfolios or across risks with similar characteristics, which can run counter to the efficiencies gained from economies of scale," Fleming adds

Link to Part II >>