Definition
Facultative reinsurance is the form of reinsurance in which the cedant offers each individual risk to one or more reinsurers for consideration. The reinsurer has the full right to accept or decline the offered risk; there is no automatic obligation. Each placement is governed by its own separate agreement.
The word "facultative" derives from Latin facultas, meaning option or freedom. This freedom to choose — held by the reinsurer — is the defining characteristic.
Vs treaty reinsurance
| Feature | Facultative | Treaty |
|---|---|---|
| Scope | Risk by risk; individual negotiation | Portfolio-wide; automatic acceptance of in-scope risks |
| Reinsurer's right to decline | Yes, per risk | No — must accept all in-scope risks |
| Negotiation | Full negotiation per risk (premium, limits, conditions) | Annual framework negotiation; individual risks then automatic |
| Flexibility | High — terms can be tailored | Lower — governed by the treaty wording |
| Processing speed | Slower — each risk requires a placement round | Fast — no per-risk step once treaty is in place |
| Use case | Large, unusual or treaty-excluded risks | Standard portfolio business |
When facultative is used
Risks exceeding treaty capacity
A treaty provides automatic capacity up to a defined sum insured per risk. When an individual risk exceeds the treaty's limit, the excess must be placed facultatively to complete the full cover.
Unusual risk profiles
Large petrochemical complexes, LNG storage, single aviation risk, unusual occupancies or novel technology risks often fall outside treaty scope or are subject to treaty exclusions. Facultative allows them to be individually priced and placed.
Accumulation management
If the cedant already has significant treaty exposure concentrated in one area, it may route additional risks in that area through facultative to avoid breaching accumulation limits within the treaty programme.
New lines or products
Before committing to a treaty for a new product line, a cedant may test facultative placements to observe how the market prices the risk.
The placement process
Slip preparation
The reinsurance broker prepares a slip on behalf of the cedant, summarising all information the reinsurer needs to make a decision:
- Risk description (insured, location, occupation, sum insured)
- Proposed reinsurance share and limit
- Premium indication or target
- Key policy conditions and exclusions
- Loss history
Market tour
The broker presents the slip to selected reinsurers. Each indicates their appetite, proposed share and any condition changes. Once sufficient capacity is assembled, the placement is complete.
Lead reinsurer
Large facultative placements typically feature a lead reinsurer who sets the rate and conditions; others follow on the lead's terms. The lead's acceptance signals market acceptability of the risk.
Proportional vs non-proportional facultative
Proportional facultative
The cedant and reinsurer share the risk (and premium) in an agreed proportion. The reinsurer receives a proportionate share of the premium and pays a proportionate share of any loss. It typically returns a ceding commission to the cedant to cover acquisition and administrative costs.
Non-proportional (excess of loss) facultative
The reinsurer pays losses that exceed the cedant's retention up to an agreed limit. The premium is separately negotiated based on the risk profile and the selected retention. This structure gives the cedant protection against large individual losses while retaining small ones.
Advantages and disadvantages
Advantages
- Terms and price are tailored to each specific risk
- Allows coverage of risks outside treaty scope
- Informs the cedant of market pricing signals for unusual risks
- Provides flexible accumulation management
Disadvantages
- Each placement requires time and administrative effort
- No guarantee of placement — reinsurers may decline
- Higher transaction costs than treaty
- Capacity may tighten after large market losses
Sources
- Swiss Re — "Introduction to Reinsurance" (technical guide)
- Munich Re — Facultative Reinsurance Solutions
- Lloyd's of London — Facultative Market Guide
- SEDDK — Reinsurance Regulations (seddk.gov.tr)