1. FACULTATIVE REINSURANCE LECTURE NOTE
WEEK 3 & 4
2. INTRODUCTION Macquarie Dictionary defines “Facultative” as: left to one’s option or choice; optional
In R/I terms, FAC R/I means that the reinsurer has the option to accept or decline each offer of insurance, whilst the insurer is not compelled to offer the risk to the reinsurer.
Therefore FAR R/I allows the insurer to take out RI on specific risks which it cannot, or does not wish to, include entirely within the treaty, or does not wish to expose its portfolio to.
3. CONT RI for normal risk is catered for within a treaty, where it is automatically allocated to the appropriate treaty RI.
Some insurer have policies for FAC RI to be strictly controlled from HO
4. LEARNING OUTCOMES Explain the purposes and operation of proportional & non –proportional FAC RI
Identify the nature of the information the insurer must provide to the Reinsurer to ensure comprehensive and effective RI cover.
5. Why Use FAC R/I? Some key points about FAC R/I:
It is optional: the insurer is free to offer any risk for RI, and the reinsurer may accept or decline it
It is concerned with individual risks (with the exception for Fac Obligatory Arrangment)
Each FAC RI proposal is priced separately and subject to its own set of coverage conditions, which may or may not be the same as the original policy
6. CONT FAC RI has a no. of purposes, including:
Treaty Protection: certain class of insurance may be considered to have an adverse effect on the treaty.FAC RI of these classes remove or reduce this adverse effect
Treaty Exclusion: FAC RI allows an insurer to take on business in areas which may be excluded from certain classes or categories of risk
Capacity : An insurer with insufficient capacity to accommodate a risk with higher sum insured than allowed for in its automatic treaty limits may increase capacity using FAC R/I
7. CONT Developing Portfolio Areas: Where the premium volume of business in a new portfolio area is too small to place in a treaty program, an insurer may use FAC RI to develop the portfolio to the point where a treaty can be introduced. The insurer can also gain experience by maintaining a smaller than normal retention without having to expose the overall portfolio to major loss fluctuations from the type of business
Technical Support: Reinsurer can often provide experience and expertise in areas unfamiliar to the insurer
8. CONT Reduce Exposure: Insurers can reduce exposure to certain liabilities within a particular portfolio
Stability: Like most RI, FAC RI helps stabilize losses/results.
9. CONT Some Disadvantages
The major disadvantages to both the insurer & reinsurer is the amount of work involved in its operation. AS each risk must be place individually, it follows that the premiums must be dealt with individually and claim settle individually. Even with modern technology is still remain labor intensive
The necessity of dealing with each risk individually means that an insurer cannot provide immediate cover if the requirements of the risk are beyond the insurer’s own capabilities or capacity. This is also applies should there be any need to alter the risk or terms and conditions applying during the currency of the insurance. As the reinsurer is under no obligation to accept any particular risk there can be no guarantee that the insurer can place the risk to its required level at the terms proposed. The insurer might have to go back to the insured and ask for revised terms, in some instance, in order to obtain sufficient R/I support
10. Property R/I Proportional FAC R/I is mainly used for property insurance. Thus the FAC reinsurer’s share of the premium is directly proportional to its obligation to pay any losses.
Also there is an increase used of Non Proportional FAC RI is now increasing & some reinsurer will now only accept/write non-prop FAC R/I
11. CONT Special Risk with high value property/sum insured, FAC NPR/I may be the most appropriate form of RI.
Low level risk the insurer is prepared to cover any possible claims within the estimated normal loss, then they may prefer to consider XOL FAC R/I so that they are able to retain the bulk of the premium
12. CONT A property risk can usually be divided into 5 categories of risk exposure – in ascending order of loss (risk), the categories are:
Frequency: low cost claims which should be handled by deductibles in the original insurance contract
Estimated Normal Loss: the working insurance area which is more predictable than higher categories
Probable Maximum Loss (PML): the expected loss considering the risk characteristics and property protection such as sprinkler etc,beyond which loss should not occur.
13. CONT PML Protection : a safety layer based on the possibility that risk protections may fail or conditions be unfavorable, resulting in a loss above the PML
Catastrophe : the possible maximum loss area
The original policy underwriter and the facultative reinsurer often use these categories in considering the proposed placement
14. Liability & Special Risk R/I XOL FAC R/I is generally used for all liability (long tail) classes of insurance, as well as for special risks (very high value property/ sum insured).
‘Layering’ is the term used to denote a stratum of cover. NP R/I programs are usually divided into a number of layers, which are often placed with different reinsurers to facilitate placement at the best terms for reinsured.
15. CONT It is common to ‘layer’ XOL FAC placement for liability covers or special risks with high limits of indemnity. Reinsurer are asked to price these different layers within the sum insured/limit of indemnity
Since the original policy will have attracted a premium based on the total sum insured or LOL, the premium must be ‘allocated’ between the insurer and reinsurers pricing each layer. Reinsurer will price each layer on its exposure to loss, in order to determine an appropriate premium. This price is based on the reinsuring underwriter’s judgment of each layer’s exposure to loss
16. CONT The layering of any risk is normally divided into 4 general levels or layers, each of which sits directly on top of the preceding layer.
PL: This layer embraces normal or expected losses. It cover losses which are generally more predictable and frequent and will attract the bulk of the original premium. These losses are retained by the insurer. The PL is referred to as the insurers ‘retention’.
17. CONT Working Excess Layer: This layer is exposed to less frequent losses and is often referred to in a multi-layer R/I placement as ‘Layer 1’.
Catastrophe Layer: This layer is exposed to significant loss events, where loss is possible but not probable. Frequency is extremely low, but severity is extremely high
Capacity Layer: probability of Loss is so low as to be almost unimaginable (‘sleep easy/ peace of mind’ insurance)
18. CONT There may be further layers between Layer 1 and the Catastrophe layer, depending on the risk involved and the overall limit of indemnity
The same model can be used for both liability and high value property risks in the placement of FAC agreements. AS with property risks, the original insurer and the reinsurer may consider liability risks in terms of the risk’s exposure at certain levels of the cover provided
19. CONT For example, ‘frequency’ claims (e.g ‘trip and slip claims) would be considered as being within the insurer’s original policy deductible levels, whilst reinsurance ‘working losses’ would be protected by the 1st layer excess of loss agreement, and so on to the upper limit of the original policy
Layering is expressed as a limit ‘in excess of’ the net value of all lower layers
20. CONT The physical property of the ZYZ Petrochemical Works is insured for full value of $100,000,000. To obtain the maximum support for the risk, the sum insured has been layered as follows:
Primary Cover (the insurer’s retention) - $10,000,000
Layer 1 (Working Excess Layer ) - $40,000,000 in excess of $10,000,000
Layer 2 (High value Loss Layer) - $50,000,000 in excess of $50,000,000
21. TO BE CONTINUED REFER TO TUTORIAL EXERCISE
22. The Facultative Placement Policy Cover FAC Reinsurer will not issue the insurer with a formal policy or R/I contract wording to confirm the RI transaction bet. the 2 parties
RI transaction is confirmed by way of a ‘Placement Slip’ or ‘Cover Note’, which set out the full details of the risk reinsured together with details of the terms, conditions, exclusions and the RI premium payable
23. CONT The reinsurer will generally follow the insurer’s original policy wording issued to the insured
24. Detailing the Risk The insurer has the duty to disclose to provide the reinsurer with all relevant information about the nature and details of the risk to be reinsured.
Principle of Utmost Good faith & Duty of Disclosure
25. CONT Original insured risk and type of Insurance
Clearly identified by name, so reinsurer can create a file for the risk, and refer to any other insurance relating to that risk. This may involve risk accumulation for other risks held by the reinsurer, either for other risks within the same premises or next to the risk premises
Information regarding approach by other insurer on the same risk
Reinsurer have different acceptance limits for the various classes of business
26. CONT Form of Reinsurance
It is important that the reinsurer understands the form of the RI protection being requested because different judgment will be made on risk/terms etc being offered according to the type of support required.
A reinsurer may not consider that the form of RI being requested is appropriate and might suggest alternative arrangement or decline to participate. Reinsurer may only quote a certain layer if it is a class of business that is deemed high risk or unsuitable according to their own RI underwriting guidelines
27. CONT If the reinsurer is seeking excess of loss protection the reinsurer will examine:
The adequacy of the information provided to arrive at the appropriate premium for XOL cover
Whether the price being charged for XOL proportion is suitable, given the original policy premium charged to the insured.
In the case of proportional RI, the reinsurer will consider the adequacy of the original policy terms and premium before indicating any level of support
28. CONT Sums Insured & Original Policy Terms
No matter what type of RI requested, or class of business, the reinsurer will want to know the SI or LOI under the original policy
FNU - Declared Values: (In accordance with the Basis of Settlement)
Section 1 - Material Damage $164,145,095 Section 2 - Business Interruption $ 1,000,000 Limit(s) of Liability: Combined Sections 1 & 2 — FJ$45,000,000
In some classes of insurance (e.g property) this may be the deciding factor for whether the RI underwriter will participate.
Classes such as PUL, in order to correctly price the XOL R/I, the reinsurance underwriter will require information such as :
The insured’s annual gross income/turnover
Full detail on excesses and any variable factor applying to the policy cover, such as special terms and endorsements.
29. CONT Period of Original Insurance and R/I
When placing FAC RI, the insurer will require RI protection for the full period of the original insurance. It is therefore important that reinsurer is informed of the period of insurance so that the RI periods follow suit
Generally period of 12 months
Marine Insurance [Facultative]can on a period of one off transit
Construction Insurance –Construction + Maintenance Period
Original Cover has the started b4 FAC acceptance, it is rare for RI underwriter to agree to accept liability for losses that have occurred bet inception of the original cover and starting date for FAC RI
30. CONT FAC RI will be on shorter period than original insurance cover
FAC RI is for specific date only. This usually expires upon expiry of the original insurance cover. There is no automatic right of renewal.
The insurer must therefore have sufficient time, after being alerted of the expiry dates of the original policy, to:
Consider the renewal terms it proposes to offer the insured
Consult with the reinsurer as to whether the reinsurer is prepared to continue the FAC cover on the renewal terms proposed by the insurer
31. CONT Claim History for the Individual Risk
Reinsurer is entitled to all the information available to the original insurance underwriter, in order to judge the adequacy of terms, the scope of cover offered and whether to participate in the risk.
32. CONT Insurer’s Retention
Part of the risk that the insurer will retain itself. Known as Net Retention
Check if there is any treaty RI in place , to know the Net Retention plus Treaty R/I – this is known as Gross Retention
This will indicate something on the risk which cause insurer to reduce exposure to both its Net Retention and its Treaty Facilities
Concern: protect treaties from inferior risks, accumulation of risk
33. CONT Reinsurance Commission
FAC reinsurer will generally allow the insurer an exchange commission in respect of the FAC placement -usually 5%
It cover Acquisition Cost & Administration Cost