DEFINITION of ‘Treaty Reinsurance’
A reinsurance contract in which a reinsurance company agrees to accept all of a particular type of risk from the ceding insurance company. Treaty reinsurance is one of the two types of reinsurance contract, the other being facultative reinsurance. Reinsurers in a treaty contract are obliged to accept all risks outlined in the contract.
BREAKING DOWN ‘Treaty Reinsurance’
When insurance companies underwrite a new policy they are agreeing to take on additional risk in exchange for a premium. The more policies that an insurer underwrites, the more risk that it takes on. One way an insurer can reduce its exposure is to cede some of the risk to a reinsurance company in exchange for a fee. Reinsurance allows the insurer to free up risk capacity, and to protect itself from claims of high severity.
Treaty reinsurance represents a contract between the ceding insurance company and the reinsurer in which the reinsurer agrees to accept all risks of a predetermined class over a period of time. It differs from facultative reinsurance, which is considered transactional, in that it allows the reinsurer to accept or reject individual risks. Treaty reinsurance involves a single contract covering a type of risk, and does not require the reinsurance company to provide a facultative certificate each time a risk is transferred from the insurer to the reinsurer.
By signing a treaty reinsurance contract, the reinsurer and the insurer are indicating that the business relationship is more likely to be a long-term one. The long-term nature of the agreement allows the reinsurer to plan out how to achieve a profit because it knows the type of risk it is taking on and it is familiar with the ceding company. This type of contract is also less expensive than facultative reinsurance because it is less transactional, and is less likely to involve risks that would have otherwise been rejected from reinsurance treaties.