Proportional facultative agreements
Proportional facultative agreements differ in several ways from proportional treaties.
Proportional treaties define how much risk within the coverage group is ceded to the reinsurer in terms of either:
- A percentage share—the quota share
- Layers to be ceded—the surplus
A treaty applies to all risks within the scope of the treaty. New risks within the coverage group signed by insurer are automatically covered by existing treaty.
Facultative agreements, on the other hand, reinsure a specific risk. The agreement can cede a monetary value, such as $2 million of the risk, or a percentage, such as 15% of the risk. If the agreement cedes a monetary value, the system determines a percentage share for determining ceded loss. In practice, you might think of the agreement as representing the layer above the highest surplus treaty.
A proportional facultative agreement, like a proportional treaty, shares premiums and losses from the first dollar.
Example of ceding amount of risk to proportional facultative agreements
This example shows how risk is ceded in a proportional facultative agreement with a monetary amount entered in the Amount of Risk Ceded field on the Facultative screen. This example builds upon “Example of Ceding Risk to Proportional Treaties” which provided reinsurance from $0 to 10 million on a specific risk. However, in this example the risk is valued at $20 million. The insurer negotiates two proportional facultative agreements to provide coverage for claims up to $20 million. One facultative agreement cedes $2 million in risk. A second facultative agreement cedes $8 million of risk.
In a reinsurance program, quota share and surplus treaties often provide reinsurance coverage as in the following example. In this example, the risk is equal to the total risk covered by the treaties and facultative agreements put together. If the risk had been smaller, some of the treaties might drop out of the coverage. Also, if the risk were smaller, the smaller risk would replace the $20 million in the proportional share of risk calculation in the last column.
Treaty |
Layers of reinsurance |
Amount of risk ceded |
Proportional share of risk |
|---|---|---|---|
Proportional Facultative Agreements |
|||
Proportional Facultative 2 |
$8 million |
$8 million of $20 million = 40% |
|
Proportional Facultative 1 |
$2 million |
$2 million of $20 million = 10% |
|
Proportional treaties |
|||
Surplus 2 |
From $5 million to $10 million |
$5 million |
$5 million of $20 million = 25% |
Surplus 1 |
From $1 million to $5 million |
$4 million |
$4 million of $20 million = 20% |
Quota share |
From $0 to $1 million ceding 40% of the risk to the reinsurer |
$400,000 |
$400,000 of $20 million = 2% |
Insurer’s share |
From $0 to $1 million 60% of the risk retained by the insurer |
$600,000 |
$600,000 of $20 million = 3% |
The following illustration shows the coverage provided by the reinsurance program:
When there is a loss of $20 million or less, the proportional agreements share the loss proportionally, as shown in the last two columns of the following table. In this example, the risk equals the risk limit of the combined treaties:
Agreement |
Proportional share of loss |
$20 million loss |
$5 million loss |
|---|---|---|---|
Proportional facultative agreements |
|||
Proportional facultative 2 |
40% of loss amount |
$8 million |
$2 million |
Proportional facultative 1 |
10% of loss amount |
$2 million |
$500,000 |
Proportional treaties |
|||
Surplus 2 |
25% of loss amount |
$5 million |
$1.25 million |
Surplus 1 |
20% of loss amount |
$4 million |
$1 million |
Quota share |
2% of loss amount |
$400,000 |
$100,000 |
Insurer’s share |
3% of loss amount |
$600,000 |
$150,000 |
Example of ceding a share percentage to proportional facultative agreements
The previous example shows how risk is ceded to proportional facultative agreements by entering a monetary amount in the Amount of Risk Ceded field on the Facultative screen. Instead of entering a monetary amount, you can specify a Ceded Share (%) field on the Facultative screen. For example, the ceding is the same if the two proportional facultative agreements specify 40% and 10% instead of $8 million and $2 million, respectively.