# Facultative vs. Treaty Reinsurance: Understanding Insurance Coverage Types

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## What Is Facultative Reinsurance?

Facultative reinsurance allows primary insurers to cover single risks or blocks, offering more tailored risk management compared to treaty reinsurance, which involves broader, long-term coverage arrangements. Understanding which option suits your insurance strategy can provide better security for your equity and solvency.

### Key Takeaways

*   Facultative reinsurance allows a primary insurer to cover specific risks individually, providing more personalized risk management.  
    
*   Unlike facultative reinsurance, treaty reinsurance involves automatic coverage for a class of risks without reviewing each individually.  
    
*   Facultative reinsurance contracts can be more expensive due to their tailored nature but provide flexibility for insuring atypical or large risks.  
    
*   Reinsurance increases an insurer's capacity to write policies by allowing them to manage solvency margins more effectively.

###   

## Understanding the Mechanics of Facultative Reinsurance

An insurance company, called a [ceding company](https://www.investopedia.com/terms/c/ceding-company.asp), enters a reinsurance contract to transfer some risk for a fee. This fee can be part of the premium the insurer gets for a policy. The primary insurer can cede specific risks or a block of risks to the reinsurer. Reinsurance contract types decide if the [reinsurer](https://www.investopedia.com/terms/r/reinsurer.asp) can accept or reject individual risks, or must accept all specified risks.

Facultative reinsurance lets the reinsurer review each risk to decide whether to accept or reject it, making it more focused than treaty reinsurance. The profitability of a reinsurance company depends on how wisely it chooses its customers. In facultative reinsurance, the ceding company and reinsurer make a certificate showing the risk accepted.

Insurance companies may find facultative reinsurance contracts more expensive than treaty reinsurance. This is because [treaty reinsurance](https://www.investopedia.com/terms/t/treaty-reinsurance.asp) covers a collection of risks. This suggests the ceding company and reinsurer aim for a long-term relationship, unlike a one-time transaction. Though facultative reinsurance may cost more, it lets the ceding company cover specific risks it otherwise couldn't.

## Comparing Treaty Reinsurance and Facultative Reinsurance

Both treaty and facultative reinsurance contracts can be written on a proportional or excess-of-loss basis (or a combination of both).

Treaty reinsurance is a broad agreement covering some portion of a particular class (or class of business), such as an insurer's entire workers' compensation or property business. Reinsurance treaties automatically cover all risks, written by the insured, that fall within treaty terms—unless they specifically exclude certain exposures.

While treaty reinsurance does not require review of individual risks by the reinsurer, it demands a careful review of the underwriting philosophy, practice, and historical experience of the ceding insurer.

> **Important**
>
> Facultative reinsurance is usually the simplest way for an insurer to obtain reinsurance protection; these policies are also the easiest to tailor to specific circumstances.

Facultative reinsurance contracts are much more focused in nature. They cover individual underlying policies, and they are written on a policy-specific basis. A facultative agreement covers a specific risk of the ceding insurer. A reinsurer and ceding insurer must agree on terms and conditions for each individual contract. Facultative reinsurance agreements often cover catastrophic or unusual risk exposures.

Because it is so specific, facultative reinsurance requires the use of substantial personnel and technical resources for underwriting activities.

## Advantages of Opting for Facultative Reinsurance

Reinsurance helps insurers secure their equity and [solvency](https://www.investopedia.com/terms/s/solvency.asp) by covering single or multiple risks, providing stability during major events.

Reinsurance also allows an insurer to underwrite policies, covering a larger volume of risks without excessively raising the costs of covering their solvency margins—the amount by which the assets of the insurance company, at fair values, are considered to exceed its liabilities and other comparable commitments. In fact, reinsurance makes substantial liquid assets available for insurers in case of exceptional losses.

## Illustrative Example of Facultative Reinsurance

Suppose a standard insurance provider issues a policy on major commercial real estate, such as a large corporate office building. The policy is written for $35 million, meaning the original insurer faces a potential $35 million in liability if the building is badly damaged. But the insurer believes it cannot afford to pay out more than $25 million.

So, before even agreeing to issue the policy, the insurer must look for facultative reinsurance and try the market until it gets takers for the remaining $10 million. The insurer might get pieces of the $10 million from 10 different reinsurers. But without that, it cannot agree to issue the policy. Once it has the agreement from the companies to cover the $10 million and is confident it can potentially cover the full amount should a claim come in, it can issue the policy.

## The Bottom Line

Facultative reinsurance is a targeted solution for insurers looking to manage specific risks, offering a tailored approach to coverage that provides security and stability in handling unusual or major events. While it can be more costly than treaty reinsurance, facultative agreements allow insurers to offload specific liabilities they could otherwise not retain, enhancing their ability to underwrite more expansive risks. In contrast, treaty reinsurance offers a broader scope of coverage with less individual risk assessment, forming a stable, long-term relationship between parties. Both forms of reinsurance—facultative and treaty—enable insurers to protect their solvency and financial health while providing diverse solutions based on the insurer's risk exposure and operational needs.