The Institute of Finance

Management (IFM)
Department of Insurance
Subject Code:IRU-08610
:
Subject Name

REINSURANCE
PREPARED BY;
MR. MLAPONI, S
 Contents
❑ Facultative Reinsurance
❑ Features of Facultative Reinsurance
❑ Uses of Facultative Reinsurance
❑ Proportional Facultative Reinsurance
❑ Non-Proportional Facultative Reinsurance
❑ Advantage and Disadvantage of Facultative Reinsurance
❑ Placement of Facultative Reinsurance
❑ Fronting Reinsurance
❑ Purpose and Motivations of Fronting
❑ Fronting Procedures in Tanzania
❑ Question Session.
FACULTATIVE REINSURANCE
 Reinsurance is broadly categorized under two branches that is treaty reinsurance also
known as obligatory reinsurance and facultative reinsurance also known as optional
reinsurance.
 These two branches can be further broken down in two sub-categories i.e.
Proportional Reinsurance and Non-Proportional Reinsurance.
 To understand what facultative reinsurance is and how it operates, it’s imperative
that we first understand what the term “facultative” means.
 Literally speaking, the word facultative simply means “granting privilege or power to
do or not to do something” which would mean that one is not obligated to partake in
something that he or she wishes not to.
 If we apply this same meaning in a reinsurance perspective, we can say that
Facultative Reinsurance therefore is a form of Reinsurance in which the cedant
(Reinsured) has the right to cede or not to cede and the Reinsurer has the right to
accept or not to accept the business or risk offered.
Facultative Reinsurance
 Facultative is the oldest and original form of
Reinsurance and can be arranged both on
proportional and non- proportional basis,
facultative reinsurance also known as optional
reinsurance.
 Facultative Reinsurance, a given risk is
negotiated individually and is independent of
the other. A facultative offer on one risk would
not be the same as a facultative offer on
another risk since each risk is reviewed and
assessed individually according to its
characteristics.
 Facultative Reinsurance
 Byway of an example, Insurer Y wishes to
reinsure part of its line on textile manufacture’s
factory to Reinsurer Z under its treaty but Z has
exluded such risks from the treaty. Options
available to Y are to reduce its gross
acceptance of the original risk to a net line
without reinsurance, or to buy facultative cover
or to see if Z is prepared to cover the risk under
the treaty as a special acceptance.
Features of Facultative Reinsurance
 Facultative means optional. Both parties to the reinsurance of an individual
risk have a choice as to enter into a contract or not i.e. the power to act
according to free choice.
▪ The Insurer is free to offer a risk to Reinsurer but is not compelled to cede the
business.
▪ The Reinsurer is also free to accept or reject the business offered in
accordance with his own underwriting judgment and other consideration that
are important to its financial or marketing position.
 Each risk is a separate reinsurance contract and each risk is offered
individually with full details provided, to enable the Reinsurer make a decision
whether or not to accept the risk, or he may state the terms on which he will
accept the risk.
 Facultative reinsurance is arranged at the point of risk acceptance by the
insurer and cover is for that individual risk and applies to one insurance policy.
Uses of Facultative Reinsurance
❑ Facultative Reinsurance is in use to day in all classes, mainly when:
✓ The automatic covers have been used up i.e. large risks where the sum
insured exceeds the treaty capacity.
✓ For example, if X covers a residential building valued at 2,000,000 and X
has a surplus treaty with a total capacity of 1,000,000. X has itself
exposed for an extra 1,000,000 not covered by the treaty. It can Re
insure itself for the 1,000,000 by way of facultative reinsurance.
✓ The risk is excluded from the obligatory treaties e.g. risks located out of
territorial scope of treaty, excluded by type etc.
✓ For-example If Z may have a client that requires a Bankers Blanket Bond
cover or Aviation cover, since this risks are usually not covered by treaty,
Z can offer its client this cover but then it would be liable for the losses all
by itself. It can therefore choose to protect itself by way of facultative
reinsurance.
Uses of Facultative Reinsurance
✓ Where the insurer does not want his treaty contracts to be
overburdened with heavy risks.
✓ For very large and unusual risks
✓ For hazardous Risks where the physical hazards of the risks are
abnormally high.
✓ Where there are unique commercial, financial and strategic
reasons.
✓ To obtain capacity where volume of business is small and
does not justify treaty arrangements e.g. when writing new
lines of business
✓ To seek expertise and experience of reinsurers on risks of
special nature.
Proportional Facultative Reinsurance
 This is by far the most common form of facultative reinsurance
used.
 Facultative reinsurance on proportional basis permits the
insurer to pass on a fixed or quota share liability it has
accepted on a particular risk by ceding a share to one or
more reinsurers.
 The Cedant offers the Facultative Reinsurer a clearly defined
proportion of risk. Upon acceptance, the reinsurer will receive
his defined share of premium less reinsurance commission and
will bear his share of all claims regardless of the amount.
Proportional Facultative Reinsurance
 Example 1
 X covers a commercial building valued at 3,000,000.00 under
its fire and allied perils policy charging a premium 6,750.00
 It arrange a reinsurance protection by way of facultative
arrangement with 3 different reinsurers A-10%, B-30% and C-
25%.
 The Building suffers a loss of 600,000.00.
 Show how the Risk, Premium and Loss will be shared between
X and the different reinsurers according to their proportions .
Proportional Facultative Reinsurance
 Example 2
 A property insurance company (ABC Insurance Company) insured a plastic
factory valued at TZS 20bn. ABC Insurance wrote it 100% at a rate of 7.5 per
mile.
 Having assessing the level of risk, the company decide to purchase 40%
facultative reinsurance cover from XYZ Reinsurance.
 XYZ Re agrees to pay 30% ceding commission for the risk given.
 The factory suffered a fire loss, giving rise to a valid claim of TZS 16bn. ABC
Insurance has no other reinsurance arrangement on the risk.
 Required:
❑ Show how liability, premium and claim will be shared between ABC
Insurance Company and XYZ Reinsurance.
Non-Proportional Facultative
Reinsurance
✓ In Non-Proportional Facultative reinsurance, there is no pre-
determined proportion or ratio for allocating the premiums and
losses between the reinsurer and the cedant.
✓ The insurance company that is reinsured retains a fixed
monetary amount on a particular risk and arranges excess of loss
protection with the reinsurer to pay any claim amount in excess
of the fixed monetary retention up to a further defined monetary
amount.
✓ In other words, the cedants retention or treaty capacity works as
the deductible for which all claims falling within that amount will
not need the participation of the facultative reinsurer.
Non-Proportional Facultative
Reinsurance
 A fixed premium is paid by the reinsured to the reinsurer, usually
at the inception of the contract or by installments.
 Reinsurers can quote their own premium rates for their
exposure, irrespective of the original rate charged by the
Insurer.
 No commissions are payable on non-proportional facultative
business.
 Non-Proportional facultative method can only be used after
approval by treaty reinsurers.
Non-Proportional Facultative Reinsurance
 Non-proportional Reinsurance is basically an arrangement to settle claims
i.e. it is focused on claim settlement.
 It is a form of reinsurance where recoveries are available when a given
loss exceeds the reinsured’s retention defined in the agreement.
 Under this form of reinsurance the arrangement is arranged as
A in excess of B
 Where A represent the cover limit, the Maximum amount of any one loss
that the reinsurer can pay in excess of the deductible.
 And B represent deductible, is the amount of any one loss or series of losses
that the Reinsured is prepared to bear before the reinsurer can pay for the
loss.
"Cover Limit Xs Deductible"
 And usually the program is arranged in layers, 1st layer, 2nd layer, 3rd layer
etc.
Non-Proportional Facultative
Reinsurance
 Example 1
X covers a commercial building valued at 3,000,000.00
under its fire and allied perils policy charging a premium
6,750.00
 Itarranges an excess of loss cover of 2,000,000.00 Xs
1,000,000.00
 The Building suffers a loss of 2,600,000.00.
Non-Proportional Facultative Reinsurance
 Example 2
 BIRM III Insurance company insured a CAR project for construction of a road from Singida to
Igunga with a contract price of TZS 80bn.
 After assess the risk BIRM III consider the risk is above its underwriting capacity of TZS 10bn.
 Its decide to purchase facultative excess of loss reinsurance of
1st Layer TZS 30bn excess of TZS 10bn
2nd Layer TZS 40bn excess of TZS 40bn
➢ The reinsurance cover was supported by XYZ Re 40% and ABC Re 60%
➢ The project suffered three losses from the ground up during period of insurance
Loss 1: TZS 15bn
Loss 2: TZS 8bn
Loss 3: TZS 55bn
Required:
❑ Calculate, show all your workings how much BIRM III will recover for each loss from each
reinsurers.
Advantage of Facultative Reinsurance
✓ Facultative reinsurance increases the insurer’s
competitive edge within its chosen market.
✓ It protects insurer’s treaty reinsurance to ensure
better overall results, and lower reinsurance cost
in the long run.
✓ There is an opportunity for both parties to
develop a successful and professional
relationship. A successful facultative relationship
with a reinsurer might be a precursor to the
insurer offering it a place on its schedule of treaty
reinsurers.
Advantage of Facultative Reinsurance
✓ Facultative enables small developing companies
with limited capital and expertise to write large
risks beyond their capacity using expertise and
capacity of large Reinsurers.
✓ Risks are considered by underwriters whose
judgment and experience can be used to
improve the risk and reduce the exposure.
✓ Creates a balanced portfolio - The insurer would
get rid of large or hazardous risks where a
significant loss would result in an overall loss for
that year.
 Advantage of Facultative Reinsurance
✓ Original underwriter can pick and choose those risks which require
protection allowing them to keep maximum amount of original
premiums.
✓ This enables the maintenance of average sized risks in the portfolio
(homogeneity) through level retentions.
✓ Protects the cedant’s other treaties from adverse underwriting
results.
✓ Enables spread of business . Facultative reinsurance like all forms of
reinsurance spread the risk over a wider number of underwriters.
Risk spreading is a major benefit of reinsurance.
✓ Reinsurance brokers may make money on facultative reinsurance
if they are involved.
Disadvantage of Facultative Reinsurance
✓ Uncertainty- as risks are considered individually, the original insurer does
not know whether he will get facultative support, and this could affect its
ability to write the underlying risk.
✓ Delay in issuing a policy can create problems with clients. For example, a
reinsurer might insist on survey and certain recommendations from the
survey being carried out before it commits cover.
✓ Errors and disputes are inevitable and facultatives are subject to the full
rigors of duty of utmost good faith.
✓ Acceptance has to be delayed until reinsurance cover is obtained for
the risk in full. This could mean loosing business to competitors with larger
capacities.
✓ The cedant has to disclose full details to competitors. The reinsurers
approached would gain an insight into the underwriting policies and
portfolio of ceding company, resulting in release of information to
competitors.
Placement of Facultative Reinsurance
 When the cedant ascertains that it would need facultative
support, it prepares a facultative offer slip.
 The slip details the type of risk, Location, the terms and
conditions on the original policy, the perils covered, PML
(incase of property policy), the cedants retention, the offer
amount, the ceding commission and the acceptance line for
the reinsurer.
 When dealing with a risk with substantial values in the sum
insured, the cedant will usually send the slip to multiple
reinsurers.
❖ Activity:
❑ Obtain facultative slip from three (3) different insurers in Tanzania Insurance Market, and
identify what are information included on the facultative slip.
Fronting
 Fronting arrangement is considered as Alternative Risk Transfer method
(ART) where an insurer licensed in a certain jurisdiction issues a policy to
cover local risks but all or virtually all of such risks are then ceded or
reinsured with an unlicensed carrier (reinsurer), who will normally take over
the administration of all claims related to the risks.
 In exchange for its services, the fronting company normally receives a
small percentage of the total premium.
 As noted above, the practice of fronting involves an insurance company
that issues a policy, which is then completely reinsured with a reinsurance
carrier which is unlicensed in the jurisdiction of interest.
 Fronting arrangements, as referred as risk-transfer schemes can respond to
various purposes and motivations, which depend on the specific business
of a given company or group of companies.
Purpose and Motivations of Fronting
For Licensing Purpose
For rating reasons
For the purpose of entering or exiting a
given market
For the functioning of captive companies
For Tax deduction purpose
Fronting Procedures in Tanzania
 Considering the regulatory concerns over the practice of fronting, there
have been various arguments to regulate it.
 On 11th December 2017, the Tanzania Insurance Regulatory Authority
(TIRA) issued Circular No.055/2017 Condition for dealing with foreign
reinsurers and reinsurance brokers.
 The Circular took effect from 1st January 2018.
 The main objective of the Circular is to enhance enforcement of section
31(2) as well as Part VII of the insurance Act, 2009 which gives the
commissioner for insurance mandate to control reinsurance
arrangements.
 The Circular was issued after the regulator observes that some insurance
companies breach certain reinsurance arrangements in Tanzania.
Fronting Procedures in Tanzania
 The Circular address some few challenges in reinsurance dealings, which includes:
a) Excessive use of international facultative reinsurance arrangement in situation that could be
accommodated under treaty reinsurance arrangement.
b) 100% Externalization of risks which could partly be retained locally.
c) Fronting of extremely low value risks which results into low premium levy payable to TIRA.
d) Poor participation of local insurance companies in assuming parts of the risks intended to be
externalized through co-insurance arrangement.
e) Tendency of insurers engaging in co-insurance arrangement with related companies based
in other jurisdictions.
f) Local insurers colluding amongst themselves so as not assume certain risk which may results
in unnecessary externalization of risk that can be insured locally.
g) Dealing with poorly rated or unrated foreign reinsurers as well as unaccredited reinsurance
companies and brokers.
h) Seeking externalization of risk whose validity period has expired or significant time has lapsed
since commencement of the cover.
i) Non-disclosure of reinsurance commission or fronting fees payable to local insurers.
Fronting Procedures in Tanzania
 However, due to some reasons learnt when implementing the circular in the year 2018, TIRA
has issued the revised circular no 055/2017 (revised version).
 The revised circular has retained largely part of the circular but also incorporate the below
amendment to the circular such as:
a) Prior approval of all foreign reinsurance arrangements before implementation by insurers
b) Restrictions on externalization of risks.
c) Irregular bundling and repackaging of risks
d) Formation of insurance pools or consortia
e) Insurers must only use local or accredited reinsurance brokers
f) All foreign reinsurers and reinsurance brokers seeking to transact in Tanzania must be
accredited by TIRA
g) Exhaustion of local capacity before externalization
h) Insurers are required to disclose certain information
i) Credit rating of all Tanzania registered insurance companies.
Review Questions
1. What is facultative reinsurance?
2. You are an underwriting manager for ABC Insurance Company, a Tanzania-based
property insurer. ABC has accepted a property insurance risk with a sum insured of £50
million. This risk requires facultative reinsurance of £25 million, on either a proportional or
non-proportional basis. Last year, the property insurance risk had a claim of £45 million
with a different insurer.
▪ Explain how the reinsurance cover and premium would differ, should facultative
reinsurance be placed on a non-proportional basis compared to a proportional basis.
▪ Calculate the reinsurance recovery due to Pine plc, on both a proportional and a non-
proportional basis, should there be a further claim of £45 million.
3. What are the circumstance does facultative is used?
4. What is fronting?
5. What are the risk of fronting
 Any Question?
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