Legal Definitions - treaty reinsurance

Treaty reinsurance refers to a type of agreement where an insurance company (known as the "ceding insurer") transfers a portfolio or a specific class of its risks to another insurance company (the "reinsurer"). Unlike "facultative reinsurance," which involves negotiating the transfer of individual risks one by one, treaty reinsurance operates under a standing contract, or "treaty," that automatically covers all risks within a defined category or up to a certain limit for a specified period.

Essentially, the ceding insurer and the reinsurer agree in advance on the terms and conditions for sharing a large volume of potential losses. This arrangement allows the primary insurer to manage its overall risk exposure, stabilize its financial results, and increase its capacity to underwrite more policies.

Here are some examples to illustrate treaty reinsurance:

• Example 1: Property Insurance for Natural Disasters

  A regional insurance company primarily writes homeowner policies in a coastal area prone to hurricanes. To protect itself from potentially devastating losses during a severe hurricane season, the company enters into a treaty reinsurance agreement with a larger, global reinsurer. Under this treaty, the reinsurer agrees to automatically cover 60% of all property damage claims exceeding $5 million that the regional insurer pays out for any single hurricane event over the next two years. This means the regional insurer doesn't need to negotiate each hurricane claim individually with the reinsurer; the treaty automatically kicks in for all covered events within the specified period and class of risk.

• Example 2: Life Insurance for High-Value Policies

  A life insurance provider frequently issues policies with very high face values, sometimes exceeding $10 million. To avoid having too much financial exposure tied to a single individual's life, the company establishes a treaty reinsurance contract. This treaty stipulates that for any new life insurance policy issued with a face value above $5 million, 75% of the liability for that policy is automatically transferred to the reinsurer for the duration of the policy's term. This allows the primary insurer to confidently issue large policies, knowing that a significant portion of the risk is automatically shared under the pre-agreed terms of the treaty.

• Example 3: Commercial Liability for a Specific Industry

  An insurance company specializes in providing commercial general liability policies for construction companies. Given the high-risk nature of the industry, the insurer wants to cap its potential payout on any single large claim. It secures a treaty reinsurance agreement where the reinsurer will automatically cover 80% of all liability claims that exceed $2 million for any policy written by the primary insurer during the upcoming fiscal year. This treaty covers an entire class of risks (commercial liability for construction) for a defined period, providing the primary insurer with predictable risk management without needing to assess each individual construction project or claim for reinsurance.