Treaty Reinsurance: Definition & Meaning

KEY TAKEAWAYS

• Treaty reinsurance is a type of insurance. It can be purchased by an insurance company from another insurance provider.
• The issuing insurer is called the cedent. The reinsurer is the purchasing company. 
• The purchasing company assumes the risks that are specified in the contract. This is in return for a premium. 
• The two types of treaty reinsurance contracts are non-proportional and proportional.

What Is Treaty Reinsurance?

Treaty reinsurance is an insurance plan that is purchased by an insurance company from a separate insurer. The insurance company that issues the insurance plan is known as the cedent. The cedent passes on all of the risks of a certain class of policies to the company purchasing the insurance. This is known as the reinsurer. 

For most traditional insurers, the riskiest policies are more expensive. This means that the highest risk of loss will incur larger reinsurance policy premiums for a single transaction. This is because the primary insurers will want to be compensated better. As they are taking on higher financial risk in terms of reinsurance premium. 

Treaty reinsurance is one of the three main types of reinsurance contracts. The other two are facultative reinsurance and excess of loss reinsurance. 

Advantages of Treaty Reinsurance

Having treaty reinsurance allows an insurance company to be able to cover itself against a class of predetermined risks. It gives the ceding insurer a stronger level of security for its equity and a more stable foundation when major or unusual events occur. 

It also allows an insurer to underwrite policies. These are policies that cover a larger volume of risks. This is without the costs of covering its solvency margins being raised excessively. Reinsurance also makes large liquid assets available for insurers. This is mainly in the case of exceptional losses. 

Disadvantages of Treaty Reinsurance

There are in fact very few disadvantages of having treaty reinsurance. One is when it comes to larger liability insurances or protection against catastrophic losses. For this type of claim, there are more suitable methods of protection. Such as the Excess of Loss or Stop Loss arrangements. 

It is also not a method that is suitable for new insurance companies. 

Facultative vs. Treaty Reinsurance

Facultative insurance and treaty reinsurance are both types of reinsurance contracts. We now know that treaty reinsurance is purchased by an insurer from another company. But facultative reinsurance differs in this sense. Here, the main insurer covers one risk or a number of risks that are held in its own books. 

With facultative reinsurance, the reinsurer can review each individual risk. These are the risks that are involved in the insurance policy. They can then either reject or accept them. While the reinsurer in a treaty reinsurance policy differs. They tend to accept everything from single risks to the whole package of risks that are involved with certain policies. 

Summary

Reinsurance treaties are a form of insurance. They allow insurance companies to protect themselves against a number of different risks. This reinsurance protection allows a level of protection for insurance companies. Any additional risk, high-frequency risks, or a specific type of risk can lead to higher premiums. This is because it is more likely for a company to make insurance claims.