Insurance plays a major role in the life of humanity. And gradually, Kenyans are beginning to understand the necessity of insurance. However, reinsurance is still a foreign topic among many. Many of the people I have interacted with perceive Reinsurance to be very complicated but from my experience, reinsurance is one of the easiest things to understand.
Reinsurance is a significant part of the system of insurance. Through reinsurance, companies are able to underwrite complex and large risks and consequently, capital relief. Reinsurance also enables policy holders to get insurance services at reduced costs.
Consider a normal Purchase-Sales agreement where the primary insurer is the buyer, otherwise known as a cedant and the reinsurer being the seller. Basically, the cedant buys protection of the risks he has undertaken from the reinsurer by paying a premium which is also known as reinsurance premium. Therefore, the primary insurance company is the policy holder and reinsurer is the insurer. Simply put, Reinsurance is the Insurance of Insurance Companies.
Types of Reinsurance: 
Treaty Reinsurance
Here, the cedant transfers a broad category of its risks to the Reinsurer through an agreement known as a treaty. For example, the cedant could transfer his entire portfolio of his fire business to the Reinsurance company. In return, the Reinsurer agrees to accept all risks ceded to him under this agreement. The advantage of this type of reinsurance is that the cedant is assured that all the risks within his agreement’s scope are protected by the reinsurance company. Basically, a treaty is to “obligatory and broad acceptances.”
Facultative Reinsurance
Facultative Reinsurance is Reinsurance for single risks. In this type of agreement, the cedant is not obligated to transfer any risk and the reinsurer is also not obligated to accept any ceded risk.
Imagine a building with a very high Insurance Value (or Maximum Probable Loss). The owner of the building approaches an insurance company (cedant) but the insurance company does not the necessary capacity to write this risk so he approaches a reinsurer, seeking additional support. If the reinsurer declines then there will no agreement in place. If he accepts to support the cedant then a facultative contract is written.
The difference between a facultative arrangement and a treaty arrangement is that under a facultative arrangement, the reinsurer can accept or decline all or part of the policy risk as opposed to a treaty arrangement where he must accept all the policy risks under the contact.
A facultative reinsurance arrangement is mostly used when the risk in question is hazardous and the primary insurer (cedant) does not wish to cede its treaty, where there is no treaty protection available for a specific risk or for purely strategic or financial reasons. If a risk exceeds the underlying treaty capacity of the cedant then the excess part of the risk can be covered under a facultative reinsurance arrangement. You can say, Faculative is to “Optional and for individual acceptances”.
Treaty and Facultative Reinsurance can also be structured under proportional and non- proportional forms of reinsurance depending on the way in which the risks, losses and Premiums are shared between the Reinsurer and the cedant.
Article by Nelly Tuluba
Image: Courtesy