Captive Insurance
An insurer owned by the businesses it covers, the forms it takes, and what separates a captive from simply retaining the risk.
Glossary
Treaty vs Facultative
Whether reinsurance covers a whole class automatically or one risk at a time, and why treaty does not mean proportional.
Treaty and facultative are two ways of arranging reinsurance. Treaty reinsurance covers a defined class or portfolio under a standing agreement. Facultative reinsurance involves the separate assessment and acceptance of an individual risk or policy.
The main distinction is how business enters the arrangement. Under a typical obligatory treaty, qualifying business is covered without a separate negotiation for every risk. With facultative placement, the insurer offers a particular risk and the reinsurer decides whether to accept it and on what terms. Munich Re’s introduction to facultative and treaty reinsurance.
How treaty reinsurance works
The ceding insurer and reinsurer agree the scope of business, period of cover, financial structure, limits, and other conditions. Eligible business then enters the treaty according to those terms.
For example, a treaty might cover a defined portfolio of commercial property policies in specified territories. The reinsurer evaluates the portfolio, the insurer’s underwriting approach, its experience, and the proposed protection.
Automatic participation applies only within the contract’s boundaries. A policy outside the permitted class or territory does not become covered simply because the insurer has a treaty. The agreement may also require individual referrals in specified circumstances.
The treaty gives the insurer a continuing framework for writing eligible business. Reporting and oversight continue after placement, even when each risk does not require separate acceptance.
How facultative reinsurance works
In a facultative placement, the insurer presents a particular risk to one or more reinsurers. The submission can include the coverage, values or limits, loss history, technical information, and the share or layer being offered.
The reinsurer may accept, decline, or propose different conditions. Acceptance must establish the actual protection, including its amount, period, exclusions, and relationship to the original policy.
Facultative placement is useful for risks that need individual attention. A large industrial site, unusual construction project, or exposure exceeding the insurer’s available treaty capacity may require a separate solution.
Swiss Re describes the individual submission and underwriting process for facultative life reinsurance, illustrating how the review differs from automatic arrangements. Swiss Re’s explanation of facultative submissions.
The differences at a glance
| Aspect | Treaty reinsurance | Facultative reinsurance |
|---|---|---|
| Main unit of agreement | A defined portfolio or class of business | A particular risk or policy |
| Acceptance | Usually automatic for business meeting the treaty terms | Separately agreed for the offered risk |
| Underwriting emphasis | Portfolio characteristics and the cedent’s practices | Details of the individual exposure |
| Common purpose | Continuing protection for recurring business | Additional capacity or a tailored placement |
| Administration | Ongoing reporting under an established agreement | Individual submission, negotiation, and placement records |
These descriptions summarize the usual structures. Hybrid arrangements also exist. Munich Re notes that some treaties allow optional cession or other non-obligatory features, so the operative contract remains decisive. Munich Re’s definitions of treaty arrangements.
Treaty does not mean proportional
Treaty versus facultative describes the placement basis. Proportional versus non-proportional describes the financial sharing of risk.
Both placement approaches can support either financial structure:
| Structure | Treaty example | Facultative example |
|---|---|---|
| Proportional | A quota share of an eligible portfolio | A percentage share of one industrial property policy |
| Non-proportional | Catastrophe excess-of-loss protection for a portfolio | An excess layer covering one large individual risk |
A quota share shares relevant premium and losses in agreed proportions. Excess-of-loss cover responds above an attachment point and within its limit. Knowing that a placement is facultative does not tell the reader which of those calculations applies. Swiss Re’s overview of reinsurance forms and principles.
A practical example
Consider a fictional insurer with a commercial property treaty that accepts eligible locations up to a $5 million insured value. A warehouse with a $3 million value satisfies the treaty’s underwriting and territorial conditions, so it can be handled through that arrangement.
The same insurer receives an application for a $12 million specialist manufacturing plant. In this example, the treaty excludes locations above its $5 million eligibility threshold. The plant therefore needs a separately arranged solution before the insurer can rely on reinsurance for it.
A facultative reinsurer assesses the plant’s construction, processes, protection measures, and proposed coverage. It might offer an agreed percentage of the policy or a defined excess layer, subject to its own terms.
The $5 million figure here is an eligibility restriction. It is not an instruction to subtract $5 million from the plant’s value and assume the remaining $7 million is the only amount needing placement. That calculation would require a different contractual structure.
Can the two approaches be combined?
Yes. An insurer can use treaties for its main portfolio and facultative placements for selected risks. Facultative cover may address business excluded from a treaty, supplement capacity, or alter the amount exposed to the treaty.
The order of application matters. If facultative reinsurance applies before a treaty, it may reduce the premium and exposure entering that treaty. Other arrangements operate differently. Swiss Re’s engineering reinsurance discussion describes the use of facultative protection alongside proportional treaties. Swiss Re on engineering insurance and reinsurance.
What must be clear in the records?
The insurer needs to connect each policy and claim to the correct protection. That includes the acceptance evidence, applicable dates, exclusions, limits, and how overlapping arrangements interact.
Treaty business may be communicated through a bordereau, while an individual facultative placement needs a record of the particular agreement. In either case, accurate premium and claims information supports the later settlement of reinsurance accounts.
The choice concerns how to secure suitable protection for the business being written. Treaty provides an ongoing framework; facultative provides individual selection and negotiation. An insurer may need both within the same reinsurance program.
