Treaty and facultative, or what binds before you know

A cedant buys reinsurance in two ways that have almost nothing in common, and the difference lies neither in the amount nor in the nature of the risk: it lies in when the reinsurer binds. Under a treaty it binds in advance, on a described scope, for business it has not seen and which sometimes does not yet exist. Under a facultative cession it binds afterwards, on a named risk, whose file it has read and which it may decline. Everything else follows from that.

A treaty is a subscription contract, and its object is not a risk but a definition. It states which classes it takes, which territories, which sizes, from which inception and to which expiry, and it adds a list of exclusions that is often the most contested part of the placement. Inside that definition the cession is automatic both ways: the cedant must cede, the reinsurer must accept. That double automatism is what makes a treaty valuable, because it gives the cedant capacity usable on the day it underwrites, with nobody to consult.

Facultative is the exact opposite, and the word says so: each side stays free. The cedant offers a risk, the reinsurer studies it, prices it and answers. A facultative cession is negotiated like a direct placement, with a submission, sometimes a survey, a price of its own, and an answer that may be no. What costs here is not only the premium, it is time: a facultative placement is counted in days, and the direct underwriting that depends on it waits meanwhile.

People often assume facultative is for small carriers with no treaty. The reverse is true: it mostly serves those that have one. Three situations make it necessary, and all three come back to the same cause, which is that a treaty is defined before the business is known. A risk may exceed the treaty's capacity, and the excess must then be placed. A risk may fall inside an exclusion, and the treaty simply does not see it. And a risk may be technically within scope yet so atypical that the cedant does not want it inside a result it will have to defend at renewal.

That third reason is the most interesting, because it is not a capacity question but an account management one. A treaty renews every year on its result, and one exceptional loss booked into it will weigh on the commission, on the rate, sometimes on the availability of the capacity itself. Taking that risk out through a facultative cession amounts to buying dedicated protection so that it does not enter an account shared with the rest of the portfolio. The arithmetic is not always favorable, and it is done risk by risk.

Between the two sits an intermediate form, facultative obligatory, under which the cedant stays free to offer and the reinsurer undertakes to accept whatever is offered. The asymmetry is obvious: the reinsurer receives what the cedant chooses to give it, therefore the risks it prefers not to keep. A reinsurer grants such an arrangement only to a cedant whose underwriting it knows, usually with a per-risk ceiling and a tight definition, and it withdraws it in the first year where the content looks like a sorting exercise.

The working order that follows is simple and it is asked in this sequence, on every submission. The direct underwriter first looks at whether the treaty takes the business: if it does, it underwrites and the cession happens by itself. If the treaty does not take it, or not entirely, it looks at what is left to place and decides whether to place it facultatively or to cut the line offered to the client. A cedant that reverses that order, and goes hunting for a facultative reinsurer before reading its own treaty, pays twice for capacity it already had.