Special termination clause
A clause allowing a party to end the treaty mid-term on a defined event, rating downgrade, loss of capital, change of control, war, so as not to remain bound to a partner whose situation has changed.
A reinsurance treaty binds the parties for a period, usually a year, during which neither can normally exit. The special termination clause opens an exception by listing events that allow early termination, immediately or on short notice. The most common cases concern the other party's strength: a downgrade of the reinsurer's financial rating below an agreed threshold, a significant fall in its capital, a change of control, merger, liquidation or regulatory sanction. Others concern the environment: a declaration of war between the parties' countries, a law making performance unlawful, sanctions targeting one of them. The clause often offers an alternative to termination, the posting of collateral by the downgraded reinsurer, and specifies the fate of outstanding liabilities, through cut-off termination with portfolio transfer or run-off to extinction. For the cedent, it protects against counterparty risk; for the reinsurer, it is a risk of losing business at the very moment its situation weakens, which worsens the procyclicality of its downgrade.
Textbook case: a treaty provides that a reinsurer downgrade below A- gives the cedent the choice between immediate termination with transfer of reserves and posting of collateral equal to 100 percent of liabilities. After its reinsurer is downgraded following catastrophe losses, the cedent demands the collateral rather than seek more expensive replacement capacity mid-year.
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