Unit
- Treaty definition: A treaty reinsurance agreement is a standing contract between a ceding insurer and a reinsurer, under which the reinsurer automatically accepts a defined share of all risks written by the ceding company within a specified class or line of business. Unlike facultative reinsurance, treaties do not require individual risk submission, providing fluid capacity and operational efficiency.
- Risk transfer mechanism: Treaties operate on an automatic basis, meaning the ceding insurer is contractually obligated to cede, and the reinsurer is obligated to accept, all risks that fall within the treaty scope. This creates a long-term partnership that stabilizes the primary underwriter's loss experience.
- Capital relief purpose: By transferring a portion of its insurance portfolio, the ceding company reduces its required regulatory capital under Solvency II or equivalent frameworks. The reinsurer provides a credit for assumed liabilities, freeing up capital for new business growth.
- Portfolio diversification: Reinsurers use treaties to gain diversified exposure across geographies and lines of business. A treaty portfolio may span multiple classes, such as property, casualty, and specialty lines, reducing the impact of localized catastrophes.
- Operational efficiency: Treaties streamline the reinsurance process through automated cessions and standardized contract language. Cedents avoid the administrative burden of negotiating each risk separately, while reinsurers achieve scale.
- Proportional vs non-proportional: Treaty structures differ in how risk and premium are shared. In proportional treaties, the reinsurer receives a fixed percentage of premium and pays the same percentage of losses. Non-proportional treaties attach only when losses exceed a retention.
- Market participants: Key players include primary insurers, professional reinsurers, Lloyd's syndicates, and reinsurance brokers. Brokers often facilitate treaty placements and negotiate terms on behalf of cedents.
- Regulatory context: Treaties must comply with local insurance regulations and international standards such as IFRS 17 and Solvency II. Reporting requirements for treaty transactions include detailed schedules of cessions and recoveries.
- Treaty duration and renewal: Most treaty agreements are structured for a one year term with automatic or negotiated renewal. Cedents and reinsurers assess loss ratios, premium volume, and market conditions before agreeing to updated terms. Some treaties include multi year commitments or evergreen clauses to promote stability and reduce transactional friction.
- Claims reporting and settlement: Under a treaty, the ceding insurer manages individual claim handling and reports aggregate ceded losses to the reinsurer on a periodic basis. The reinsurer reviews claim bordereaux or summary data and reimburses the cedent according to the treaty’s loss payment provisions. Timely and accurate data submission is critical for cash flow.
- Common treaty types: Quota share treaties cede a fixed percentage of every risk within the class, while surplus share treaties cede risks exceeding a defined retention up to a maximum line. Excess of loss treaties cover losses above a specified attachment point, and stop loss treaties protect the cedent’s aggregate loss ratio. Each type addresses distinct risk transfer needs.
Financial Formula
Treaty Premium Calculation (Proportional)
Ceded Premium = Quota Share % x Gross Written Premium
Ceded Premium = Quota Share % x Gross Written Premium
Where:
- Quota Share %: The fixed percentage of risk ceded (e.g., 30%).
- Gross Written Premium: Total premium written by the ceding insurer on in-scope policies.
- Ceded Premium: Premium transferred to the reinsurer, net of brokerage and ceding commission.
Quick Revision
- Treaty reinsurance provides automatic, contractual risk transfer for a defined class of business.
- It reduces capital requirements and enables portfolio diversification for both cedent and reinsurer.
- Proportional treaties share premium and losses proportionally; non-proportional treaties attach above a retention.
- Key participants include insurers, reinsurers, Lloyd's syndicates, and brokers.