Part Two Advanced facultative reinsurance: a new approach to risk management

My previous article, Facultative reinsurance: the need for more advanced solutions, looked at the shortcomings of the traditional approach of facultative reinsurance.

It also examined the current pressures redefining the reinsurance industry and how a customisable, diversified approach is now needed if insurers are going to be protected from systemic risks.

This article unpacks the various types of advanced facultative reinsurance solutions and the benefits they offer.

Advanced facultative reinsurance is not a traditional facultative reinsurance replacement, but an evolution of the same. While traditional facultative reinsurance is a simple transfer for individual risks, advanced solutions are designed to address complex, unique risks and act as a strategic tool for capital optimisation.

These solutions can be defined by four key characteristics:

• Complex layering: These are multi-layered structures with customised attachment points designed for specific risks.
• Bespoke structures and terms: They feature tailored provisions that go beyond standard market clauses to fit unique risk profiles.
• Strategic applications: They are used for much more than simple risk transfer, including portfolio optimisation, entering new markets, and risk management.
• Technology-enabled: These solutions leverage digital platforms, data analytics, and hybrid structures for enhanced efficiency and precision.

Facultative facilities: pre-negotiated capacity

Facultative facilities and binders represent a transformative approach to managing entire portfolio segments with efficiency and consistency.

These facilities provide pre-negotiated, automatic capacity for a defined class of specialised business that eliminates individual risk negotiations. They offer greater speed, eliminating lengthy negotiations for each risk; certainty through pre-security capacity with known terms; and increased competitiveness, as they facilitate immediate market responses.

Facultative facilities provide:

• A pre-agreed framework: Establish terms and pricing with a panel of reinsurers upfront, creating a streamlined placement process for qualifying risks.
• Automatic placement: Individual risks meeting defined criteria are automatically placed without individual submissions, reducing placement time from days to hours.
• Consistent protection: Uniform coverage across defined portfolio segments ensures predictable protection and eliminates gaps in reinsurance coverage.

This approach ensures enhanced efficiency through streamlined workflows, which eliminate repetitive individual submissions and accelerate market access, as well as stronger ties with preferred reinsurers through committed capacity and a partnership approach. 

It also provides access to customised structures that are designed to meet specific portfolio characteristics and business objectives.

Parametric facultative solutions

The integration of advanced technology is transforming facultative reinsurance, enabling more precise risk assessment and innovative parametric solutions for volatile environments.

Parametric insurance, with roots dating back to the 1800s, has evolved from simple predefined triggers to sophisticated models enhanced by AI and data analytics, offering more personalised and efficient insurance solutions.

Unlike traditional insurance solutions that compensate for assessed damages, parametric insurance offers payouts based on the occurrence of predefined triggers related to a defined event, such as seismic activity for earthquakes or wind speeds for hurricanes. This type of insurance is designed to complement traditional policies, addressing coverage gaps, and reducing overall risk exposure.

Parametric facultative solutions bypass traditional loss adjustment, leading to rapid payouts that improve an insurers' liquidity post-event and accelerate recovery efforts for policyholders. They can cover areas where traditional indemnity insurance might have excluded perils, limited capacity, or provided insufficient coverage for certain events.

The benefits of this solution include more precise risk assessment for complex portfolios; automated risk assessment and pricing for specialised perils; reduced dependency on traditional loss adjustment; and accelerated claims resolution.

Bespoke reinsurance solutions

Bespoke reinsurance arrangements are designed for unique risk challenges that require deep collaboration and strategic thinking.

Strategic applications include:

• Managing earnings volatility: Smoothing out financial performance across multiple periods.
• Multi-year capacity: Securing long-term coverage for difficult-to-place exposures.
• Capital relief: Freeing up capital for strategic deployment and growth initiatives.

Customised solutions offer structures that are tailored precisely to specific needs and risk profiles, but do require strong partnerships between cedants and their reinsurers.

Strategic portfolio analysis

To determine which of these solutions best suits a particular business, a disciplined, three-step approach to strategic portfolio analysis is recommended.

Firstly, volatility and peak exposures must be identified. This involves a deep analysis of the portfolio to find areas of significant volatility and identify the peak exposures that are straining capital.

Secondly, existing treaty gaps must be analysed. Current treaty arrangements should be reviewed to pinpoint coverage limitations and capacity shortfalls. This helps determine where a facultative solution can be most effectively integrated.

Finally, the portfolio must be segmented. The portfolio should be divided into distinct segments, focusing on areas with unique risk characteristics or high-growth areas that require more flexible capacity. The output of this process will be a clear map of facultative target areas, such as high-volatility cat risks or new market expansion opportunities.

Once the target areas have been identified, the solution needs to be designed and placed. The success of this process hinges on a critical element - the submission of high-quality data.

To secure the best terms and capacity, granular exposure data and accurate exposure details must be provided. This allows reinsurers to truly understand the risk. A complete loss history is also essential, as it provides the foundation for pricing and risk assessment.

Comprehensive risk engineering is also important. This includes technical risk assessments and details on the hazard mitigation and loss prevention measures that the business already has in place. A robust, data-rich submission is the foundation for a successful placement and a true partnership.

Choose a trusted reinsurance partner

Businesses must partner with experienced facultative reinsurance specialists to conduct this comprehensive portfolio analysis and to design customised solutions that are aligned with their strategic objectives and risk appetite.

These advanced solutions should complement organisations' existing treaty programmes, as opposed to competing with them. A business's treaty reinsurance programme is its bedrock, designed to automatically cover a defined portfolio. It is highly efficient for stable, predictable, and homogeneous risks.

A portfolio facultative solution, on the other hand, is for targeted risk transfer. Its strength is its flexibility. It is ideal for volatile segments, peak exposures, and complex risks that fall outside the treaty's scope.

By strategically integrating them, facultative solutions can be used for peak exposures that exceed treaty retention limits or portfolio-level facilities can be applied for specific risk segments. This creates a more complete and resilient reinsurance structure.