Facultative reinsurance in trade credit insurance

Facultative reinsurance placements are individual risk cessions in which a reinsurer participates in a particular credit insurance risk, in contrast to obligatory reinsurance where the reinsurer participates in a cedent's total, precisely defined insurance portfolio. The International Credit Insurance and Surety Association (ICISA) states that distinction directly in its reinsurance FAQ for trade credit insurance and surety. Facultative cover is used in both credit insurance and surety, and more frequently in surety because larger single contracts can create facultative needs above existing obligatory reinsurance agreements.

Trade credit insurance protects against non-payment by buyers. Berne Union materials describe short-term credit insurance as comprehensive cover against non-payment and buyer default, and note public and private cooperation through reinsurance and co-insurance structures. Facultative placements are one mechanism for that risk transfer on named risks.

Facultative reinsurance versus obligatory treaties

ICISA describes a reinsurance company as insuring the risk that has been underwritten by an insurance company. Reinsurance makes it possible for risks to be underwritten that no single company can bear alone. Under an obligatory reinsurance agreement, a reinsurer participates in a cedent's total, precisely defined insurance portfolio. Under facultative reinsurance, the reinsurer participates in a particular individual risk.

That portfolio versus individual-risk contrast is the institutional definition. Obligatory treaties attach automatically to qualifying risks in the defined portfolio. Facultative placements are offered and accepted risk by risk. In trade credit, a facultative cession may sit above an obligatory treaty where a single buyer limit, sector accumulation or large transaction exceeds treaty capacity.

ICISA states that facultative reinsurance is used in both credit insurance and surety, though more frequently in surety because occasionally bigger single contracts may lead to facultative reinsurance needs above potentially existing obligatory reinsurance agreements. Credit insurance still uses facultative capacity where individual buyer or transaction exposures exceed treaty terms.

Why credit insurers buy reinsurance

ICISA states that insurance companies in trade credit and surety buy reinsurance mainly for risk management and capital relief reasons. Reinsurers with broad product and geographical diversification can offer value because their capital costs may benefit from broader diversification. Underlying trade credit and surety business can be affected by economic cycles, so reinsurance also contributes to the financial stability of insurance companies over the cycle.

Reinsurance fits capital modelling because, in addition to risk sharing, broad product and geographical diversification offered by the reinsurer may lead to lower capital costs for the credit insurer or surety. The financial rating of the reinsurer is of high importance for both proportional and non-proportional covers.

ICISA also states that trade credit and surety are specialty classes requiring knowledge of default probabilities of corporates, economic developments in trade sectors, and economic as well as political developments in countries. Specialised reinsurance departments respond to that demand. Facultative underwriting of a named trade credit risk therefore draws on the same specialty credit and country analysis that supports the original insurance.

Accumulation, capacity and public-private structures

In trade credit as well as surety, insurance companies may give separate covers for the same buyer, sector or country several times. ICISA describes that as accumulation. Insurance and reinsurance companies maintain detailed accumulation control. Depending on individual risk appetite and risk bearing capacity per category, insurance companies seek reinsurance coverage for which reinsurance companies offer support. Facultative placements are a natural tool when accumulation on a named buyer or country pushes an insurer beyond treaty or retention limits.

The Berne Union describes a synergy between the public and private spheres of the credit insurance market. Cooperation brings additional capacity, diversification and underwriting expertise through reinsurance and co-insurance structures. Official export credit agency programmes and private insurers may therefore meet on facultative and treaty structures when capacity for a large export or investment related credit risk is shared. An export credit guarantee and a private credit insurance policy remain different primary products; reinsurance is the secondary risk transfer layer behind a primary insurer or, in some cooperative structures, behind official cover.

Berne Union short-term materials state that insurance may cover whole turnover, key accounts only, or single risk transactions. Single risk and large key account exposures are the practical settings in which facultative trade credit reinsurance is most often discussed, because the individual risk is discrete enough to offer and accept outside the automatic portfolio treaty.

Proportional context around facultative placements

ICISA distinguishes proportional reinsurance, largely offered as quota share agreements sharing premium, costs and losses for all qualifying risks at the same cession level, from non-proportional reinsurance, where the insurer retains losses up to a predetermined level and the reinsurer reimburses above that level up to a limit. Facultative placements can be structured on proportional or non-proportional terms for the individual risk. The facultative versus obligatory distinction concerns how the risk is selected and bound. The proportional versus non-proportional distinction concerns how premium and loss are shared once the risk is ceded.

ICISA also describes follow the fortunes language, under which the reinsurer follows the underwriting fortunes of the reinsured for risks accepted under insurance contracts that form part of the reinsurance agreement, including alterations and claims, provided the reinsured acts as it would if not reinsured. Treaty parties may deviate from that general rule. Facultative wordings similarly allocate claims following and alteration rights for the named risk.

Berne Union industry materials also place multilateral agencies, including MIGA, alongside official export credit agencies and private insurers in the credit and investment insurance market. Facultative capacity can therefore sit behind private primary policies, and in cooperative structures may interact with official cover programmes when large single-name trade credit exposures require additional risk sharing beyond obligatory treaties.

Facultative reinsurance is the individual-risk reinsurance path for trade credit exposures that sit outside, or above, obligatory portfolio treaties. It supports risk management, capital relief and accumulation control on named buyers, sectors or countries, and forms part of the wider public and private capacity sharing that the Berne Union describes for the credit insurance market.