The Facultative Contract

by Thomas M. Tobin*

     Facultative certificates are reinsurance contracts. Although sometimes they receive less attention from management than other forms, these contracts nevertheless constitute the forward line of defense of the principles which set reinsurance apart from direct insurance. They are potentially the most vulnerable area for piercing the principle of privity of contract between the reinsurer and the ceding company.

     In addition, the facultative business acts as a bellwether of market conditions, providing valuable intelligence for treaty underwriters and others in a reinsurance organization. Treaty business is generally renewed annually but in the time between treaty renewals market forces change. Increases and decreases in prices are made, developments are revealed in primary insurance wording, and new laws are passed, all of which are reflected in the frequent negotiations between facultative underwriters and reinsured companies. Those first inklings of change can be critical in the treaty negotiation process.

Distinguished from Treaty

     Facultative contracts or certificates differ from treaty agreements in the following ways:

1. Facultative certificates are generally prepared in advance on a preprinted form, with declarations on one side and general terms and conditions on the other, and with endorsements attached.

2. Facultative contracts generally relate to a specific, insured risk.

3. Facultative contracts are nonobligatory cessions. Each piece of facultative business must be separately underwritten.

4. Facultative certificates are far more easily adapted to electronic data processing systems.

5. Facultative reinsurance, because of its individual risk focus, entails more documentation and therefore more expense in putting the business on the books.

* Senior Vice President, General Counsel & Corporate Secretary, SKANDIA AMERICA GROUP, One Liberty Plaza, New York, New York 10006. An autobiography follows the chapter.

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