FoundationsApplied

Cut-Through Clause

When the reinsurer pays the insured directly

A narrow, negotiated exception to "no privity" that lets money move straight from reinsurer to policyholder if the cedent fails.

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Definition

Reinsurance normally creates no privity of contract between the reinsurer and the original insured: the policyholder cannot sue the reinsurer directly. A cut-through clause is an express, specifically negotiated exception — usually written into the reinsurance contract and sometimes endorsed onto the original policy too — that redirects the reinsurer's payment straight to a named insured or third party, typically a lender, if the cedent becomes insolvent or fails to pay. It is common in project finance, structured transactions and fronting arrangements where a lender wants certainty that its collateral is not stranded in someone else's insolvency.

Absent a cut-through, an insolvent cedent's reinsurance recoverable is paid into its estate, not to the policyholder — the insured or lender then queues with other creditors rather than being paid directly.
Regulators in many jurisdictions view broad cut-throughs with suspicion, since they can look like an unlicensed reinsurer transacting primary insurance business without a licence — they are typically permitted only in narrow, specifically negotiated circumstances.
A cut-through does not create new money or increase the total payable — it only changes who receives it and when. The reinsurer's normal defences (breach of warranty, non-disclosure, treaty limits) still apply in full.

Worked example

A ski resort borrows $40M secured against a fronted property policy. The bank insists on a cut-through clause naming it as beneficiary: if the fronting insurer collapses before a loss is paid, the reinsurer pays the bank directly instead of the money getting stuck in an insolvent estate.

Scenario · figures in USD

A fronting insurer fails mid-claim

Meridian Fronting Co. writes a $30M property policy for a captive-owned hotel group, 100% reinsured to Highline Re under a treaty carrying a cut-through clause naming the hotel group's lender. A fire causes a $30M total loss. Before claims are settled, Meridian is placed into liquidation.

Gross loss	$30M
Reinsurance ceded to Highline Re	100% · $30M
Without a cut-through clause	Highline Re pays Meridian's estate — the lender queues with other creditors
With the cut-through clause in force	Highline Re pays the lender directly
Amount the lender ultimately recovers	$30M

So whatThe clause creates no new money and changes nothing about what was owed — the $30M was always covered. It changes who is standing at the front of the queue the moment the fronting insurer stops being solvent.

Check your understanding

In normal reinsurance, why can't a policyholder sue the reinsurer directly when the cedent becomes insolvent?

No privity of contract exists between the insured and the reinsurer, absent an express exception. Reinsurance is a separate contract between two carriers. A cut-through clause is precisely the express, negotiated exception to that rule — not the default position.

Why do regulators generally restrict cut-through clauses to narrow, specifically negotiated situations rather than allowing them broadly?

They can look like an unlicensed reinsurer doing primary insurance business. A reinsurer paying policyholders directly starts to resemble a primary insurer transacting business it may not be licensed for in that market, which is why the exception stays narrow.

Word problem

A cut-through clause names Lender A as beneficiary for its $18M interest only, out of a $27M total covered loss, 100% reinsured. The fronting insurer becomes insolvent before paying anything. Split the $27M reinsurance recovery between what the cut-through clause guarantees to reach Lender A directly, and what remains exposed to the fronting insurer's insolvency.

Show a hint

The clause protects only the interest it names. Work out what is left over once that named amount is paid, and who that remainder actually belongs to.

Reveal the worked answer

Total covered loss = $27M, 100% reinsured, so the full $27M is owed by the reinsurer
The cut-through clause names only Lender A's interest: $18M
The reinsurer pays $18M directly to Lender A, bypassing the insolvent estate entirely
Remaining amount = $27M − $18M = $9M, paid to the cedent's estate as normal — it covers Lender B's interest and any other insureds, not just Lender A
Lender B's interest was never named in the clause, so its recovery becomes a claim against the insolvent estate alongside every other general creditor — a question for the liquidation, not the reinsurance contract

$18M reaches Lender A directly and immediately, because the treaty named it. The other $9M — technically still recovered from the reinsurer in full — lands in the insolvent estate and behaves like any other asset in a liquidation, available to creditors generally rather than ring-fenced for Lender B. A cut-through clause protects exactly the interest it names, no more.