Placement StructuresApplied

Facultative-Obligatory Treaty

"Fac/oblig" — optional in, automatic out

The cedent chooses risk by risk whether to cede; once ceded, the reinsurer must accept it.

Open the interactive version → definition, quiz, structure diagram and progress tracking

Definition

A facultative-obligatory (or "fac/oblig", or open cover) arrangement is facultative for the cedent and a treaty for the reinsurer: the cedent decides, risk by risk, whether to cede a qualifying risk into the arrangement, but once it does, the reinsurer is obligated to accept it on pre-agreed terms — no individual underwriting, no right to decline. It trades the reinsurer's selection rights for the cedent's administrative speed.

The obligation runs only one way: the cedent retains full discretion to cede or not, while the reinsurer has none — this makes fac/oblig arrangements structurally exposed to anti-selection, where a cedent naturally cedes its worst risks and keeps its best.
Because of that exposure, fac/oblig capacity is usually granted sparingly, priced above an equivalent treaty share, and often capped by an annual aggregate limit alongside the per-risk limit.
It sits between facultative and treaty in almost every respect — faster than placing each risk individually, but carrying more selection risk for the reinsurer than an obligatory treaty where the cedent has no discretion to withhold good business.

Worked example

A cedent holds a $20M fac/oblig facility, capped at $30M in any one year. It cedes a $15M risk it is uneasy about in March and keeps a much better $12M risk entirely net in April — both decisions are its own to make, and the reinsurer must accept the March cession without a second look.

Scenario · figures in USD

The same facility, two very different risk profiles

Union Re grants a cedent a $25M per-risk fac/oblig facility, capped at $80M in aggregate cessions per year, priced at a flat 18% rate on ceded premium — a premium over the 12% the cedent pays on its ordinary quota share treaty for comparable risk.

Per-risk facility limit	$25M
Annual aggregate cap	$80M
Rate on fac/oblig cessions	18%
Rate on the ordinary quota share treaty	12%
Cedent cedes four large, higher-hazard risks in the year	$78M ceded — aggregate cap nearly exhausted
Loss ratio on the fac/oblig cessions	96%
Loss ratio on the ordinary treaty	58%

So whatUnion Re priced the facility 6 points over the treaty precisely because it expected this: a cedent with full discretion tends to cede what it likes least about its own book, and the loss ratios above are exactly that pattern showing up.

Check your understanding

In a facultative-obligatory arrangement, who has the discretion to decide whether a risk is ceded?

Only the cedent — the reinsurer must accept whatever qualifies. The obligation runs one way: the cedent chooses, the reinsurer accepts. That asymmetry is the whole definition of fac/oblig.

Why is fac/oblig capacity usually priced higher than an equivalent quota share treaty?

The one-sided discretion exposes the reinsurer to anti-selection — the cedent tends to cede its worse risks. Anti-selection is the structural cost of letting only one side choose. The extra rate is the reinsurer pricing for that in advance.

Word problem

A fac/oblig facility has a $40M per-risk limit and a $150M annual aggregate cap, priced at 20% of ceded premium, where ceded premium equals 2% of the sum ceded. Across the year the cedent cedes five risks, in order: $40M, $35M, $28M, $22M and $30M. Confirm each is within the per-risk limit, find how much of the aggregate cap is left when the fifth risk arrives, and calculate the reinsurer's total income for the year.

Show a hint

Check each risk against the per-risk limit, then run a cumulative total against the aggregate cap in order — the cap may not have room for the whole of the last risk.

Reveal the worked answer

Each of the five risks is at or below the $40M per-risk limit, so all qualify individually
Running total of cessions in order: $40M, $75M, $103M, $125M — then the fifth risk ($30M) would bring the total to $155M, $5M over the $150M aggregate cap
Capacity remaining before the fifth risk = $150M − $125M = $25M
Only $25M of the $30M fifth risk is accepted under the facility; the remaining $5M falls outside it entirely
Total accepted cessions = 40 + 35 + 28 + 22 + 25 = $150M (the cap, exactly)
Ceded premium = 2% × $150M = $3.0M; reinsurer's income at 20% of that = $600,000

The facility absorbs $150M exactly and then stops — the last $5M of the fifth risk falls outside it, the cedent's problem to place elsewhere or retain. On the $150M it did accept, Union earns $600,000. An aggregate cap works like an annual aggregate deductible in reverse — it protects the reinsurer's book, not the cedent's.