Placement StructuresCore

Treaty Reinsurance

Q: What makes a treaty "obligatory"?

Both parties must cede and accept every qualifying risk — Obligatory cuts both ways: the cedent cannot select against the reinsurer by ceding only bad risks, and the reinsurer cannot decline the ones it dislikes.

Obligatory / automatic

One contract covering a whole class of business for a period — cessions are automatic on both sides.

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

Definition

Treaty reinsurance covers an agreed class or portfolio of business for a defined period, usually twelve months. It is obligatory: the cedent must cede everything falling within the treaty's scope and the reinsurer must accept it, with no risk-by-risk underwriting. Terms are set once at placement, so new business written the day after inception is protected automatically.

Cheap to administer and gives immediate, automatic capacity — the cedent can quote a large risk on the spot.
The reinsurer takes the good with the bad, which is why it underwrites the cedent's discipline and prices off the whole book.
Premium is normally adjustable: a deposit is paid during the year and trued up against actual subject premium (GNPI) afterwards.

Worked example

A twelve-month property treaty covers "all fire and allied perils business written by the cedent in Ontario". Every qualifying policy is ceded automatically the moment it is written — no notification, no acceptance, no negotiation.

Scenario · figures in USD

A deposit premium trued up at year end

A property excess-of-loss treaty is rated at 4% of gross net premium income. The cedent estimates GNPI of $200M, so a minimum and deposit premium is agreed at 80% of the estimated cost and paid in four quarterly instalments. The book grows faster than planned.

Estimated GNPI	$200M
Rate on GNPI	4.00%
Estimated premium	$8.0M
Minimum & deposit premium (80%)	$6.4M
Quarterly instalment	$1.6M
Actual GNPI at year end	$230M
Adjusted premium (4% × $230M)	$9.2M
Balance due at adjustment	$2.8M

So whatGrowth is not free. The reinsurer's premium follows the book automatically, so a cedent that outgrows its plan owes an adjustment cheque — and should have budgeted for it.

Check your understanding

What makes a treaty "obligatory"?

Both parties must cede and accept every qualifying risk. Obligatory cuts both ways: the cedent cannot select against the reinsurer by ceding only bad risks, and the reinsurer cannot decline the ones it dislikes.

Under the scenario above, the book shrinks to $170M instead. What happens?

The premium adjusts to $6.8M but the $6.4M minimum floors it. 4% × $170M = $6.8M, which is above the $6.4M minimum, so the cedent still owes $0.4M. The minimum premium only bites when the adjusted figure falls below it.

Word problem

A casualty treaty is rated at 6.5% of GNPI with a minimum and deposit premium of $5.2M. Actual GNPI comes in at $72M. What is the final premium, and what balance moves at adjustment?

Show a hint

Calculate the adjusted premium, then compare it with the minimum — the cedent pays the higher of the two.

Reveal the worked answer

Adjusted premium = 6.5% × $72M = $4.68M
Minimum and deposit premium already paid = $5.2M
The minimum premium is the floor, so the final premium is $5.2M
Balance at adjustment = $5.2M − $5.2M = nil; no return premium is due

Final premium stays at the $5.2M minimum and no money moves. The cedent has effectively paid an 7.2% rate on its actual income — the price of over-estimating its plan when the minimum was negotiated.