Treaty reinsurance is a reinsurance contract under which a reinsurer agrees to accept a defined share of an entire portfolio or class of a ceding insurer's business, for example all commercial property policies the insurer writes in a given year, without examining each policy. Once the treaty is in force, the insurer must cede the policies that fall within it and the reinsurer must accept them, within agreed limits and exclusions.
Treaties carry most of the premium that flows through the reinsurance market, with one-off facultative reinsurance used for risks that fall outside them. They split into proportional treaties, where premiums and losses are shared in agreed proportions, and non-proportional treaties, where the reinsurer pays only above a set threshold. Most treaties run for twelve months and are renewed on a handful of market dates.
Treaty reinsurance in plain terms
A café can buy milk in two ways. It can phone the dairy each morning, describe what it needs and haggle over the price, or it can sign a yearly standing order: the dairy delivers whatever the café uses, at terms agreed once, and nobody has to negotiate every bottle.
A treaty is the standing order. The insurer and its reinsurers agree once a year on which kinds of policies are shared and on what terms. After that, every policy that fits the description is shared automatically, whether the insurer writes ten of them or ten thousand. This lets the insurer quote customers quickly, knowing the backing is already in place, while the reinsurer relies on the insurer's judgement and on the overall spread of business rather than inspecting each case.
How a treaty is structured
A treaty wording, often summarised first in a short slip, sets out the commercial and legal terms:
- Business covered. The classes, territories, currencies and period, together with exclusions such as war, nuclear or certain cyber exposures.
- Retention and limits. How much the cedent keeps and the maximum the reinsurer will pay, per risk, per event or in aggregate.
- Premium and commission. For proportional treaties, a share of original premium less a ceding commission; for non-proportional treaties, a priced premium, often with a minimum and deposit.
- Claims terms. Clauses obliging the reinsurer to follow the cedent's good-faith settlements, rules on whether loss adjustment expense is included, and notice requirements for large claims.
- Reporting and disputes. Periodic accounts (bordereaux) listing premiums and claims, inspection rights, and an arbitration clause, which is the usual way reinsurance disputes are resolved.
Large treaties are usually shared by a panel of reinsurers, each taking a percentage, with a lead reinsurer setting terms that the others follow.
Proportional and non-proportional treaties
| Treaty type | How the reinsurer pays | Typical use |
|---|---|---|
| Quota share | A fixed percentage of every policy's premium and losses | Capital relief, new companies, new lines |
| Surplus | A share that varies by policy, covering the part of each sum insured above the cedent's line | Property portfolios with uneven policy sizes |
| Excess of loss | The part of each loss or event above a retention, up to a limit | Large single losses and catastrophes |
| Stop-loss | The part of the year's total losses above an agreed loss ratio | Protecting annual results |
Insurers often combine several of these into a programme, for example a quota share to support growth, a per-risk excess of loss to cap individual losses and a catastrophe excess of loss to protect against a single storm or earthquake.
The renewal cycle
Treaty business is concentrated on a few renewal dates. 1 January is the largest, covering much of Europe and many global programmes; 1 April is significant for Japan and India; 1 June is closely watched for Florida wind risk; and 1 July covers much of Australia, New Zealand and part of the United States. Brokers market the cedent's programme in the weeks before each date, and pricing moves with recent catastrophe losses, investment returns and the supply of reinsurance capital. Periods of rising prices and tighter terms are called a hard market; the reverse is a soft market.
Because insured catastrophe losses have fat tails, one severe year can reset prices across the market, and the diversification that reinsurers achieve by writing many regions and classes is central to their business model.
Why insurers buy treaties, and how they are regulated
Treaties let an insurer write more business than its own capital supports, reduce the volatility of earnings on its income statement, protect against catastrophes and draw on reinsurers' pricing and underwriting expertise. Supervisors allow reinsurance to reduce required regulatory capital only if it transfers genuine risk. In the mid-2000s, investigations into finite reinsurance deals that moved little real risk but improved reported results led to tighter risk-transfer and disclosure rules.
In the United States, credit for reinsurance is governed by state laws based on the NAIC model law, and treaty recoverables are reported in the statutory annual statement. In the EU, Solvency II recognises reinsurance in the calculation of capital requirements, subject to counterparty risk charges. Under IFRS 17, which took effect on 1 January 2023, reinsurance contracts held are measured separately from the underlying insurance contracts in an insurer's financial statements, and treaty recoveries are reflected against the gross claims reserve.