Spot Reinsurance

What Is Spot Reinsurance?

Spot reinsurance is a contract between an insurance company and a reinsurance company that transfers coverage of a single risk to the reinsurer.

An insurance company may obtain spot reinsurance when a subsection of its total portfolio involves considerably more risky than its portfolio as a whole.

Understanding Spot Reinsurance

Insurance companies are willing to give up part of the premiums paid by their policyholders by entering into reinsurance agreements in order to reduce their risk exposure. They are effectively paying another insurer to take some of the underwriting risks off their books.

A reinsurance agreement may cover an entire line of business or specific policy types. It may allow the reinsurer to be selective when it comes to which perils it accepts. This is known as facultative reinsurance. Or, it may require the insurer to automatically accept a peril. That is known as treaty reinsurance.

Facultative Reinsurance vs. Treaty Reinsurance

Facultative reinsurance agreements allow a reinsurer to be selective, but they also allow a ceding company to obtain coverage that may be outside of the bounds of the terms and conditions of treaty reinsurance.

For example, an insurance company may underwrite flood insurance policies across a wide geographic area but may choose to take on only a small number of policyholders. This small number may push the company’s aggregate risk over its limit, leading it to reinsure those policies.

Insurance companies can purchase spot reinsurance to cover policies using a limit other than what is granted for its portfolio as a whole. It may be purchased to cover a specific peril or policies in a certain location, or it can be as specific as covering a single policy.

For example, a company that underwrites auto insurance policies might purchase spot reinsurance to cover a single driver who is identified as much riskier than the other drivers that it insures. By separating the risk associated with the more accident-prone driver the insurer reduces the odds that its general portfolio of policies will bump up against its coverage limit.

Facultative reinsurance contracts can be more expensive than treaty reinsurance. This is because treaty reinsurance covers an entire “book” or category of risks. It is an indication that the relationship between the insurer and the reinsurer is more long-term than if the reinsurer dealt only with one-off transactions covering single risks.

While the increased cost is a burden, a facultative reinsurance arrangement may allow the insurer to take on clients that it may otherwise not be able to accept.