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When Capacity Falls Short: Using Coinsurance and Facultative Reinsurance

How coinsurance and facultative reinsurance are used when a single insurer lacks the capacity for a large risk: the difference between the two, how they are combined (with a worked example), how facultative reinsurance is placed, and what to check to keep terms aligned, based on public material from the FSA, the General Insurance Association of Japan and reinsurers.

Large risks such as corporate earthquake, property and business interruption cover, or the credit limit on a major buyer, can exceed what one insurer is able to write. In some cases the line shrinks at each renewal and the cover needed can no longer be secured. The tools used then are coinsurance and the facultative reinsurance that supports it. This article explains the two mechanisms and how they are combined, based on public material from Japan's Financial Services Agency (FSA), the General Insurance Association of Japan (GIAJ) and reinsurers.

Why capacity falls short

Insurers set internal limits on how much they can write per policy and per event. These limits depend on their own capital and on the reinsurance they buy. The GIAJ explains that, with natural disasters becoming more frequent and severe, and with rising claims and reinsurance costs, both the price and the supply of insurance have become constrained. The constraint is most visible in risks such as earthquake and windstorm or flood, where a single event can hit many policies.

A capacity shortfall is therefore not only a sign that the policyholder's risk is poor. It can also come from the insurer's side: its total exposure to the same area or risk, and its reinsurance terms. In that case, adding more insurers can solve the problem.

Coinsurance and reinsurance compared

	Coinsurance	Reinsurance
Mechanism	Several insurers share one insurance contract	An insurer transfers part or all of the liability it has written to a reinsurer
Relationship with the policyholder	Each insurer is directly liable to the policyholder for its share	No contract between the policyholder and the reinsurer; the primary insurer remains liable to the policyholder
Nature of liability	Several, not joint: each insurer is liable only for its own share	A separate contract, independent of the primary policy
Visible to the policyholder?	Each insurer's share is shown on the policy	Usually not visible

In coinsurance, the lead insurer handles administration on behalf of the other insurers, such as collecting premium, issuing the policy and receiving claims. The policyholder has one point of contact, but each insurer is liable to pay claims only for its own share. If one of the insurers cannot pay, the others do not make up its share.

Reinsurance, described by reinsurers as "insurance for insurance companies", is bought by an insurer for the liability it has written itself. Even if a reinsurer cannot pay, the primary insurer is not released from its liability to the policyholder.

Combining the two

When the existing insurers cannot write enough, an additional insurer is invited to join the coinsurance. Even if the additional insurer cannot keep the full amount on its own account, backing its share with facultative reinsurance may allow it to participate. Because the reinsurance contract is separate from the primary policy, the client's primary contract stays as it is.

Worked example

Suppose a contract needs a limit of JPY 5 billion, but the two existing insurers can write only JPY 3.5 billion between them.

Insurer	Line	Share	Reinsurance
Lead insurer	JPY 2.5 billion	50%	Its own reinsurance program
Existing insurer	JPY 1.0 billion	20%	Its own reinsurance program
Additional insurer	JPY 1.5 billion	30%	Part of its share backed by facultative reinsurance arranged for this contract

* An illustration of the mechanism. Actual shares depend on each insurer's underwriting policy and review.

From the policyholder's point of view, one more insurer appears on the policy and the required limit is secured. The reinsurance behind the additional insurer is not visible to the policyholder, but it is what allows that insurer to participate.

How facultative reinsurance is placed

Facultative reinsurance is arranged for a specific contract, with terms negotiated individually. Unlike treaty reinsurance, which automatically cedes contracts within an agreed scope, each reinsurer decides case by case whether to accept.

Prepare the submission: risk information on the property, sum insured, loss history, probable maximum loss (PML) and the terms of the primary policy. An English submission is needed when approaching overseas reinsurers.
Approach reinsurers: present the submission to several reinsurers and receive their decisions and quoted terms.
Compare and adjust terms: compare reinsurance premium, line and conditions, and adjust them to match the primary policy.
Firm order: once the required amount is secured, fix each reinsurer's share.
Bind the primary policy: with the reinsurance confirmed, the additional insurer joins the coinsurance.

It takes time to get from submission to firm order. Options are limited just before expiry, so preparation should start several months ahead when a shortfall is expected.

Aligning terms matters most

When several insurers and reinsurers are involved, any difference in their terms can leave part of a loss unpaid. The main points to check are:

Whether the covered perils, exclusions and limitations match across all parties
Whether limits and deductibles are defined the same way
Whether the start and end of the policy period match
Who leads claims notification and loss adjustment
Whether the reinsurance terms are no narrower than the primary policy
Whether the reinsurers' financial strength ratings meet the primary insurer's criteria

Points for non-life insurance agencies to confirm

Who handles the client contract and solicitation
The shares of the lead insurer and each other insurer
Whether the additional insurer's terms match those of the existing insurers
Whether commission is paid on the additional insurer's share as well
Whether the same structure can be maintained at renewal

Recent discussion of coinsurance

In recent years the FSA has raised coinsurance as one of the issues facing the non-life insurance industry. It has pointed out that the practice of forming coinsurance around the lead insurer's premium increased the risk of breaching the Antimonopoly Act. Each insurer is now expected, more than before, to quote terms on its own judgment. For policyholders and agencies, this makes it more important to check and compare each insurer's terms individually.

Frequently asked questions

Q. Does coinsurance make the claims process more complicated?
A. The lead insurer acts as the single point of contact, so the policyholder's process is much the same as for an ordinary policy. However, because each insurer pays its own share, the terms of all insurers need to match.

Q. If a reinsurer cannot pay, does the policyholder lose the claim payment?
A. The primary insurer is the one liable to the policyholder. Reinsurance is a separate contract, and failure to recover from a reinsurer is not a reason for the primary insurer to refuse payment to the policyholder.

Q. Can an additional insurer always be found?
A. Not always. Whether cover is offered, and on what terms, depends on the review by the primary insurers and reinsurers. The better the risk information, the easier it is for them to consider the risk.

Working with Credit Hills

When a non-life insurance agency's existing client contract faces a capacity shortfall, Credit Hills arranges an additional insurer and brokers the reinsurance behind it. The agency continues to handle solicitation and administration of the primary contract and keeps its commission; Credit Hills' only remuneration is the reinsurance brokerage. Whether cover is offered, and on what terms, depends on the review by the primary insurers and reinsurers.

For non-life insurance agencies →　Corporate insurance capacity (insight) →

References (in Japanese)

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