Indiana State Life and Health Insurance Practice Exam

What type of reinsurance contract involves two companies automatically sharing their risk exposure?

1. Arbitrage

2. Facultative

3. Excess

4. Treaty

The correct answer is: Treaty

The correct choice is treaty reinsurance, which is a type of reinsurance contract wherein two insurance companies automatically agree to share a certain portion of their risk exposure. This arrangement allows the ceding insurer to transfer a portion of its liabilities to the reinsurer without the need for individual negotiation for each policy or risk. Treaty reinsurance is advantageous because it streamlines the process of risk management; it provides a framework for ongoing risk sharing between the parties for a specified time period. Since these agreements usually cover a portfolio of risks, they offer stability in underwriting and can help insurers achieve their growth goals while maintaining adequate capital reserves. In contrast, the other options do not have this automatic risk-sharing feature. Arbitrage typically refers to a trading strategy used in financial markets rather than a type of reinsurance. Facultative reinsurance involves the reinsurer evaluating and accepting or rejecting individual risks presented by the ceding insurer, which requires negotiation for each specific case. Excess reinsurance involves the reinsurer covering losses above a certain threshold, but not necessarily engaging in automatic risk sharing for all policies. Thus, treaty reinsurance stands out for its comprehensive and automatic approach to managing risk exposure.