Reinsurance contracts are filled with exotic and, to the uninitiated,
mind-numbing words like "treaty," "facultative
certificate," "cede," "bordereau,"
"follow-the-fortunes," "honorable engagement,"
"ultimate net loss," and more. Although previous commentaries
addressed some of these words, I thought we should examine a few of these terms
of art.
Terms of art are often used to set a particular industry or profession apart
from others by using jargon that has a "special" meaning only
understood by those working in that industry or profession. As Professor
Kingman Brewster Jr. said, "Incomprehensible jargon is the hallmark of a
profession."
Let's start with the basics. While many reinsurance contracts have the
words "contract" or "agreement" in their titles, many
others use words like "treaty" or "facultative
certificate." Moreover, reinsurance contracts, regardless of how they are
titled, are generally categorized by people in the reinsurance industry as
either treaties or facultative certificates. So, what is a treaty or a
facultative certificate?
What's in a Name?
A "treaty" is the name given to a reinsurance contract that covers
a portfolio of business. For example, if under a reinsurance contract, a
reinsurer is obligated to share in the premiums and losses of all the insurance
company's medical malpractice policies written in the United States during
the treaty period, that reinsurance agreement is called a treaty. Why a
reinsurance contract covering a portfolio of business is called a treaty is a
bit of a mystery lost in the annals of time, but we know for sure that it is
not an international agreement between two sovereign states but a reinsurance
agreement between an insurance company and a reinsurance company covering a
large number of insurance policies that the insurance company intends to write
during the period.
If, however, the reinsurance contract only covers a specific risk insured by
an insurance policy, for example, the property of the Empire State Building in
New York, the reinsurance agreement is known as a "facultative
certificate" of reinsurance. A facultative certificate is better known as
a "fac cert." According to the Guy Carpenter & Co. LLC
Glossary, the word "facultative" connotes that both the
primary insurer and the reinsurer usually have the faculty or option of
accepting or rejecting the individual submission (as distinguished from the
obligation to cede and accept, to which the parties agree in most treaty
reinsurance).
Next time you hear someone talk about a reinsurance treaty, you will know it
is a reinsurance contract covering a segment of the insurance company's
policies. And, if they ask about a fac cert, you will know it is reinsurance of
a specific policy covering a specific risk.
To Cede or Not To Cede
The word "cede" appears in various forms throughout the world of
reinsurance. First, the direct insurance company that purchases the reinsurance
from a reinsurance company is called the "cedent," the "ceding
insurer," or the "ceding company" (as well as the reinsured).
Next, the policies and risks underwritten by the direct insurance company are
"ceded" by the insurance ceding company to the reinsurer and a
"ceded" risk is called a "cession."
For example, if an insurance company writes homeowners insurance and enters
into a reinsurance contract on a proportional basis where the reinsurer shares
in 80 percent of the premiums and losses, the ceding company cedes 80 percent
of the premiums and losses on all its homeowners insurance policies, and each
policy that it writes is a cession to the reinsurance contract.
And, just to make it more confusing, a reinsurer that cedes a portion of its
business to another reinsurer is called a "retrocedent" and the
assuming reinsurer is called the "retrocessionaire." Where does this
all come from?
The word "cede" comes from the Latin verb cēdere, which
means go, go away, withdraw, or yield. While in English, "cede"
generally means to give up, surrender, or transfer rights, in reinsurance, it
means transferring the risk from the insurance company to the reinsurance
company. The party that transfers the risk and cedes the underlying insurance
liability is the cedent (or retrocedent if a reinsurer is assuming reinsurance
risk).
In the United Kingdom, and sometimes in the United States and elsewhere,
cedent is often spelled "cedant." Many years ago, I did some
grammatical research and concluded that the word is correctly spelled
"cedent." But whether you use cedent or cedant, it means the buyer of
a reinsurance contract.
Bordereau Defined
As one delves into the more technical aspects of a reinsurance contract, the
term "bordereau" often comes up. The uninitiated may immediately
recoil from a word like bordereau, but those who have been around the block
know that a bordereau is just a list or report. But is it just a list?
The venerable Robert W. Strain defined bordereau as follows.
Furnished periodically by the reinsured, a detailed report of reinsurance
premiums or reinsurance losses. A premium bordereau contains a detailed list
of policies (or bonds) reinsured under a reinsurance treaty during the
reporting period, reflecting such information as the name and address of the
primary insured, the amount and location of the risk, the effective and
termination dates of the primary insurance, the amount reinsured and the
reinsurance premium applicable thereto. A loss bordereau contains a detailed
list of claims and claims expenses outstanding and paid by the reinsured
during the reporting period, reflecting the amount of reinsurance indemnity
applicable thereto. Bordereau reporting is primarily applicable to pro rata
reinsurance arrangements and to a large extent has been supplanted by summary
reporting.1
The IRMI.com
Glossary definition of bordereau is "a report providing premium or
loss data with respect to identified specific risks. This report is
periodically furnished to a reinsurer by the ceding insurers or
reinsurers." A single report or list is a bordereau. When describing more
than one bordereau, add an "x" after the "u" to make the
term plural: "bordereaux."
Why Bordereau?
The word "bordereau" derives from the middle French word
"bordrel" and from the old French word "bort," which means
edge or margin. Merriam-Webster Dictionary shows the first known use
around 1858, but A Treatise on the Law of Principal and Agent, Chiefly with
Reference to Mercantile Transactions (Paley, William. 3rd ed. New York:
Banks, Gould, 1847) mentions bordereau in the context of a statement or
memorandum listing the details of negotiable instruments. Earlier uses can also
be found if you search the Internet or hang out in dusty corners of business
libraries. As with most terms of art, "bordereau" was used instead of
report or list by reinsurance professionals and became common usage in the
industry in the 1800s.
Interestingly, the errors and omissions clause found in many reinsurance
contracts was developed when all information received by the reinsurer was
presented on comprehensive bordereaux. The clause ensured that coverage was
provided even though an item was inadvertently left off the
bordereaux.2 See our Expert
Commentary, "When
Errors Occur in a Reinsurance Relationship" (December 2002).
Types of Bordereaux
The term bordereau is used to describe most lists or reports of premium or
losses required under the reinsurance contract from the reinsured to the
reinsurer. In the facultative context, where an individual risk is reinsured, a
bordereau is not necessary. The premium report is the reinsurance premium paid
for the facultative certificate for that individual risk. On the loss side,
typically, there is individual loss reporting. But, if a facultative
certificate generates multiple losses emanating from an individual risk,
monthly or quarterly reports listing all claims and all payments on claims
attributable to that single risk may be deemed a bordereau.
In the treaty context, a premium bordereau is merely a detailed report of
the premiums ceded to the reinsurers from each of the underlying policies
subject to the proportional reinsurance treaty. Typically, the premium
bordereau will set out policy-level detail, including the gross premium, the
brokerage if any, and the ceded premium, along with basic details for each
policy ceded to the treaty. The premium bordereau is also the initial method by
which the reinsurer finds out the exact details of the business being written
by the reinsured and assumed by the reinsurer.
Most reinsurance contracts will specify the reporting requirements for the
periodic premium bordereau. I am sure by now all reinsurers have standardized
the bordereau format and accept them electronically either in a proprietary
format based on the reinsurance accounting system being used or in a common
format like Excel. Certain statistical organizations and industry compilers of
information in certain markets have standardized electronic bordereau
reporting. For those using blockchain technology for reinsurance, the detailed
information found on the bordereau will now be one of the blocks on the
chain.
The premium bordereau generally goes directly to the reinsurer's
accounting function so that the ceded premium can be booked. Nevertheless, it
is important for the reinsurer to examine the premium bordereau for anomalies
in either the premium volume or the risk information being supplied. The
premium bordereau also serves as an important tool for the reinsurer when
selecting certain risks for audit if the reinsurer engages in periodic audits
of the business being ceded to the treaty.
A proportional treaty typically will have reporting requirements for losses,
and these often manifest as a loss or claims bordereau. The reinsurance
contract will set out the information requirements for the loss bordereau.
Generally, the loss bordereau will contain risk details such as the
insured's name, claimant's name, policy number, claim number, effective
date, date of loss, loss reserve, expense reserve, and any paid losses or
expenses. The loss bordereau, like the premium bordereau, is provided in
electronic format and often in a standardized design. On a quota share treaty,
the loss bordereau is often the only way the reinsurer will obtain information
about the losses being ceded to the treaty unless there are special reporting
requirements for certain risks or certain losses. Like the premium bordereau,
the loss bordereau will be the tool against which the reinsurer will make
selections when doing a claims audit.
Reinsurance Contract Requirements
Not every reinsurance contract requires premium bordereau reporting. Very
often, reporting clauses require summary accounting information rather than the
individual risk detail typically found in bordereau reporting. For example, a
reporting clause may provide simply as follows.
The Company shall render a monthly account within __ days after the end of
the period. This account shall summarize premiums, return premiums,
allowances for commissions, losses paid, loss adjustment expenses paid, and
salvage recovered. The account shall also reflect the balance due by either
party.
These monthly or quarterly reports are merely account statements summarizing
the business under the treaty and do not provide policy-level detail. Where the
reinsurance contract does not prescribe detailed bordereau reporting, the
reinsurer must audit periodically to test the business being ceded and to
ensure compliance with the terms of the reinsurance contract.
Where bordereau reporting is required, the reinsurance contract will express
the detailed information required. For example, here's the following.
The Company shall furnish the Reinsurer with the following:
1. Bordereau within 30 days after the last day of each month, payable
within 60 days after the last day of each month. The bordereau is to include
the following items:
- Name of Insured
- Policy Number
- Effective/Expiration Dates
- Type of Transaction (New, Renewal, Endorsement, or Cancellation)
- Policy Limit
- Premium
- Ceding Commission
- Net Premium
Conclusion
Terms of art and industry jargon are off-putting to many. The reinsurance
industry is littered with these terms. Yet, words like "treaty,"
"fac cert," "cede," and "bordereau," once their
meaning is known, are no longer mysterious and are easily understood and put to
common use.