South Dakota Crop Insurance Practice Exam

What characterizes treaty reinsurance?

1. A contract for one-time risks

2. A binding agreement for automatic risk sharing

3. An informal agreement between insurers

4. A type of insurance sold to consumers

The correct answer is: A binding agreement for automatic risk sharing

Treaty reinsurance is characterized by a binding agreement for automatic risk sharing between the ceding insurer and the reinsurer. This type of reinsurance involves a pre-agreed arrangement where the reinsurer agrees to accept certain risks covered by the primary insurer, automatically and within the terms established in the treaty. By establishing a treaty, insurers can manage their risk exposure efficiently and obtain a stable and predictable reinsurance arrangement, as the agreement covers a portfolio of policies rather than individual risks. This contrasts with facultative reinsurance, where each risk must be negotiated and accepted separately. This automatic risk-sharing mechanism allows insurers to maintain capital efficiency and protect themselves from loss concentrations, particularly in cases of catastrophic events. It ensures that both parties have a clear understanding of their roles and obligations without needing to renegotiate terms for each specific risk. This systematic approach is fundamental to the operation of reinsurance markets.