In a facultative reinsurance agreement, what does a commercial insurance company do if it encounters a risk exceeding its limits?

In a facultative reinsurance agreement, a commercial insurance company typically seeks reinsurers willing to cover the excess amount when it encounters a risk that exceeds its capacity or limits. This process allows the primary insurer to manage its risk exposure effectively. By obtaining additional coverage from reinsurers for specific, larger risks, the insurer can still provide coverage to its clients without overexposing itself financially.

The option regarding transferring all policies to a reinsurer is not accurate in facultative arrangements since these are typically negotiated on a case-by-case basis for specific risks rather than transferring entire policies. Denying coverage for the risk is also not the primary function of facultative reinsurance, as the intent is generally to offer coverage, and increasing premiums for all insured would not be an immediate response to a specific high-risk situation but rather a broader strategy that doesn’t address the current need for additional coverage. Thus, the focus in facultative reinsurance is to selectively transfer portions of risk rather than taking more drastic measures.