What "obligatory" means
An obligatory treaty, also called an automatic treaty, binds both parties. The ceding insurer must cede every policy that falls within the treaty's terms, and the reinsurer must accept every one of those cessions. The reinsurer cannot pick the good risks and reject the bad ones, and the insurer cannot keep the best business for itself. This mutual obligation is what makes most treaty reinsurance efficient: no individual underwriting approval is needed.
Three forms compared
| Form | Cedent must cede? | Reinsurer must accept? |
|---|---|---|
| Facultative | No | No |
| Facultative-obligatory (fac-oblig) | No, it chooses | Yes |
| Obligatory (automatic) treaty | Yes | Yes |
Obligatory vs facultative-obligatory
In a fac-oblig arrangement, sometimes called an open cover, the cedent decides which risks to cede, but once it does the reinsurer is bound to accept them within the agreed limits. Fac-oblig gives the cedent flexibility and quick capacity for peak risks, but it exposes the reinsurer to anti-selection: the insurer may cede only the risks it is least comfortable keeping. Reinsurers therefore price fac-oblig more cautiously, set tighter limits and monitor cessions closely.
In a fully obligatory treaty, the spread of risk is guaranteed because everything in scope is shared. That balance usually produces better terms, higher ceding commissions on proportional business and longer-term relationships.
How cessions work in practice
- Automatic attachment: cover applies as soon as the cedent writes a qualifying policy, often before the reinsurer hears about it.
- Bordereaux: the cedent reports premiums and losses periodically, often monthly or quarterly, in premium and loss bordereaux.
- Underwriting guidelines: the treaty usually defines the maximum line, permitted classes, territories and pricing standards. Business outside them is excluded and may require facultative placement.
- Inadvertent errors and omissions: most treaties include a clause that preserves cover if the cedent accidentally fails to report a risk.
Utmost good faith and following
Because the reinsurer does not see individual risks, it relies on the cedent's underwriting and claims handling. Obligatory treaties therefore rest on utmost good faith, full disclosure of material changes in the portfolio, and follow-the-fortunes or follow-the-settlements clauses, which require the reinsurer to accept the cedent's good-faith, business-like claim decisions. Inspection and audit rights balance that trust.
International practice
Obligatory quota share and surplus treaties are standard in Europe and Asia, where large reinsurers support primary insurers' whole portfolios. In the US, obligatory excess of loss and catastrophe programs dominate property, while casualty often combines quota share with excess layers. Lloyd's syndicates and Bermuda reinsurers participate on obligatory programs worldwide, and Lloyd's also writes many fac-oblig and binding-authority arrangements in specialty lines such as marine cargo.
Choosing the right form
An obligatory treaty suits a stable, homogeneous book where predictable cost and capacity matter. A fac-oblig cover suits peak or irregular risks where the cedent wants an option without a full facultative negotiation each time. Many insurers use both, plus pure facultative for the exceptions.
Polis Re can help you compare structures and prepare treaty submissions; placement is completed through licensed reinsurance intermediaries and authorized reinsurers. Request support or check terms in the glossary.