Final answer:
Facultative Reinsurance is the method by which a ceding insurer transfers specific risks to an assuming insurer on a case-by-case basis, providing a bespoke solution to risk management. It differs from coinsurance and other forms of coverage such as excess liability or indemnity transfer, and serves as one of the many tactics insurers use to mitigate moral hazard.
Step-by-step explanation:
When considering the transfer of risk in the insurance industry, a ceding insurer may use a process known as Facultative Reinsurance. This process involves the ceding insurer transferring a portion of the risk associated with a single insurance policy or risk to another entity, known as the assuming insurer, on a case-by-case basis. Unlike other forms of reinsurance, Facultative Reinsurance is not an automatic process and requires the approval of the assuming insurer for each risk or policy transferred.
Facultative Reinsurance is different from other insurance concepts such as coinsurance, where both the policyholder and the insurance company share the costs of a loss. It also should not be confused with excess liability, which provides additional coverage beyond what is provided by a primary policy, or indemnity transfer, which generally refers to the transfer of liability from one party to another.
In the context of moral hazard, reinsurance helps mitigate the risk of loss that an insurance company might face by spreading the risk across multiple entities. However, the concept of moral hazard also implies that when an individual or entity is protected against a certain event, such as through an insurance policy, they may be less motivated to prevent the occurrence of that event. To counteract moral hazard, insurance policies often incorporate measures such as deductibles, copayments, and coinsurance which require the insured to bear a portion of the losses.