Finite Legit, But Oversight Needed, N.Y. Regulator Says

Boston

An accounting professional said insurance company boards arekilling the appetite for finite deals, but a regulator said thelesson to take away from investigations into such deals isn't thatcompanies should cease to engage in them.

In fact, Audrey Samers, deputy superintendent of the New YorkDepartment of Insurance, said the real lesson is that boardoversight is critical.

"We, at the department, recognize that finite insurance is alegitimate product [that] protects insurers from interest rate riskand timing risk," she said during a session at the ProfessionalLiability Underwriting Society International Conference here.

She added that if the finite transactions are not properlyaccounted for, "or there's not an actual transfer of risk, thetransactions can distort the underwriting and surplus positions ofthe insurers entering into them."

Investigations into finite--a term that encompasses a variety ofdeals in which there are contractual limitations on the amount ofrisk sellers assume--are still being conducted by the departmentand the New York attorney general's office.

Reacting to what the department uncovered during itsinvestigations so far, Ms. Samers said that New York regulatorshave worked with the National Association of InsuranceCommissioners to put some uniform requirements for disclosingfinite arrangements in place.

The disclosures, in part, stem from a directive issued by thedepartment earlier this year--Circular No. 8--which has since beenwithdrawn in the interest of having uniformity across the UnitedStates.

The circular had proposed that, for the purposes of financialexaminations conducted by the department, the chief executive ofthe company being examined would have to attest that there were noside agreements--agreements that would alter the transfer ofrisk--in its reinsurance contracts. In addition, it required anunderwriting file documenting the "economic intent" of everyreinsurance transaction.

The NAIC disclosure rule now requires insurers to file suchattestations (from the chief executive officer and chief financialofficer) in their annual statements in all 50 states. In addition,they must attest that they are in compliance with statutoryaccounting.

Ms. Samers said the intent was "to get greater controls out ofour licensees and to improve the ability of regulators to see wherethere are transactions we should be looking at."

She added that while industry participants debate thresholds fortransfer of risk--questioning whether 9 percent or 11 percenttransfer of risk is appropriate for insurance accountingtreatment--the department, in its investigations, is really notdealing with such questions. Instead, "the abuses we've seen arewhere there are no underwriting files, and it is clear there is notransfer of risk," she said.

A recent study by the American Academy of Actuaries, and arecent survey by the NAIC, produced similar findings. The AAA studyfound that there is no consistent standard used by insurers tomeasure the level of risk transfer in their reinsurance contracts.The NAIC confirmed that most companies using finite contracts don'thave internal procedures for testing reinsurance contracts fortransfer of risk, she said.

"What you see time and time again are problems with corporategovernance," she noted. "That's really the lesson to learn from thefinite investigations," investigations into broker compensationpractices, and increased scrutiny of insurers generally.

At an earlier session, Peter Porrino, who heads the worldwideinsurance practice of Ernst & Young in New York, reported thathe attends audit committee meetings on a regular basis. "You can'tgo to an audit committee meeting without someone asking, 'You'renot writing any of that finite stuff? You're not buying any ofthat, are you?'"

Mr. Porrino continued that "finite" gets "confused with fraud,"adding that the majority of the restatements so far were fraudsinvolving side agreements.

In the future, however, he predicted more restatements that havenothing to do with fraud. Going forward, "the bigger issue is goingto be the transactions that the SEC is looking at today," hesaid.

Officials at the SEC, he reported, are saying things like, "'Iunderstand this contract is the entire contract--that there are noside agreements or related-party transactions--but it doesn'twork.' There isn't enough risk transfer in the way that we look atrisk transfer," he reported.

He predicted that future restatements won't be constrainedbecause of side agreements but because of the SEC's view that notenough risk was transferred.

"The abuses we've seen are where there are no underwritingfiles, and it is clear there is no transfer of risk."

Audrey Samers, Deputy Superintendent

N.Y. Department of Insurance