Expert Explains Finite Reinsurance Needs

|

By Daniel Hays

|

NU Online News Service, April 26, 11:10 a.m.EDT?Despite the controversy raised by recentinvestigations, finite reinsurance deals when done properly serve avalid purpose and will remain as an important niche in themarketplace, according to an expert in the field.

|

"I see this area continuing as an important subset underwhatever clarified guidelines emerge," commented Dan Malloy.

|

Mr. Malloy, executive vice president of ART solutions withBenfield Group's New York Office, used his knowledge of structuredreinsurance in February to provide a briefing on the topic forregulators at the National Association of Insurance Commissionersmeeting.

|

According to Mr. Malloy, finite reinsurance arrangements accountfor somewhere between three and 10 percent of the reinsurancemarket, but while he said the number of transactions is "miniscule"they tend to be larger.

|

This is because rather than providing a carrier with coveragefor a single line for a single year such contracts may cede therisk from multiple lines in an insurer's portfolio over multipleyears.

|

Arrangements of this sort come under regulatory scrutiny, heexplained, when they fail to meet the requirements of the FederalAccounting Standards Board Regulation 113.

|

Accounting rules require that for a contract to be recorded asreinsurance, it must be reasonably possible that the reinsurer willrealize a significant loss on the contract. Accountants haveadopted a rule of thumb to interpret the rule, requiring that atransaction carries a 10 percent probability of loss of 10 percent,of the premium to the reinsurer, evaluated on a discountedbasis.

|

Mr. Malloy said that if the FASB finite reinsurance riskpercentage rules promulgated in 1993 are not met, then the primaryinsurer must keep reserves sufficient to cover the losses subjectto the contract, since proper risk transfer credit cannot be takenfor ceding the risk. In other words, the primary insurer gets lessfavorable accounting treatment and cannot net down premiums andreserves that would be ceded to the contract if it were areinsurance contract.

|

He added that if the insurer takes credit for buyingreinsurance, but the reinsurer doesn't have risk?the economics arestill sitting with the [reinsurer's] client and they haven't gottenrid of the downside."

|

Further, said Mr. Malloy, if the primary insurer is basicallykeeping all the exposures, the insurer is "misstating the riskposition and understating its leverage."

|

Explaining the market for reinsurance, Mr. Malloy said thatinsurers are more comfortable accepting reinsurers' tightercoverage limits on a big predictable book of business encompassingseveral lines over a longer period.

|

Compared with the traditional reinsurer, who wants to do asingle line over one year, the finite reinsurer reduces thepossible volatility of results. With greater data from examiningmultiple lines over multiple years outcomes fall between a muchtighter range. "The coverage based on the entire portfolio smoothesout some of the peaks and the troughs," he related.

|

As an example, Mr. Malloy said a finite reinsurer would look ata total book over three years, which would have less volatilitythan an individual line. The reinsurer would offer a cap of xamount of dollars and reduce the cost if there is a favorable lossoutcome. "So the client says I'll accept your limit on liabilityand get a big profit share."

|

He said that 99 years out of a 100, the insurer is never goingto hit the finite insurance maximum."

|

When it comes to finite insurance "people aren't doing it justfor accounting" said Mr. Malloy.

|

In his presentation to the NAIC, he pointed out that use ofstructured transactions may be attractive to insurers for severalreasons, including:

|

? They recognize economics of long tail lines of business

|

? They deal with company experience that is better than average,making reinsurance "too expensive."

|

? They allow a company to increase writings or take largerretentions in favorable underwriting environments.

|

? They work for a company with historic experience that is muchworse than average making ?reasonably' priced reinsuranceunavailable.

Want to continue reading?
Become a Free PropertyCasualty360 Digital Reader

  • All PropertyCasualty360.com news coverage, best practices, and in-depth analysis.
  • Educational webcasts, resources from industry leaders, and informative newsletters.
  • Other award-winning websites including BenefitsPRO.com and ThinkAdvisor.com.
NOT FOR REPRINT

© 2024 ALM Global, LLC, All Rights Reserved. Request academic re-use from www.copyright.com. All other uses, submit a request to [email protected]. For more information visit Asset & Logo Licensing.