Max Re Chief Executive's Quick Exit Shines New Light On Finite Deals

However, "new information" regarding the deals led members of the carrier's Audit and Risk Management Committee to conclude there was an oral side agreement that cast doubt as to whether two finite-risk contracts signed in 2001 contained enough risk transfer to qualify for preferable accounting treatment. About $10 million in earnings are in question, according to a statement issued by the firm.

So-called "side letters"–or in this case, "side oral agreements"–have figured prominently in recent accusations of wrongdoing in reinsurance accounting, for they have the effect of secretly removing out of contracts most of the risk transfer that qualifies them for reinsurance accounting and credit for reinsurance.

Executives must now attest that no such agreements exist, according to guidelines from both the New York Insurance Department and those recommended by the National Association of Insurance Commissioners.

As a result of the new information, Max Re will restate its earnings from 2001 though the first half of this year.

The carrier said the additional information did not relate to the third contract reviewed in the internal investigation, which was with a different counterparty.

Andrew Barile, a reinsurance consultant based in Rancho Santa Fe, Calif., said that since the board requested Mr. Cooney's resignation, it seemed likely that he was a party to the oral agreement.

Mr. Cooney has also resigned from the board. "After founding and leading Max Re for seven years, I have submitted my resignation because I believe it is in the best interests of the company to do so," he said in a statement. "I am confident that Max Re will continue to succeed and grow under the new management team put in place."

It remains unclear just what impact the resignation of the founding officer and the new investigation will have on the company's fortunes.

A.M. Best declined to take any action, asserting that Max Re's actions "were prudent, and the current management team has sufficient depth to direct and maintain the current business strategy."

Fitch Ratings, however, put the carrier and some of its Dublin subsidiaries on review for a possible downgrade.

Fox-Pitt Kelton analyst Daniel Farrell said in a note to investors that the major concerns now are fines and penalties, as well as further management upheaval down the line. But he said debt and credit downgrades seem unlikely, since the financial position of the company has not been affected.

For the industry, new questions about the reliability of financial reporting cannot be welcome just when it seemed such stories were subsiding, although many of these issues have been simmering for years. "Side letters go back to the 1980s," Mr. Barile noted.

Some agreements include the promise by the insured not to make a claim during the period of the agreement, while others can include a "commutation clause"–stating that if the risks covered by the official reinsurance transaction start to turn very bad, the reinsurer has the right to cancel the whole policy on terms that mean it will still make a profit, Mr. Barile explained.

So far, regulators have not gone beyond the attestation requirement, with the NAIC considering and then abandoning the idea of bifurcating reinsurance contracts to separate their financial and risk elements.

With many of these forms of reinsurance contracts extending five years, Mr. Barile said it was unclear at this point how many more such side agreements will be unearthed in the near future.

While Max Re's stock is down roughly 12 percent this year, its auditor said the reinsurer expects to earn about $25 million in the third quarter–which Mr. Farrell said was better than his estimates.

Mr. Cooney founded Max Re in 2000, which was unusual in that it was in the middle of a soft market and was not set up to exploit a temporary upsurge in pricing related to a catastrophe, such as Hurricane Andrew or Sept. 11.

In addition, he parlayed $331 million from investors–including a New York-based hedge fund, Moore Capital–at a time when that was anything but a common practice.

Mr. Cooney had earlier this year expressed some chagrin about the effect of New York Attorney General Eliot Spitzer's investigations into the AIG-Berkshire Hathaway deal that raised the whole question of insufficient risk transfer.

"Obviously there were abuses with improper accounting practices on some large finite deals," he said at the time, adding that if prices started to drop, "I could see us shrinking our traditional risk-taking business, and maybe those alternative structures, with less risk transfer, will become more interesting to us."