Bermuda was a natural home for the first finite risk writers but today there is plenty of competition from elsewhere. Valerie Denney asked Bermuda companies how they approach the future.

Bermuda's regulatory environment, infrastructure, location and history of alternative insurance solutions made the domicile the natural base for the first finite risk writers established in the mid 1980s. The success and subsequent growth of these companies established Bermuda as the leading finite risk market. However, as finite risk has entered the mainstream and continues to be increasingly popular, Bermuda's leadership is being eroded by the dissemination of finite techniques throughout the global market.

Having asked several finite risk underwriters whether they feel Bermuda remains the market centre, Global Reinsurance met with various replies, ranging from absolutely to absolutely not. It has to be said, however, that geography generally influenced these viewpoints.

Stockton Re's new president and ceo, Daniel Malloy, best sums up the situation: "The globalisation of finite risk can either further establish Bermuda as the leader in this area of business, or let others take an increasing share. It all depends on whether or not the Bermuda finite companies can continue to offer the highest level of responsiveness, innovative ideas and cost efficiency."

Certainly, the finite risk market is growing harder to serve than in the past. As George Hutchings, vice president, underwriting, Centre Solutions (Bermuda) Ltd, points out, today's products bear little resemblance to those of the early days. "Risks are more leveraged than they have ever been. Today, it is more of a whole risk solution as opposed to finite risk. Tailor made products are part of a general risk management programme."

At a push, Mr Hutchings would rather not use the word product. Like many of his counterparts, he prefers to use the term risk financing solution. "We do not have products as such since all our transactions are different. We sit with clients and discuss their objectives. We consider all those elements before coming up with a structure."

The turning point for the finite risk market was 1993, according to Stephen H. R. Young, associate, underwriting, Scandinavian Re. Until then finite risk products had been focussed on retrospective covers and timing risk. Mr Young explains: "New generally accepted accounting principles were adopted in 1993 that forced buyers to purchase tailor made solutions that addressed prospective exposures including timing and underwriting risk."

Today, opportunities abound thanks to the twin impact of newly emerging exposures and the growing emphasis on holistic risk management. Finite risk writers may have to sell harder in the soft traditional market, but they are finding an increasing number of companies willing to break with tradition and deal with risk financing over the long term, which plays to the strengths of finite reinsurance. These ceding companies expect creative, innovative solutions to classes of business and exposures that have not been looked at before. It is the finite writers' ability to do just this which is the key to their continued success.


A measure of this success is the increasing competition. Few major reinsurers are not currently involved in some finite capacity.

One of the few who is happy to talk products, Mr Young details Scandinavian Re's recent development in terms of the coverage it offers. "We offer a range of products including loss portfolio transfers (LPTs), aggregate stop loss and catastrophe excess of loss contracts. Loss portfolio transfers continue to flow into our office because of the soft market and the high volume of mergers and acquisitions taking place in the market. Companies that once were self-insured or insured through a captive are now trying to take advantage of the low guaranteed cost rates so as to release their liabilities for past years' losses.

"Mergers and acquisitions are also forcing LPTs as companies sell off old liabilities in order to look healthier for inevitable takeovers. Aggregate stop loss covers continue to be popular because they limit a company's loss ratio or combined ratio during the contract. The management and shareholders of the company enjoy the stop loss as the share price may be less volatile with the stability of loss ratios and earnings.

"Catastrophic excess of loss contracts are multi-year catastrophic transactions in which the reinsured is able to smooth out spikes from large losses over the time period.

"In the soft market, all insureds and reinsureds have become demanding in the pricing and negotiation of their contracts. The increasing capacity of the (re)insurance arena and lack of large catastrophes have dropped rates to extremely low levels. This rate pressure will continue to preside over the industry until some catastrophes and/or bankruptcies of corporations may reverse the trend."

What a difference finite risk makes

The traditional market has not been the same since finite risk emerged into the mainstream. As Mr Hutchings puts it, the market has "opened traditional underwriters' eyes".

"Finite risk has made a tremendous difference to the traditional reinsurance market," remarks Mr Young. "Since Scandinavian Re and other finite reinsurers were initiated, we have seen the blending of traditional and finite qualities within (re)insurance contracts. Now, traditional (re)insurers offer profit commissions and multi-year contracts that normally would never have been executed prior to the emergence of finite risk reinsurance. Additionally, it has forced the traditional market to increase their analytical skills and improve their product spectrum."

Adds Mr Malloy: "Finite reinsurance's biggest contribution to the traditional reinsurance market is a heightened awareness that reinsurance is a vital component of the long term capital structure for ceding companies. Prior to the development of finite products, most ceded reinsurance buyers viewed reinsurance as a means of reducing excessive loss activity, but very few recognised the financial statement and shareholder value implications of a properly structured reinsurance programme. Today, far more reinsurance programmes incorporate elements of finite risk, which have been developed to maximise the surplus and shareholder value over a longer period of time."


What, then, of the future for finite risk? "Promising" is the most favoured description. "What we write today is not necessarily the same as tomorrow," contends Mr Hutchings. "The opportunities are there. There are new problems to work out in the future. For example, we'll be asked to write more types of risk such as exchange rates."

"At the moment, mostly US and UK (re)insurers realise the benefit of the use of finite risk in their reinsurance programmes," comments Mr Young. "In the future, finite risk will expand to include the rest of the world as companies start to realise that they can use the benefits of finite risk to their advantage, that is, to reduce earnings volatility, etc."

Mr Malloy concludes: "In finite risk, as in any line of business in today's market, those companies which have established a leadership position due to their experienced personnel, sufficient capital and focus on their clients will continue to thrive. Ultimately, continuing to provide products which add value to customers will separate the successful companies from the rest of the pack. Our 'independent' status is a strong positive as customers tire of having reinsurers compete with them."

What is finite risk?

As Stephen H. R. Young of Scandinavian Re explains, finite risk cannot be clearly defined, but it generally involves four characteristics that differ from traditional contracts. The first attribute that distinguishes finite risk from traditional contracts is that it accounts for the time value of money in all transactions. Investment income is always used in the computation of premium for the individual contract.

Secondly, finite risk involves a limited amount of risk transfer. In each transaction, the limit is agreed in advance by both parties so the reinsurer's risk not only lies in the underwriting portion but also the untimely payment of losses (timing risk).

The third characteristic of finite risk transactions is that the contracts normally involve a profit commission paid to the (re)insured at expiration or cancellation. The profit commission is required because the premium for the contract is normally a high percentage of the limit. The mechanism allows the (re)insured to receive funds back for good loss experience.

Finally, finite risk is normally used in transactions involving multi-year contracts. These multi-year transactions allow the reinsurer to use the time value of money and to spread losses from one year of the (re)insured to other years with good results.

Valerie Denney is co-editor of Global Reinsurance.