Ernie Csiszar says regulators must adopt a consistant approach
An increasing number of state regulators are conducting inquiries in response to concerns over the value and validity of finite reinsurance transactions. While we understand the regulators' concerns over the issue - especially in light of the media microscope the industry is currently under - we hope that they will take a consistent approach and avoid creating a crazy-quilt of confusing and conflicting investigative practices and compliance rules. More importantly, regulators must realise that the tools to address this issue are largely in place.
Finite risk transactions can be structured to cover past or future losses and some contracts start with the recognition that a loss has already happened but that its ultimate cost may not be known for a long time. Finite reinsurance transactions have been vital tools in managing risk and stabilizing balance sheets since the 1980s. It is estimated that finite risk transactions make up about 3% to 5% of the $35bn US reinsurance market.
The only thing controversial about these transactions is how to account for them. Finite policies should not be recorded as insurance transactions unless risk has been transferred. If there is no risk transfer, the contract should be accounted for as a loan, which would not enhance a corporate balance sheet.
Accounting standards for finite reinsurance transactions are already in place. Both Generally Accepted Accounting Principles (GAAP) and statutory insurance accounting give clear guidance on reporting and accounting for finite reinsurance transactions. However, there may be a need for increased disclosure requirements that would alert regulators to the types of contracts that may demand closer review. Moreover, it's important that all components of the transaction be disclosed. Finite contracts with side agreements are clearly illegal without disclosure of the entire transaction.
Finite reinsurance products are an important financial tool for both primary insurers and reinsurers. They can lower the cost of reinsurance and even make reinsurance coverage more available because they allow reinsurers to appropriately limit their risk. However, it is critical that these transactions be accounted and reported properly.