Fedor on Finite Risk Reinsurance "Let's Not Kill It With Over-Regulation
As the keynote speaker at the recent American Conference Institute symposium on Finite Risk Reinsurance, Joe Fedor, Executive Vice President of U.S. RE, declared that, "Finite Risk Reinsurance is a useful tool that fills an important niche in the inventory of reinsurance products. Let's not abandon a useful tool just because the abuses of a few have created a political firestorm."
The conference brought together insurance industry executives, regulators, trade association representatives, and SEC staffers to discuss Finite Risk Reinsurance and debate approaches to prevent repetition of abuses that surfaced in recent investigations.
"Misuse of Finite Risk reinsurance to present a false picture of a ceding company's financial condition has given a bad name to a legitimate product. Abuses ranging from borderline manipulation of the books to outright fraud must be stopped and punished. Increased regulatory scrutiny is justified. However, we need to guard against destroying a useful insurance/ reinsurance mechanism by over-regulation," Fedor commented.
He pointed out that there is no clear definition of Finite Risk Reinsurance. The term covers a range of products, but is used most frequently to provide catastrophe protection. According to Fedor, "Finite Risk Reinsurance refers generally to multi-year contracts in which the reinsurer can recover some portion of a single year's shock loss over the term of the contract, taking into account the time value of money." However, he emphasized, "the reinsurer must be exposed to the absolute risk of potential loss, of actually losing money over the term of the contract."
"Unless the ceding carrier transfers real risk to the reinsurer, the contract is not reinsurance. It's a financial or banking transaction. It is the obligation of the insurer to determine through actuarial analysis that the premium ceded to the reinsurer could result in an actual loss to the reinsurer. Only then can the contract be legitimately accounted for as reinsurance."
"The best control is the ceding company's auditor," Fedor said, adding: "Actual risk transfer must be determined by actuarial studies of the book of business ceded to the reinsurer. The pool of risks transferred is analyzed to project loss experience over the term of the Finite Risk Reinsurance contract, based on past experience with these or similar risks. The time value of money”potential investment income on the ceded premium - is taken into account. The premium assumed by the reinsurer, less the ceding commission, is calculated to determine the reinsurer's exposure to potential losses. In other words, if the reinsurer does not take the risk of actual losses, the transaction is not reinsurance and must not be accounted for as such by the ceding company."
Fedor's conclusion: "New regulatory proposals should be considered in terms of their potential impact on insurance and reinsurance markets. In recent years, the focus has shifted away from solvency concerns toward short-term results and their impact on share prices. Statutory accounting is geared to protect insurance consumers from insolvent companies. GAAP accounting focuses on full disclosure to protect shareholders. Both are important. However, the long-term responsibility of the insurance-reinsurance business is to protect consumers. In today's complex economy, with the extraordinary risks businesses face, insurers must be allowed to come up with innovative products, such as Finite Risk Reinsurance, to meet the needs of their customers. There must be a balance between securities regulation and solvency regulation that allows the market to function efficiently. Finite Risk Reinsurance is a useful tool, albeit one of many, that allows the insurance mechanism to cover extraordinary risks. Let's not kill it with over-regulation."
U.S. REviews Fall 2005