Finite deals drop off in number as scrutiny increases

Heavy regulatory scrutiny of finite reinsurance products has hampered the popularity of such deals, but they won't disappear from the marketplace completely, industry experts and observers say.

Some demand for the products remains, but those finite transactions that are completed now undergo far more rigorous analysis to ensure that they will pass muster with regulators, they say.

Widespread probes by insurance regulators--who since 2004 have zeroed in on the alleged misuse of finite contracts to smooth earnings and mask true financial results--have spurred a flurry of insurer and reinsurer earnings restatements for improper accounting of finite deals, as well as regulatory settlements to resolve allegations of finite risk-related abuse.

The investigations have also led to criminal indictments of former executives at American International Group Inc. and General Reinsurance Corp., and even prompted the exits of top officers, including the former chief executives of AIG, RenaissanceRe Holdings Ltd., and just last week, Max Re Capital Ltd.

Fewer deals

"Pressures from regulators" have resulted in a drop in the number of overall finite risk transactions, said John Andre, vp, reinsurance and alternative market ratings for Oldwick, N.J.-based A.M. Best Co. Inc.

"Less of what we consider to be finite deals are being done," said Mr. Andre, who noted that the term "finite reinsurance" has multiple definitions.

Especially in cases where there is a question about whether a particular finite risk contract should be accounted for as a deposit rather than insurance, "those deals are being approached with more skepticism by cedents, and the transaction flow has diminished considerably," according to Robert DeRose, assistant vp, reinsurance ratings, at Best.

While there can be legitimate uses of finite products--for instance, a loss-portfolio transfer that allows companies to "cap the potential impact on discontinued business" and "to focus on the ongoing business"--a large portion of "finite deals were not meant to do anything beneficial from a financial perspective; it was just window dressing" according to Brian Schneider, director, insurance, at Chicago-based Fitch Ratings.

According to Mr. DeRose, many who historically purchased finite contracts "are just going uncovered, or purchasing traditional reinsurance protection instead."

"If they are using traditional reinsurance, it is likely costing them more by virtue of the fact that there is more risk transfer in a traditional structure then a finite one," Mr. DeRose said.

"These things really had their best use because they were deceptive," Mr. Schneider said. "The attention the industry has experienced...has reduced demand for such finite products," he said, though, "there is still a market out there."

"There's always going to be people who want or need something other than the traditional market," said Dan Malloy, executive vp at Benfield Inc. in New York with responsibility for specialty lines, including alternative risk transfer and structured reinsurance. "People always want alternatives."

"Finite has been associated with bad reinsurance...largely due to misuse by interested parties," according to Mr. Malloy. But certain factors such as cost, breadth of coverage and confirmed capacity for more than 12 months are among the reasons that finite reinsurance will remain attractive to a portion of the market, he said.

Among other things, certain finite reinsurance products can offer ways to "improve capital efficiency and risk management efficiency," said William Anderson, head of structured reinsurance solutions for Swiss Reinsurance Co. in New York. "Clearly, the demand dropped...but the actual execution (of finite deals) fell off more," said Mr. Anderson.

Mr. Malloy noted that underwriters who continue to offer finite reinsurance can only do so with increased due diligence. "Every reinsurer that's offering these products has to have at least one additional step in their underwriting process to make sure that what they are offering is reinsurance."

Benfield--which places finite products including loss portfolio transfers associated with a sale or discontinued line, quota shares across several lines of business and aggregate stop loss covers--"has had rating agencies, regulators, auditors vet the deals that have been done in the past 12 months," Mr. Malloy said.

"Even if the regulators were to try and get rid of all uses of finite, I think it would be very difficult," said Fitch's Mr. Schneider. "You'll always see degrees of it here and there to the extent that it's an economic benefit to both parties, and doesn't distort economic statements."

And among the companies that continue to use products that fall under the finite reinsurance umbrella, "I don't think you're going to see some of the abuses (of the product) anymore," Mr. Schneider predicted.