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Finite Reinsurance - Where’s the Risk?

This article explores the basics of finite reinsurance, including risk transfer, accounting treatment, and current trends. It also discusses the perspectives of both buyers and sellers, as well as deal features and concerns over finite reinsurance. Additionally, it covers accounting treatment and risk measurement, using the FASB 113 standard and the "10/10 Rule" as examples.

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Finite Reinsurance - Where’s the Risk?

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  1. Finite Reinsurance - Where’s the Risk? David Molyneux, FCAS, MAAA PartnerRe New Solutions Inc.

  2. Topics • Finite Reinsurance Basics • Risk Transfer & Accounting Treatment • Trends

  3. Finite Basics – Buyer’s Perspective • Smooth Earnings & Reduce Volatility • Capital/Surplus Management • M&A • Tax Management • Balance Sheet Optimization • BCAR • Cost Efficiency

  4. Finite Basics - Seller’s Perspective • Motivation behind transaction is not primarily Risk Transfer • Defined maximum limit • Good balance between upside and downside

  5. Finite Structures • LPT/Adverse Development Covers • Aggregate Stop Loss • Finite Quota Share • Multi-Year Funding

  6. Highly Structured Defined Limit Additional premiums to offset adverse experience Funds Withheld or Funds Transferred Profit Sharing Multi-Year Optionality Explicit recognition of Investment Income Finite Reinsurance - Deal Features

  7. Concern Over Finite • Post Enron – more concern over Balance Sheet Integrity • Finite • Explicit Recognition of Invest Income – in line with the true underlying economics of insurance • Reducing Volatility - same goal as traditional reinsurance • De-leveraging Capital – can be more cost effective than CM

  8. Accounting Treatment & Measuring Risk • FASB 113 Qualifying for Reinsurance Accounting Treatment: “It is reasonably possible that the reinsurer may realize a significant loss from the transaction.” Significant Loss “… based on present value of all cash flows between the ceding and assuming enterprises….” , “… same interest rate shall be used to determine present value of cash flows…” Reasonably Possible No explicit guidance given for determining what is “reasonably possible”

  9. Accounting Treatment & Measuring Risk • In Practice • Scenario Approach • Rules of Thumb - “10/10 Rule” • Loss Measurement • Cash flows excluding brokerage, expenses, taxes • Single discount rate versus yield curve • Probability Measurement • Variety of approaches

  10. “10/10 Rule” Defining a 10% Loss • Loss at 90th Percentile • Average Loss between 90-100th Percentile

  11. “10/10 Rule” Defining a 10% Probability Past Practice • Subjective Measurement/Scenario Approach Current Practice • More Technical Modeling • On-level Loss Distributions • Payout Patterns/Variability

  12. Issues – Finite Quota Share FASB 113 2nd Test – reinsurer must assume “significant insurance risk under the reinsured portions of underlying contracts….” ; there must be “variation in amount or timing of payments…”; no delay in timely reimbursement Substantially all the risk exception • Caps • Loss Corridors • Slides • Materiality

  13. Issues - Aggregate Stop Loss • “In the Money” Covers • Multi-Year • Appropriate Interest Crediting Rate for FW

  14. Issues - LPT/ADC • Rating Agency Scrutiny AM Best gives credit for XS of Discounted Carried • Appropriate Interest Crediting Rate for FW

  15. Current Environment • More Scrutiny from Regulators, Auditors & Rating Agencies • Lack of Uniformity in Measuring Risk • “Changing Face of Finite” • More Risk built into Structures • Higher Cost • Development of New Products

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