Finite risk reinsurance

Finite risk reinsurance covers multi-year treaties in which risk transfer is deliberately bounded, the substance of the deal being financing and smoothing. An experience account tracks premiums paid, losses settled and interest credited, and the balance returns to the cedant at the end of the contract if positive. The reinsurer in truth carries only residual risk, of timing or amount, bounded by a cap. The problem it solves is funding volatility: a cedant may want to spread the cost of a bad year across several periods rather than expose its capital, which classical reinsurance does not do since it transfers risk rather than smoothing it. The objection is accounting and long-standing: where risk transfer becomes negligible, the deal is a loan and must be booked as one. Between 2000 and 2005, American International Group used a structured transaction with General Re, a Berkshire Hathaway subsidiary, to artificially inflate its loss reserves by $500 million with no genuine risk transfer, which triggered an investigation by the US Securities and Exchange Commission and the Department of Justice, led to the resignation of its chief executive Maurice 'Hank' Greenberg in March 2005 after nearly forty years running the group, and resulted in 2006 in a settlement of roughly $1.6 billion between AIG and US authorities. The affair led standard setters and regulators to require a demonstration of significant risk transfer, failing which the treaty is recharacterized.

A cedant enters a five-year treaty in 2026, annual premium of 12 million euros credited at 2.8 percent, cover cap of 75 million and effective risk transfer limited to 18 million. The auditor applies the regulatory risk transfer test: the probability of a significant loss to the reinsurer comes out at 11 percent, above the threshold applied, and the deal keeps its reinsurance characterization.

Finite risk reinsurance, Réassurance à risque fini, Finite reinsurance, Réassurance non traditionnelle