Finite risk reinsurance

Finite risk reinsurance covers multi-year treaties in which risk transfer is deliberately bounded: the substance of the deal is 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: it transfers risk instead of 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 $$500 million with no genuine risk transfer. The US Securities and Exchange Commission and the Department of Justice opened an investigation. Its chief executive Maurice 'Hank' Greenberg, at the head of the group for nearly forty years, resigned in March 2005. In 2006, AIG and US authorities reached a settlement of roughly $$1.6 billion. The affair led standard setters and regulators to require a demonstration of significant risk transfer, failing which the treaty is recharacterized.