N.Y. Toughens Reporting on Finite Reinsurance

March 30, 2005

The New York State Insurance Department has decided it will require insurers’ chief executive officers to verify that any finite reinsurance contracts their companies have are correctly reported.

The CEOs will be required to sign off under oath that all reinsurance contracts they enter into contain documentation on their economic intent and a risk transfer analysis. They will also have to include a statement indicating that neither written nor oral agreements are in effect that would potentially alter a reinsurance contract’s terms.

Officials hope this will assist in verifying that insurers with finite reinsurance contracts are utilizing the correct accounting treatment. Some insurers including American International Group have come under scrutiny for alleged improper use of finite reinsurance to manipulate financial reporting results. New York officials said that while there are legitimate uses of finite reinsurance, these transactions “can distort the underwriting and surplus positions of insurers entering into them when there is no actual transfer of risk or the transaction is accounted for improperly.”

As a financing arrangement, insurers often use finite reinsurance to protect themselves from interest rate risk and timing risk. Insurers’ concern about interest rate risk involves potential losses they could realize because of interest rate fluctuations. Concerning timing risk, insurers want to hedge against variations in the timing of their future loss payments. If finite reinsurance is accounted for as a traditional reinsurance product, however, the capital and income of the companies involved can be manipulated.

“Policyholders, investors, and regulators need assurances that insurers’ finite reinsurance contracts are completely transparent,” Acting Superintendent Howard Mills stated upon issuing the Circular letter No. 8 (2005) with the new reporting requirements. “The Circular Letter we’ve issued today is a tough, necessary step that will help to restore confidence to the regulatory process. The insurance department is confident that the letter’s requirements will also prevent insurers from using finite reinsurance contracts as a way of hiding their company’s true financial condition.”

The text of the Circular Letter No. 8 (2005) reads as follows:

The Department is concerned about the improper use of finite reinsurance to manipulate financial reporting results. While the Department recognizes there are legitimate uses of finite reinsurance (such as the transfer of interest rate risk and of timing risk), these transactions can distort the underwriting and surplus positions of insurers entering into them when there is no actual transfer of risk or the transaction is accounted for improperly.

Therefore the Department will now require as part of its examinations of insurers, the Chief Executive Officer to attest, under penalty of perjury, that with respect to cessions under any reinsurance contract, that:

(I) there are no separate written or oral agreements that would under any circumstances, reduce, limit, mitigate or otherwise affect any actual or potential loss to the parties under the reinsurance contract; and

(II) for each such reinsurance contract, the reporting entity has an underwriting file documenting the economic intent of the transaction and the risk transfer analysis evidencing the proper accounting treatment, which is available for review.

In addition, the Department will require increased disclosure of finite risk transactions in the annual statement, including the attestation described above.

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