Financial reinsurance

Document description

Financial reinsurance is a growing phenomenon, as illustrated by the (known) growth in premiums written by financial reinsurers. Current annual premiums are estimated to be in the order of $5bn per annum. It arises out of the desire of insurers to introduce an element of control into their reported results whether to smooth, enhance or reduce profits; and out of the skill of reinsurers in designing contracts which minimise the risk of significant loss to the reinsurers. There are many commercial pressures on insurers which encourage them to consider purchasing financial reinsurance, and in current market conditions one particularly important need is to obtain reinsurance cover to continue the previous level of gross writing. The primary mechanism of financial reinsurance is fairly easy to understand. By utilising the differences in tax or regulatory rules in different jurisdictions, the result is to effect a change - or to set up a means whereby a change can be controlled in the future - in the reinsured's balance sheet/revenue account without commensurately altering the underlying economic reality. It is not true to say that there is never any real insurance element to a financial reinsurance contract. There may be elements of risk transfer, especially when the contract is marketed as filling a gap in cover in a difficult conventional market. However, it will usually be found on examination that such cover is only a small part of the contract, the potential downside (but admittedly also the upside) to the reinsurer is very limited, and its price may be high when the effects of compound interest are taken into account.