Finite Deals Seen Legit, But Need Oversight
BY SUSANNE SCLAFANE
National Underwriter News
Nov. 15, 2005
Posted Nov. 28, 2005
Boston - Company boards examining finite insurance transactions need to scrutinize them carefully, but need not dispense with them altogether, a regulator told an industry conference here.
Audrey Samers, deputy superintendent of the New York Department of Insurance, made her comments as an accounting professional reported that corporate directors are backing away from finite deals and equating them with fraud.
Finite deals have come under scrutiny since federal and state investigators turned up evidence that some have involved hidden side agreements and been used as an improper accounting device to improve company financial statements.
Ms. Samers said the lesson to take away from investigations into such deals isn't that companies should no longer engage in them, but that board oversight is critical.
"We, at the department, recognize that finite insurance is a legitimate product [that] protects insurers from interest rate risk and timing risk," she said during a session at the Professional Liability Underwriting Society International Conference.
"But if these finite transactions are not properly accounted for, or there's not an actual transfer of risk, the transactions can distort the underwriting and surplus positions of the insurers entering into them," she noted.
Investigations into finite transactions a term that encompasses a variety of deals in which there are contractual limitations on the amount of risk sellers assume are still being conducted by the department and the New York attorney general's office.
Reacting to what it uncovered during its investigations so far, Ms. Samers said the department has pushed for better disclosure. Earlier this year, it issued a directive (Circular Letter Number 8) that, for the purposes of the department's financial exams, required the chief executive of a company being examined to attest that there were no side agreements agreements that would alter the transfer of risk in its reinsurance contracts.
In addition, it required an underwriting file documenting the "economic intent" of every reinsurance transaction.
The National Association of Insurance Commissioners, working with New York, subsequently put a uniform disclosure rule in place that now requires such attestations from both the chief executive officer and chief financial officer to be filed in insurer annual statements in all 50 states. New York as a result has withdrawn its circular letter.
Ms. Samers said that while industry participants debate thresholds for risk transfer questioning whether 9 percent or 11 percent transfer of risk is appropriate for insurance accounting treatment the department is really not dealing with such questions. Instead, "the abuses we've seen are where there are no underwriting files and it is clear there is no transfer of risk," she said.
"What you see time and time again are problems with corporate governance," she said. "That's really the lesson to learn from the finite investigations."
"There's an increased need for stronger internal controls and greater board and auditor independence," she said. The people in charge of compliance should report directly to the CEO and board of directors, there should be a sufficient number of independent directors, and the audit committee should have sufficient authority.
At an earlier session, Peter Porrino, who heads the worldwide insurance practice of Ernst & Young in New York, reported that he attends audit committee meetings on a regular basis. "You can't go to an audit committee meeting without someone asking, 'You're not writing any of that finite stuff? You're not buying any of that, are you?'"
"From a corporate governance point of view, they're asking questions, [and] if you're in management, you sure as heck don't want to be answering in the affirmative," he said.
"I'm not going to say finite is dead, but I think the appetite is dramatically reduced for at least three-to-five years," he said.
He continued, "I think the word finite gets confused with fraud a lot," adding that the majority of the restatements so far were frauds involving side agreements.
In the future, however, he predicts more restatements that have nothing to do with fraud. "The bigger issue is going to be the transactions that the SEC is looking at today." Officials at the Securities and Exchange Commission are saying things like, "'I understand this is the entire contract, that there are no side agreements or related-party transactions. But it doesn't work. There isn't enough risk transfer in the way that we look at risk transfer,'" he reported.
"Those conversations are just starting now," he said.