Fitch comes out strongly against finite re

Fitch Ratings, following suit with Standard & Poor’s, has come out strongly against the use of finite reinsurance, saying the practice “means to disconnect the accounting results from the underlying economic reality” faced by insurers buying the product.
Raters are reacting to investigation of finite reinsurance (or what S&P terms “financial engineering products”) by New York Attorney General Eliot Spitzer and the U.S. Securities Exchange Commission.
Fitch says it has always taken a dim view of finite reinsurance products because they are less about risk transfer than about smoothing the earnings of the buyer. “It is Fitch’s view that the purchasers of finite risk reinsurance are driven less by risk transfer and more by a means to either improve current period earnings, smooth earnings, effectively discount reserves and/or enhance capital,” the rater notes.
The investigations themselves have also proven harmful to both buyers and sellers of finite reinsurance, given the operational risk posed by potential outcomes of these probes. In the worst case, investigators may uncover actual fraudulent behavior on the part of buyers or sellers, but a more widespread impact is the potential for more stringent accounting guidance or review. Even in the best case for buyers and sellers, the investigations may make such products “taboo” and reduce demand for them, Fitch predicts. “If the marketplace and regulators systematically “backed out” the financial statement benefit of the arrangements, as Fitch has done for many years, the incentive to purchase is gone. Along similar lines, if the marketplace or regulators adopt an overall negative stance toward finite reinsurance, potential buyers may be reluctant to risk the reputation damage of a purchase.”
Clearly the reinsurers who sell finite products would be negatively impacted if finite reinsurance is either “taken off the proverbial shelf” or demand is reduced, or if current agreements are unwound, although many of these are large players with diversified offerings who could well weather the blow. Nonetheless, some sellers could face rating action, Fitch warns.