The Bermuda Monetary Authority will begin consulting with industry in the New Year over supervision of finite reinsurance.

The loss mitigation tool came under the regulatory microscope after a regulatory probe launched by New York Attorney General Eliot Spitzer uncovered found that American International Group Inc. had misused a finite contract to hide losses. The commercial insurance giant in May restated several years of its financial results, in large part because of a $500 million contract it bought from a unit of Berkshire Hathaway.

The BMA?s consultation process follows the adoption of the Guidance Paper on Risk Transfer, Disclosure and Analysis of Finite Reinsurance by the International Association of Insurance Supervisors at its recent Annual General Meeting. The Authority, which participated in developing the paper which seeks to define finite reinsurance, indicate what constitutes risk transfer and how risk transfer, is assessing the applicability of its recommendations to the Bermuda market.

The BMA said in a statement that it is focused on ensuring transparency in the financial reporting of finite reinsurance products and contracts and that they are used appropriately.

?Any reinsurance contract subject to review by the Authority that is deemed inappropriate would not be permitted in the Bermuda market.

?From the moment IAIS discussions began regarding the issue of finite reinsurance we have had an interest and provided input. Bermuda, in common with other jurisdictions, is in the process of considering the most appropriate regulatory response to the issues related to finite reinsurance moving forward; this is a work-in-progress and the IAIS guidance paper comments and recommendations are one aspect of many to be considered as part of our review of this issue,? the Authority said.

The paper also looks into accounting and disclosure issues while suggesting various supervisory approaches to finite reinsurance.

While finite risk products have been used by insurers for decades as highly structured vehicles to transfer clearly defined limited amounts of insurance risk, the paper states that these products must be separated from possible abuse such as inadequate risk transfer or transactions which are not accounted for appropriately.

The use of finite reinsurance by insurers is defined as appropriate by the IAIS when it is used to capitalise on an insurer?s above average underwriting loss experience when traditional reinsurance coverage is too expensive and to increase underwriting capacity to take larger retention in favourable environments or risks that traditional markets would not cover.

Using finite to engineer the insurer?s reported financial position and present better results or enhance the balance sheet to avoid such things as a ratings downgrade, non-compliance with creditor lending conditions or avoid or delay supervisory intervention is inappropriate use under the IAIS paper.

The BMA said that while development of the paper may have been driven by concerns over improper uses of finite, it provides a balanced overview of how finite products are used legitimately and provides regulators with a range of approaches for supervision.

Regulators have focused the most attention on ensuring there is proper accounting and disclosure of finite reinsurance transactions and assessing whether there is adequate risk transfer when these take place, the Authority said.

Recommendations include ensuring that the supervisor has access to all reinsurance documentation to aid in understanding the structure of agreements and the underlying commercial reality, and having the ability to verify that insurers have disclosed and accounted for any separate or side agreements between the parties.