Finite risk is a reinsurance contract under which the ultimate liability of the reinsurer is capped in return for the potential for a rebate on good loss experience of the insured.

Although this kind of reinsurance is sometimes referred to as ?financial reinsurance? it is really a misnomer to call it that as all reinsurance has a financial impact on the balance sheet of the insureds.

The origins of the usage of the term ?financial reinsurance? have some origin in the Time & Distance (T&D) policies bought by the Lloyds? syndicates up until the early 1990?s.

These contracts were effectively bank deposits by virtue of having no uncertainty as to amount of loss or timing of loss.

A prominent example of a Time & Distance writer in Bermuda was Pinnacle, a company formed in the early 1980s.

In contrast, finite risk has some limited variability as to the timing and amount of loss, contrasted with traditional reinsurance and insurance, where there is a much broader range of the amount of loss and timing of loss, the most extreme example being catastrophe re/insurance.

All types of re/insurance have a financial effect for the counterparty, therefore the term financial reinsurance could be applied to any reinsurance contract because of its effect on the balance sheets of the insured.

Inter-Hemispheric Reinsurance Company Ltd. was the first Bermuda company devoted to writing expressly capped limits, although it was not termed ?finite risk? at that time. It was established in 1978 as a joint venture formed by American International.

Inter-Hemispheric was later succeeded by Richmond Reinsurance Co. Ltd. (named for Richmond Road) ? the company today at the heart of a US Securities and Exchange Commission (SEC) probe of AIG?s finite risk deals with offshore reinsurers ? continues to write finite risk as a joint venture with a major European partner records show to be Munich Re.

The techniques used in such policies evolved through the years, with the term ?finite risk? eventually coined by Centre Re?s founders Michael Palm and Steven Gluckstern when they formed the company in 1988.

The founders, Mr. Palm and Mr. Gluckstern, had worked for Berkshire Hathaway but went out on their own when their business plan got no interest there. Berkshire?s legendary leader Warren Buffett is now facing questions from US regulators about a finite risk transaction between Berkshire?s Gen Re and AIG.

Centre was the first company explicitly formed and capitalised to focus entirely on a reinsurance format called ?finite risk?.

The formation of Centre was notable because of the relatively large initial capitalisation of $250 million and its shareholder base of JP Morgan, Kemper Insurance and Zurich Insurance, amongst others.

Mr. Gluckstern and the late Mr. Palm are credited with bringing finite risk reinsurance into the mainstream. Centre Re?s success made Bermuda the focus for much of the finite reinsurance, and later, finite insurance, which developed.

The Wall Street Journal recently reported that Mr. Palm and Mr. Gluckstern had considered calling their product ?limited insurance,? but rejected that as shifty-sounding, later settling on ?finite-risk reinsurance?.

A finite insurance or reinsurance programme has several characteristics including assumption of limited, or finite, risk by re/insurer; a significant portion of the contract?s performance influenced by investment returns; relatively large premiums; multi-year contract term; and provision for profit sharing at termination of programme.

Finite risk was seen as an alternative to traditional policies where buying insurance was not working for either party, the re/insurer or buyer. The concepts behind finite risk included an observation that the re/insurance industry?s poor performance was resulting in volatility in pricing and availability.

Finite enabled better economics for the reinsurer and explicit availability over a multi-year term that would not fluctuate in price, and enabled more stable business flow for the insurer.

Insurance and reinsurance companies who write finite risk programmes do not face risks as broad as traditional underwriters.

The limits finite risk writers offer and their assessment of probability of loss on the programme determines the amount of premium involved.

There are no preconceived programme structures or attachment points, as each programme is structured for that particular insured and situation.

Further, finite risk has traditionally been written without being directed at one class of business but instead has tended to be offered across multiple classes of risks held by a client. This provides for more efficient purchase of coverage for the insured and better diversification of the risk for the insurer.

@EDITRULE:

Some forms of finite risk re/insurance include:

? One way finite risk can be structured is as a Loss Portfolio Transfer, also known by its acronym LPT or as a ?buyout?. An LPT involves the transfer of accrued liabilities. The total ultimate losses and payout patterns are actuarially determined and valued in terms of present-day dollars. The premium is then established based on the expected losses plus a charge to cover adverse development. A loss portfolio transfer allows companies to clean up their balance sheet and remove the uncertainty of loss. They are often used in acquisition situations to remove liabilities or where captives or other self-insured programs wish to close out their liabilities.

? Spread loss programmes give the ability to a company to stabilise their results over a multi-year period. Many companies can predict their losses over a multi-year period but cannot predict exactly when these losses will occur. In a spread loss programme, a fixed premium is paid for a number of years in return for which the insurer or reinsurer assumes the timing risk on the losses. They can be used in catastrophic situations, for windstorm or earthquake exposures, or for more high frequency exposures such as excess workers compensation.

? Adverse development covers provide protection for losses that may develop in excess of the insured?s or reinsured?s current loss reserves. This includes both IBNR (incurred by not recorded) and inadequate reserves. They are often used in acquisition or merger situations to afford protection against long- tail liabilities. It is possible to include coverage for insolvency of current insurers or reinsurers thus eliminating the need for bad debt provisions.

@EDITRULE:

Information gathered from interviews, and online resource, Bermuda Market Solutions