Financial reinsurance

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Jack Phiyong Mo

Financial Reinsurance is a form of reinsurance which is focused more on capital management than on risk transfer. In the non-life segment of the insurance industry this class of transactions is often referred to as finite reinsurance.

One of the particular difficulties of running an insurance company is that its financial results - and hence its profitability - tend to be uneven from one year to the next. Since insurance companies generally want to produce consistent results, they may be attracted to ways of hoarding this year's profit to pay for next year's possible losses (within the constraints of the applicable standards for financial reporting). Financial reinsurance is one means by which insurance companies can "smooth" their results.

cash loan

A pure financial reinsurance contract for a non-life insurer tends to cover a multi-year period, during which the premium is held and invested by the reinsurer. It is returned to the ceding company - minus a pre-determined profit-margin for the reinsurer - either when the period has elapsed, or when the ceding company suffers a loss. Financial Reinsurance therefore differs from conventional reinsurance because most of the premium is returned whether there is a loss or not: little or no risk-transfer has taken place.

In the life insurance segment, financial reinsurance is more usually used as a way for the reinsurer to provide financing to a life company, much like a loan except that the reinsurer accepts some risk on the portfolio of business reinsured under the fin re contract. Repayment of the fin re is usually linked to the profit profile of the business reinsured and therefore typically takes a number of years. Financial reinsurance is used in preference to a plain loan because repayment is conditional on the future profitable performance of the business reinsured such that, in some regimes, it does not need to be recognized as a liability for published solvency reporting.

References

Bear Stearns International (European Reinsurance: Life Reinsurance Demystified)