Financial (Finite Risk) Reinsurance

CAUSES OF GROWTH                                                           280

     AND LOSS PORTFOLIO                                                    281

     FINITE RISK REINSURANCE                                           283
          Single v. Multi-Year Loss Horizons
          Profit Sharing
          Comparison with Traditional Covers

COST AND STABILITY TRADE-OFF                                 287

FINITE RISK APPLICATIONS                                              288

REGULATIONS                                                                        289

SUMMARY                                                                               291


Financial (Finite Risk) Reinsurance

by David L. Wasserman *

     As a term, financial reinsurance has had a broad range of meanings over the years as the product has evolved, ranging from low- or no-risk retrospective contracts in the early years to the more sophisticated, prospective risk-bearing contracts of today. This chapter will address this evolutionary process, the underwriting and financial principles associated with the product, and its current and future uses.

     Financial reinsurance is an innovative alternative to so-called traditional forms of reinsurance, and its recent popularity has led to a significant rise in premiums devoted to this category. Financial reinsurance is a practical risk management tool, especially useful when the motivations of the reinsured insurance company are centered not only on cost effectively managing underwriting risk but also on explicitly recognizing and addressing other financially oriented risks such as credit, investment, and timing risks. In any reinsurance transaction, there are four possible types of risks that may be affected or transferred, in part or in whole: underwriting risk (uncertainty about the ultimate amount of claims), timing risk (uncertainty about the timing of loss payments), asset risk (uncertainty that the assets employed and invested will achieve expected future values), and credit risk (uncertainty that the reinsured will pay the agreed premium in full and that the reinsurer will meet its obligations to the reinsured when called upon to do so). The last three types, when incorporated into a reinsurance contract along with underwriting risk using the features described in this chapter, are often referred to as the "financing element of finite reinsurance."

     By focusing more keenly on the financial outcomes of the reinsured, financial reinsurance combines common features of traditional . . .

* President and CEO, CENTRE REINSURANCE COMPANY OF NEW YORK, One Chase Manhattan Plaza, 35th Floor, New York NY 10005. An autobiography follows the chapter.

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