Finite reinsurance will be a hot topic over the next few months as the criminal trial of former General Reinsurance Co. (Gen Re) CEO Ronald Ferguson and his four co-defendants commences in January in federal court in Hartford, Connecticut. Mr. Ferguson stands accused with Christopher Garand, a former vice president of Gen Re's finite reinsurance operation, Robert Graham, Gen Re's former assistant general counsel, Christopher Milton, a former vice president of Reinsurance for American International Group (AIG), and Elizabeth Monrad, former chief financial officer of Gen Re, as a result of a finite reinsurance transaction that the United States alleges was fraudulent.
Finite reinsurance is a type of reinsurance that transfers only a finite amount of risk, limited through accounting or financial methods. This type of reinsurance appeared in the 1990s as a way for buyers of reinsurance to acquire some risk protection in times of limited capacity in the reinsurance market. By transferring less risk, insurers have been able to acquire limited reinsurance coverage on potential claims at a lower cost than they could through traditional reinsurance. In recent years, however, some finite reinsurance transactions have been challenged on the ground that they transfer no risk at all.
Finite transactions have been negotiated in several kinds of reinsurance, including loss portfolio transfer, where an insurer passes to the reinsurer some responsibility for a bundle of insurance claims. The indictment against Mr. Ferguson and his co-defendants contains allegations about this type of agreement. The indictment alleges that the transaction in question was a sham, was fraudulent, and violated the federal securities laws.
According to the indictment, the reinsurance agreement provided that AIG was to reinsure a bundle of Gen Re policies under two contracts with a total liability limit of $600 million extending over a two-year period, at a total premium of $500 million, for a net exposure of $100 million. AIG allegedly was to receive $10 million of the premiums as a loss portfolio transfer fee, while Gen Re could withhold the remaining $490 million in an experience account. The indictment alleges that the agreement also contained a commutation provision by which Gen Re could unilaterally terminate the contract at any time and keep any remaining withheld portion of the premiums.
These terms purported to transfer a finite risk from Gen Re to AIG. AIG ultimately appeared to assume a limited risk of $100 million in exchange for $10 million in cash premiums.
According to the indictment, however, the parties also reached a secret side agreement. Under the alleged terms of this agreement, (1) the parties agreed that AIG assumed no real exposure by the transaction — i.e., there was no chance that AIG would ever have to take a loss on its contractual $100 million exposure; (2) AIG agreed to repay to Gen Re the $10 million loss portfolio transfer fee it had advanced as part of the public contract; and (3) AIG agreed to pay to Gen Re a $5 million service fee for its participation in the transaction.
According to the indictment, AIG benefited from the transaction because, on the basis of the total premium owed by Gen Re under the terms of the reinsurance contracts, it increased the loss reserves on its balance sheet by $250 million in the fourth quarter of 2000 and by another $250 million in the first quarter of 2001, enhancing its apparent financial health. Because of the alleged side agreement, however, prosecutors claim that Gen Re essentially lent the purported premium amounts to AIG, amounts that could not properly be booked by AIG as loss reserves.
The Ferguson trial will be the most prominent example to date of the skeptical eye government regulators at the federal and state levels have cast toward some kinds of finite reinsurance transactions in the last few years. If convicted, Messrs. Ferguson, Graham, Milton, and Ms. Monrad each will face up to 230 years in prison and $46 million in fines and Mr. Garand will face 160 years in prison and $29.5 million in fines.
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