Understanding the Efficiency of Financial Reinsurance Impacts on Insurance Sector
Financial reinsurance (Fin Re) is not something new in the insurance sector. It’s the tool insurance companies use to spread a finite or limited amount of risks and serve as an alternative source of capital. These financial objectives can be achieved in two ways — through cash injection from the reinsurer or optimizing future profits of new or in-force business to attain full benefits.
Financial services or products in reinsuring contracts can naturally be complex due to several regulatory concerns including statutory disclosures and regulatory supervision. Fortunately, custom options can be made to meet clients’ needs (direct writer) and depending on the contract the product may or may not involve cash injection from reinsurer.
Cash transfers to the direct writer are often based on unpredictable future surplus and/or emergence. Insurers writing direct insurance contracts allow them to maintain a minimum reserve or money that is lesser than the initial cash liability. Financial reinsurance products are of several variations but all designed to unbundle risks involved and spread it to other parties — banks or reinsurers– involved in the contract.
Because of the complex nature of these transactions, commercial litigation lawyers are very much active in the formation and execution of financial reinsurance contracts. In addition to the generation of capital for businesses, Fin Re financial services can also ensure:
- Improve investment viability
- Increase opportunities for future growth and returns
- Guarantees future surpluses
However, there are potential contractual disputes that could arise from misusing these financial reinsurance products trying to deceive interested parties — investors, regulators, or financial advisors.
This malpractice commonly happens when Fin Re is used to improve the solvency position and risk management practices of a company, and there is apparent misreporting of returns and the accounting statement — obscuring the true financial position of the company.
Thus, strict measures are put to deal with contract issues such as accounting and disclosure, as well as improving solvency levels of the direct writer. Such regulations include a minimum level of risk transfer an insurer can allow to be eligible for reserving credits.
However, regulators have concerns about whether to allow or prohibit the use of this financial tool. The benefits offered through these products though give a legitimate reason against the prohibition of the same. Legitimate use of financial reinsurance products allows companies to:
- Functiong properly without financial constraints.
- Improves overall financial market efficiency by bringing together all-important industry stakeholders from banks, insurance companies to reinsurance companies and other major industrial players.
- Improve the internal rate of return by reducing the technical reserves
- Helps companies meet regulatory requirements for capital reserves and solvency margins.
- Help produce accurate disclosures to provide a fair value of the company
- Alternate source of capital
- Improves investment freedom for higher returns
Some variations of financial insurance optimize future surpluses such that the risks of non-emergency excess or surplus are transferred to the reinsurer, guaranteeing future profits to the insurance company. Other reasons why Fin Re is considered a preferred alternative source of capital are because of its ease to generate capital, especially with a low solvency level. Custom made contracts with more features and flexibility. Builds relationships with the insurer while offering risk transfer and leveraging opportunities.