News Analysis - Finite possibilities.

(From Reinsurance)

Byline: Adrian Leonard.

Listed companies in the European Union will not be required to follow International Accounting Standards (IAS) until 2005, but already their impact is being felt in the reinsurance sector. IAS raises and resurrects questions over the accounting treatment of certain financial reinsurance products, and could diminish the benefits (and perceived benefits) that such contracts provide.

Exposure Draft 5 (ED5), the document which outlines the proposed IAS treatment of insurance contracts, has a section describing "examples of items that are not insurance contracts". These include: "Contracts that have the legal form of insurance, but pass all significant insurance risk back to the policyholder through mechanisms that adjust future payments by the policyholder as a direct result of insured losses - for example, some financial reinsurance contracts ... such contracts are non-insurance financial instruments."

MARKET CHALLENGE

The challenge for the market is to define which contracts will fall foul of the definition. The topic has been the subject of significant debate in recent months, and has been cited as a factor in the increased reluctance of some insurers to enter in to buy finite. "We have seen more demand for traditional retrocession than ever before, driven primarily by the changed way that International Accounting Standards require cedants to book finite reinsurances," said Piers Cantlay, chief executive of the ReSpecialty property division of international broker Aon. "Typically, any cover that is judged to have a compulsory payback is out, since contingent additional premiums payable in years two or three must be booked in the year of loss."

Such an accounting treatment would have the effect of eliminating the much-vaunted benefit for cedants of results-smoothing, since losses must be recognised in the accounts for the year they are incurred, albeit as liabilities to reinsurers. For sellers of financial reinsurances, premiums due will be recorded as debt assets, but they will not be part of the underwriting account.