FSA to tighten rules on financial reinsurance

The Financial Services Authority is proposing new rules that would require greater disclosure by insurers of their use of financial reinsurance.

Earlier this year, the FSA wrote to firms asking about their use of financial reinsurance.

Their responses have helped to develop the proposals. The FSA is also looking into the use of financial reinsurance contracts by a number of insurers.

Financial reinsurance is a term that refers to certain types of reinsurance arrangements. Typically these arrangements are used to improve, or sometimes to smooth, reported profits, or to improve the reported balance sheet position.

David Strachan, sector leader for insurance at the FSA, says: “The use of financial reinsurance is an issue that the FSA has been examining for some time. Our research has shown that its use is not widespread. Whilst there can be perfectly legitimate reasons for using financial reinsurance, its use should be properly disclosed. The proposed rules will provide greater clarity about firms’ use of financial reinsurance.

“Our work has identified a small number of contracts that warranted further examination. Where we find firms have made improper use of such contracts or not made a full disclosure of financial reinsurance contracts or arrangements, we will take action.”

If used improperly, financial reinsurance can conceal the true financial position of a firm. For this reason the FSA examined the use of financial reinsurance in consultation paper 144, published in July 2002. In order to establish the extent of its use, the FSA wrote to general insurers in March 2005. The FSA has now analysed the responses to the letter and has found that the use by UK insurance firms of financial reinsurance is not widespread.

However, the FSA has found that a number of insurers have used financial reinsurance arrangements in recent years. A limited number of cases are being looked into by the FSA. This work has included liaison with overseas regulators on specific transactions and also discussion on wider policy issues.

The March 2005 letter said that the FSA would consider introducing specific rules on disclosure of financial reinsurance contracts or arrangements. The draft rules and guidance on which the FSA is now consulting are largely based on firms’ responses to the FSA.

They would require disclosure in insurers’ annual regulatory returns about financial reinsurance arrangements and transactions where the credit in the regulatory return does not match the economic value added after taking account of the level of risk transferred, or there are specified terms, side-letters or foreseeable contingencies that could make the reinsurance agreement ineffective or reduce its value.

The availability of more information about firms’ use of financial reinsurance arrangements will allow more accurate assessments of firms’ financial positions.