Government regulators investigating dealings between insurance giant American International Group Inc. and its business partners are focusing on a type of insurance typically sold to insurance companies that want to spread large losses over time.
Many companies legitimately carry this form of insurance, known as "finite insurance." As the name implies, finite insurance limits the potential exposure of an insurance company to liabilities or other payouts, such as those arising from a class-action lawsuit, a fire or other accident.
American International Group, with headquarters in New York, is being investigated in relation to finite insurance policies.
(Joe Tabacca -- Bloomberg News)
The regulators' investigation is part of a four-year crackdown on financial transactions that companies undertake for an improvement in their books' appearance instead of for business purposes.
At issue for the Securities and Exchange Commission, the New York state attorney general's office, the Justice Department and state insurance regulators is whether AIG and other firms used finite insurance policies to mislead investors. The key question: Were the products sold actually insurance or were they in fact loans disguised as insurance to make the firms' financial statements look better?
The answer depends on whether the issuer of finite insurance assumes significant risk. If so, the policy could meet the legal definition of insurance, allowing the policyholder to reduce losses incurred in a single year by spreading the cost of the premiums out over many years.
However, if there is little or no transfer of risk, regulators say, then the insurance is a loan, which should count as an expense and not dampen losses.
"If a product is solely used for the purpose of achieving an accounting result -- that's the crux of the inquiry," said Mark S. Radke, former chief of staff at the SEC and an attorney at the law firm of LeBoeuf, Lamb, Greene & MacRae LLP specializing in SEC matters.
The issue of whether risk is involved in cases under investigation arises from the fact that finite risk insurance often has been sold to cover events that have already occurred for which the liability is well-known.
Why would a company sell an insurance policy to a buyer to cover a liability both it and the buyer already know exists?
The answer, insurance regulators and other experts say, is that the premiums are usually hefty. The seller is betting it can make more money by investing those premiums, as well as fees it gets, than it will have to pay out when it is finally called upon to make good on the policy.