AIG has bought and sold finite insurance. General Re Corp., a unit of Berkshire Hathaway Inc., has mostly sold it.
The buyer's benefit is that such insurance payouts offset the expense of maintaining reserves against losses, which regulators require and count as a cost against earnings. In contrast, if the same buyer borrows the money, the loan should show up on the books as a liability.
American International Group, with headquarters in New York, is being investigated in relation to finite insurance policies.
(Joe Tabacca -- Bloomberg News)
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According to experts, accounting rules allow a finite product to be considered bona fide insurance -- and accounted for as such -- only if a policy writer has at least a 10 percent chance of sustaining at least a 10 percent loss. If not, it should be booked as a loan.
Regulators say there is a legitimate use for finite insurance -- limiting losses on changes in interest rates, for instance -- as long as the company buying it accounts for it properly.
Disguising a loan as insurance enables a purchaser to obscure its liabilities, said J. Robert Hunter, director of insurance at the Consumer Federation of America and former insurance commissioner of Texas. An insurer facing a loss -- or more generally wishing to make its balance sheet look better -- might buy a finite insurance product that appears to shift a liability or liabilities off its books, he said.
Spreading the premium payments, which would have to be subtracted from profit, would allow the company to "smooth" its earnings, rather than take a big hit all at once. A sharp drop in profit often hurts stock prices.
Such a deal might also improve a company's balance sheet and allow it to tell regulators that since it has reinsurance it does not need to hold extra money in reserve.
If insurers did that, "they in effect hid their reserves by this reinsurance that wasn't really transferring risk," making them seem financially stronger to shareholders and regulators, Hunter said.
