What Is Finite Risk Insurance?

Finite risk insurance is an insurance transaction in which the insured pays a premium that constitutes a pool of funds for the insurer to use to cover an൩y losses. If losses are lower than the premium, the insurer returns most or all of these charges back to the insured. If, on the other hand, the losses exceed the premium, the insured is required to pay an additional fee to cover them.

How Finite Risk Insurance Works

Under standard insurance arrangements, the insured transfers a 澳洲幸运5官方开奖结果体彩网:liability associated with a specific risk to an insurer in exchange for a premium or fee. The insurer maintains a 澳洲幸运5官方开奖结果体彩网:loss reserve with its own funds and is able 💙to keep any income that 💎it makes.

Finite risk insurance is an alternative 澳洲幸运5官方开奖结果体彩网:risk transfer type of insurance product with features of both excess insurance and 澳洲幸运5官方开奖结果体彩网:self-insurance. Finite risk insurance allows the insured to spread out payments for losses over time while retaining the ability to receive a ref🍃und of some of its premiums and investment income if losses are less than anticipated.

The insurer provides a standard insurance policy but modifies the limits and 澳洲幸运5官方开奖结果体彩网:deductibles in a specific way. On a per-occurrence and aggregate basis, the total limit and retention are a function of the total premium, which is computed as the losses that will be paid discounted for 澳洲幸运5官方开奖结果体彩网:investment income.

The insurer issues the policy and segregates the premium, net of fees, into a dedicated account that 澳洲幸运5官方开奖结果体彩网:accrues interest for the insured. If at the💯 end of the policy period funds remain in the account, the insured may c🐽laim them.

Conversely, should losses exhaust the account at some point during the policy period, the insured either pays an additional premium or the 澳洲幸运5官方开奖结果体彩网:transaction ends.

Types of Finite Risk Insurance Products

Finite risk insurance products are not as easily disseminated as other insurance products because these types of products are tailored to the need of each individual client. Loss Portfolio Transfers (LPT), Adverse Development Coverage, Spread Loss Coverage, and Finite Quota Share Reinsurance are identified as the main types of what are considered to be finite risk insurance products.

Loss Portfolio Transfer

A loss portfolio transfer is when an insurer cedes policies to a reinsurer and is considered a 澳洲幸运5官方开奖结果体彩网:reinsurance contract. These are often policies that have already incurred losses. In such a transfer, a reinsurer assumes and accepts the existing open and future claim liabilities of an insurer through the transfer of that insurer's 澳洲幸运5官方开奖结果体彩网:loss reserves.

Adverse Development Coverage

Adverse development coverage (ADC), which is sometimes called retrospective excess of loss cover (RXL), is a finite risk product in which a reinsurer agrees to provide excess-of-loss coverage for losses incurred on a retrospective liability that exceed the cedant's current reserves or planned retention. In other words, they do not provide firms with the opportunity to combine pre-loss financing with their excess-of-loss protection. Instead, the reinsurer agrees to compensate the cedant for any losses above an attachment point equal to a defined retention level.

Spread Loss Coverage

Spread loss coverage is a form of reinsurance under which premiums are paid during profitable years to build up a fund from which losses are recovered in years that are lower performing. This reinsurance has the effect of stabilizing a cedent's loss ratio over an extended period of time.

Finite Quota Share Reinsurance

Finite quota share reinsurance, or 澳洲幸运5官方开奖结果体彩网:financial quota share, is a reinsurance treaty in which the ceding company is responsibl🍸e for a portion of the loss associated with the claim. An interesting f𒁏acet of these products is that the ceding company is not required to pay a deductible before the coverage begins as that company will always be responsible for a portion of the loss.

Benefits of Finite Risk Insurance

Companies may rely on finite risk insurance to cover liabilities that have long durations. While they might save money by self-insuring for these risks, particularly if there💟 are no losses, a finite risk insurance contract💛 provides an element of risk transfer. 

A business could enter into a finite insurance agreement to cover excess losses over other policies, including its own self-insurance strategy, and may use these products for 澳洲幸运5官方开奖结果体彩网:warranties and environmental, pollution, and 澳洲幸运5官方开奖结果体彩网:intellectual property risk. By entering into a multi-year agreement, the insured can better match the amount of money it sets aside𒐪 for liability protection to the estimated liabilities that it expects to face.

Criticism of Finite Risk Insurance

Finite risk insurance has generated some controversy in the past. Critics claimed it functions more like a loan and can hide the true condition of insurers, helping them manipulate and smooth their earnings. Considering that finite transactions take into a☂ccount the time value of money which could allow t🅰he ceding insurer to monetize its value of loss reserves, it is not difficult to see how this could be easily adjusted to benefit the party.

Some corporations will work in tandem with the insurers, where the corporation will fail to disclose the true extent of the transaction to independent authorities and regulators. This has resulted in the finite risk business v🔯iewing some finite risk products as not only unethical but downright illegal. Depending on how the products are used and the extent of what is covered up, they certainly have the potential to be. However, that can be said of other insurance products as well.

The Bottom Line

Finite risk insurance is a hard-to-define product that is often criticized due to its malleable nature. Some think that such products are used to adjust a balance sheet to show greater profit without actually transferring risk. However, as long as both parties remain transparent about the liabilities, fi🦹nite risk insurance transactions can be considered viable and beneficial.