RiskProf : Ex Post Flood Insurance compares finite insurance to the ex-post flood insurance concept floated in Mississippi. Taylor plans bill to help residents without flood insurance - The Clarion-Ledger (Sep. 27, 2005)
The analogy is tempting, and promotes thoughtful debate, but a few differences occur to me.
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Those who sell finite insurance, and finite reinsurance, typically are smarter and bigger than the average bear: Warren Buffet's National Indemnity comes to mind. Not always smarter, though: Warren Buffet's Gen Re comes to mind, too. That means they take so little risk, they sometimes get investigated for participating in a sham transaction. See: Unintended Consequences: Spitzer and SEC investigate "finite insurance" (Nov. 16, 2004)
Although such transactions are usually quiet and private, we know from public disclosures made in connection with Atty. Gen. Spitzer's investigations and SEC filings (as well as some infamous insolvenies such as Reciprocal of America) that they usually involve the up-front transfer from buyer to seller of most or all of the money that the insurer/reinsurer expects to pay out.
The benefit to the assuming company from finite insurance or reinsurance is that they get a nice premium with so little exposure that they sometimes have to scratch and wriggle to find enough insurance or credit risk to persuade their lawyers that it really is insurance, and not a disguised loan.
The benefit to the ceding company is mostly due to the magic of tax accounting and "statutory" accounting. It enables an insurer facing a big income statement hit to disguise or "rationalize" it as a surplus haircut. The potentially material distortion of earnings is what excites some CEOs, the SEC, and the disappointed creditors of the ceding companies that don't survive.
Homeowners and small business owners are not in the same circumstances. They are less worried about tax and statutory accounting and being eyeballed by a suspicious regulator than they are about not having the cash to rebuild and have a place to live. Unlike the cedents in a "finite insurance" transaction, they are not long on assets and short on earnings.
If these homeowners and small business owners don't pay for all of the retroactive insurance up front, the credit risk from this promise to pay flood insurance "forever" sounds like the drowning man's promise to God: "Save me Lord, and I'll go to services forever! I swear!" Some keep it, but a lot don't.
Without some obligation that "runs with the land" and "binds the assignees" (like the proverbial Fee tail), what is to prevent the newly liquid owner of a moldy shell that was once a house from collecting his retro flood coverage, paying off the mortgage, selling his plot to the friendly neighborhood condo/casino developer and then taking the money to a new parcel?
Haven't thought this all through, but I've had enough experience with insurance sold on credit to know that when the bill goes unpaid, there is often a lot of money that is left "Blowin' in the Wind," sometimes leaving the insurer "Waist Deep in the Big Muddy".
And thanks, RiskProf, for the link to Unintended Consequences: "Finite Risk Reinsurance" background online (Nov. 24, 2004). I've "got your six," good buddy.
Doug Simpson is a Connecticut lawyer who spent 25 years with the law department of a major insurance company and who now practices and teaches law and writes occasionally about disruptive technologies, networks, and insurance law in his weblog, Unintended Consequences.
Posted by dougsimpson at September 28, 2005 07:37 PM