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HMRC internal manual

General Insurance Manual

Reinsurance and other forms of risk transfer: financial reinsurance and alternative risk transfer (ART): time and distance policies

Time and distance policies were among the earliest forms of financial reinsurance developed in the USA for Directors’ and Officers’ (D&O)liability. Such policies have also been employed in the Lloyd’s insurance market with a view to smoothing underwriting cash flows. Although perfectly commercial in principle, certain policies were implicated in alleged fraud in the 1980s, giving rise to enquiries conducted by both Inland Revenue and the Serious Fraud Office.

The US authorities challenge time and distance policies as not involving true risk transfer. This gave rise to blended insurance contracts which aimed to incorporate a larger element of risk transfer. For example, option products provided for a lower initial cost and a more limited payback, such as a D&O liability contract over a five year period and covering a $10m sum assured. The initial premium was calculated according to a percentage of a conventional insurance premium with additional amounts reflecting a charge for the credit risk associated with instalment payments, and an element for the cost of insuring (as it was described) the loss of use of funds. The premium compiled from these various elements might be say $300,000, for which the insurer indemnifies up to $10m. In the event of a claim for this amount, an additional premium is payable in instalments over say 3 years equal to the amount of the claim, up to a ceiling of $6m. So effectively cover of say $1m costs the insured $1.3m, and cover of $10m costs the insured $6.3m.