Zurich Financial Services (ZFS), of Switzerland, has agreed to pay a $25 million penalty, plus $1 million in disgorgement, for participating in an allegedly fraudulent finite risk arrangement involving its Bermuda office and two Bermuda reinsurers, Inter-Ocean Reinsurance Company Ltd. and the other unidentified.

A civil complaint was filed against ZFS at the US District Court for the Southern District of New York on December 11, 2008 and settled on the same day, KYC News' Offshore Alert online newsletter reported.

"Zurich aided and abetted a fraud by Converium Holding AG involving the use of finite reinsurance transactions to inflate improperly Converium's financial performance," it was stated in the complaint.

"Beginning in 1999, the management of Zurich's reinsurance group, which operated under the name Zurich Re, developed three reinsurance transactions for the purpose of obtaining the financial benefits of reinsurance accounting. However, in order for a company to obtain the benefits of reinsurance accounting, the reinsurance transaction must transfer risk.

"Here, Zurich Re management designed the transactions to make them appear to transfer risk to third-party reinsurers, when, in fact, no risk was transferred outside of Zurich-owned entities. For two of the transactions at issue, Zurich Re ceded risk to third-party reinsurers, but took it back through reinsurance agreements - known as retrocessions - with another Zurich entity.

"For the third transaction, Zurich Re ceded the risk to a third-party reinsurer but simultaneously entered into an undisclosed side agreement with the reinsurer pursuant to which Zurich Re agreed to hold the reinsurer harmless for any losses the reinsurer realised under the reinsurance contracts. Because the ultimate risk under the reinsurance contracts remained with Zurich-owned entities, these transactions should not have been accounted for as reinsurance."

In December 2001, Zurich spun off its reinsurance operations under the name of Converium, but the complaint alleged that the "improper accounting" of the reinsurance transactions in question meant Converium's IPO documents were "misleading".

"Among other things, Converium understated its reported loss before taxes by approximately $100 million (67 percent) in 2000 and by approximately $3 million (one percent) in 2001," the complaint read.

"In addition, for certain periods, the transactions had the effect of artificially decreasing Converium's reported loss ratios for certain reporting segments - the ratio between losses paid by an insurer and premiums earned - that is frequently cited by analysts as a key performance metric for insurance companies.

"Through the IPO, which was the largest reinsurance IPO in history, Zurich raised significantly more than it would have raised had Zurich and Converium not improperly inflated Converium's financial performance."

Among the Bermuda entities involved in the allegedly fraudulent transactions were Zurich Insurance Bermuda, which appears to operate as a branch of Zurich Financial Services; Inter-Ocean Reinsurance Company, Ltd., which was a wholly-owned subsidiary of Bermuda-domiciled Inter-Ocean Holdings, Inc., a joint venture between ten reinsurers in which ZFS acquired a 9.9 percent interest in 1998 before later transferring the stake to Converium; and a reinsurer that is not named in the complaint.