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than the risk of future adverse experience. If the reinsured
business was volatile or losses developed, and Guardian did leave
the reinsurance in place, the risk of loss would have remained
with petitioner. Guardian’s unilateral right to terminate the
Agreements increased rather than decreased petitioner’s risk.
Throughout the duration of the Agreements, a negative EAB
represented the remaining surplus relief generated for Guardian
by the underlying agreement. The amount of the negative EAB also
represented petitioner's outstanding liability for the ceding
commission payable under the related Agreement. The moment that
the EAB was zero was important because Guardian would have had to
start paying petitioner profits from the reinsured business,
rather than crediting the EAB, if the agreement continued after
that time. Petitioner had no meaningful control over the
operation of the EAB.
Each of the Agreements had a “funds withheld” provision that
was common in the insurance industry. Such a provision
eliminates unnecessary cash-flow and does not affect the economic
substance of the agreement or the risk that is transferred. The
“funds withheld” provision in the Agreements avoided the need for
petitioner to transfer to Guardian funds equal to the ceding
commission, only to have Guardian transfer funds back to
petitioner for the reinsurance profits. As petitioner earned and
reported renewal profits from Guardian, petitioner simply reduced
its liability to Guardian by the amount of the cash that would
otherwise have been transferred to it by Guardian. The “funds
withheld” provision provided additional security to Guardian, and
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