(FORTUNE Magazine) – IF I HAD ASKED YOU A YEAR AGO what AIG, Berkshire Hathaway, and GE had in common, you probably would have said, "They're all big blue-chip companies." If I asked you that question today, you might say, "They all have problems in their reinsurance businesses." (Yes, AIG's situation appears to be worse than Berkshire's or GE's. But you'd best believe Warren Buffett and Jeff Immelt would love their reinsurance woes to disappear every bit as much as Hank Greenberg would like to be rid of his.)

Making sense of this particular set of scandals is hard, because the heart of the problem is a gnarly financial product known as "finite reinsurance." But the underlying truths are pretty simple. Consider what Buffett said about finite reinsurance at Berkshire's annual meeting this spring: "You could hardly invent a word more meaningless. Basically all insurance is denominated in an amount that is finite. There is nothing wrong with finite insurance." In other words, there are no bad insurance policies, only bad insurance executives. Is that true?

To help answer that question, let's look at a simplified example. Plain-vanilla reinsurance is essentially protection that insurance companies buy for themselves to limit their financial exposure. If a hypothetical company we'll call Regressive Insurance is insuring a Chicago skyscraper against general property damage, Regressive might turn around and reinsure itself by buying a policy to cover the natural catastrophe (e.g., tornado or earthquake) portion of its total risk from Island Re. (Bermuda happens to be where many of the reinsurers are domiciled.)

Finite reinsurance, frankly, is hard to define--even for the experts. But generally speaking it covers a contractually agreed-upon amount of loss over a set time period. So in a finite reinsurance deal, Regressive might parcel off, say, the first $50 million of its disaster liability above $100 million to Island Re for a five-year period with financing terms (see below) that benefit Regressive.

Problems arise when the reinsurer isn't actually assuming any risk. For instance, Regressive agrees to pay Island premiums over five years that would fully reimburse Island for its potential $50 million liability based on present value. Another scenario might require Island Re to pay back the premiums plus interest to Regressive if the earth doesn't shake in the Windy City. (Confused yet?) So in reality what we're talking about is a loan. "You're not really buying insurance, you're financing a loss," says Fitch Ratings senior director Don Thorpe. (The general rule of thumb is that there would have to be at least a 10% risk that Island Re would lose 10% of the insured amount.) The sketchiest arrangements involve side letters, undisclosed even to auditors, that alter the written contract so that there's less transfer of risk.

It's not really that difficult to discern when a finite reinsurance deal fails the smell test. When the intent of the transaction isn't to buy insurance but instead to dress up a balance sheet or obfuscate financials, that's when one of these deals stinks. Apparently that was the case in a transaction in 2000 between AIG and Gen Re, a subsidiary of Berkshire Hathaway. The SEC now reportedly plans to file civil fraud charges against three current and former employees of Gen Re. In mid-May, Chubb was subpoenaed as part of a widening federal investigation into finite reinsurance.

Back on March 29, the State of New York Insurance Department issued a four-paragraph letter adding two new and remarkably simple requirements for reinsurance contracts. "1) There are no separate written or oral agreements that would under any circumstances reduce, limit, or mitigate ... any loss." (Meaning side deals that would abate the transfer of risk are forbidden.) And "2) ... the reporting entity has an underwriting file documenting the economic intent of the transaction...." (Meaning the parties must state the intent of the deal.) Insurers that violate either the letter or the spirit of these regulations may soon find themselves considered a little less blue-chip than they used to be.

ANDY SERWER, editor at large of FORTUNE, can be reached at aserwer@fortunemail.com. Read him online in Street Life on fortune.com and watch him on CNN's American Morning and In the Money.