William C. Marcoux reviews the evolution of US property/casualty reinsurance regulation over the past 10 years and examines the reinsurance issues likely to be addressed at the start of the 21st century.
Ten years ago, reinsurance was at the centre of a fierce debate over the quality and structure of insurance regulation in the United States. In February 1990, Congressman John Dingell, then chairman of the powerful Committee on Energy and Commerce in the US House of Representatives, issued a stinging critique of insurance regulation in the US in a report entitled Failed Promises. The report charged, in part, that “reinsurance abuse has been a key factor in every insolvency studied. The level of reinsurance has been excessive, the quality has been poor and controls on reinsurers have been minimal or nonexistent.”
After the spectacular collapses of several US insurers, including Mission Insurance Company, Ideal Mutual Insurance Co., and Transit Casualty Co. and faced by the scathing criticism of Representative Dingell, and others in Congress, insurance regulators scrambled to plug what was widely seen as a hole in the dyke of state regulation.
Through the late 1980s and early 1990s, state regulators adopted a number of new regulatory proposals and considerably enhanced their monitoring of reinsurance transactions. They substantially modified the cornerstone of US reinsurance regulation, the National Association of Insurance Commissioners (NAIC) Credit for Reinsurance Model Law. They adopted a new Model Credit for Reinsurance Regulation, a new Reinsurance Intermediary Model Act. In addition, the regulators pursued significant changes to the financial statements filed by US insurance companies to provide for greater reporting of and control over cedants' reinsurance programmes.
During the last half of this decade, there have been relatively few regulatory issues involving reinsurance. The reinsurance industry itself, however, has undergone dramatic change with an accelerated rate of consolidation and globalisation. At the same time, there has been excess capacity in many lines resulting in depressed (and in some instances dangerously inadequate) rates, the emergence of competition from capital markets and changing distribution systems. It appears, however, that the recent period of calm regarding reinsurance regulation is ending. New solvency concerns have been raised regarding reinsurance as a result of the financial difficulties of the workers' compensation pool managed by Unicover Managers, Inc. and the financial distress of some reinsurers. As a result of these, and other market developments, the NAIC decided at its Fall 1999 meeting that the NAIC's Reinsurance Task Force will be reconstituted in the year 2000, for the first time in six years.
At this point it may be useful to review the evolution of property/casualty reinsurance regulation over the past ten years. I propose this exercise not as a simple millennium retrospective, but to illuminate the reinsurance issues that will likely be addressed at the start of the 21st century.
The following is a brief chronology of the major events in reinsurance regulation over the past ten years.
1989: After more than five years of debate, the NAIC's Reinsurance Task Force, and ultimately the plenary of the NAIC, adopted substantial revisions to the NAIC Model Credit for Reinsurance Law. As most readers know, this law sets forth standards which must be met in order for a US ceding company to count reinsurance protections as an asset or deduction from liabilities on its financial statements. Essentially, the reinsurer must either be licensed in one of the states in the United States, or post collateral in the form of letters of credit, acceptable trust funds or funds withheld.
The 1989 changes in the law were largely directed towards non-US reinsurers. They related to the standards and reporting requirements for reinsurers who establish multi-beneficiary trust funds in the United States for the protection of their US cedants. In addition, changes were made to the standard form of letter of credit. These changes, although reasonable, were pursued and debated in an environment which was highly critical and suspicious of the role of non-US reinsurers in the US marketplace. Stimulated by regulators' fears of the unknown, and by aggressive lobbying by some domestic interests, the regulatory debates and press articles of the day were filled with claims of an uncontrollable market of alien reinsurers running roughshod over US interests.
1990: The NAIC adopts its Reinsurance Intermediary Model Act, after more than 10 years of debate. This law established new licensing requirements for reinsurance intermediaries and imposed restrictions on the types of activities in which they could engage.
The NAIC also adopts its accreditation programme. This programme established minimum requirements for state insurance departments to become accredited regulators. The Model Credit for Reinsurance Law and Credit for Reinsurance Regulation and Reinsurance Intermediary Law become mandatory requirements for accreditation. This leads to a dramatic increase in the number of states which adopted the Model Law on Credit for Reinsurance and this law becomes the standard of the land.
1991: Regulators work on fine tuning the credit for reinsurance standards, but they move away from the adoption of significant new model laws and model regulations affecting reinsurance. US regulators, however, find a more efficient means of controlling reinsurance transactions, by way of accounting standards and annual statement reporting requirements. The changes required much greater detail concerning assumed and ceded reinsurance programmes by US ceding companies. Insurance regulators and the Financial Accounting Standards Board adopted significant rules concerning risk transfer requirements for financial reinsurance transactions.
1992: Representative Dingell introduces his first proposal for a federal regulation of insurance and reinsurance, the Federal Insolvency Act of 1992. This legislation provided for a federal licence for insurers and reinsurers who wanted to operate nationwide.
At this time a number of alien reinsurers responded to the changes in the credit for reinsurance law adopted in 1980 and established multi-beneficiary trusts in lieu of posting letters of credit on a contract-by-contract basis.
1993: Representative Dingell introduced his second legislative proposal for a comprehensive federal regulatory regime, which was largely based on his first bill. By this time, however, state regulators have demonstrated great resolve to take the necessary steps to shore up the weaknesses in state regulation and the threat of federal regulation subsides.
1994: The NAIC's Reinsurance Task Force is disbanded, as it is determined that there are only a few remaining issues to be considered, and the decision is made that these can be handled by a working group under one of the standing committees of the NAIC. The NAIC's Property & Casualty Reinsurance Study Group, however, remains in existence, and continues to focus on reinsurance accounting issues.
1995-1997: Technical amendments are considered for the Model Credit For Reinsurance Law. Regulators continue to be concerned about the security of some reinsurance recoverables and the impact that reinsurance programmes have on the balance sheet of cedants, but there are few changes in the regulatory rules.1998: The NAIC begins to consider issues revolving around reinsurance pooling agreements.
1999: Concerns over reinsurance transactions involving Unicover, as well as the emergence of securitisation and other financial market products begin to be discussed at the NAIC. At the same time, the International Association of Insurance Supervisors (the IAIS) begins work on a reinsurance issues paper. The IAIS regulators are particularly concerned with harmonizing reinsurance regulation throughout the world, including accommodation of reinsurers domiciled in developed countries and the proper role of reinsurers in the growth of insurance industries in developing countries.
2000: The NAIC's Reinsurance Task Force is scheduled to be reconstituted. Some regulators express the concern that reinsurers have become the dominant players in the insurance industry and that US regulators do not sufficiently understand the products and the markets that exist. In addition, prolonged soft market conditions begin to raise the spectre of some insolvencies.
In light of this history, and the commercial developments in the reinsurance market, I have the following observations and predictions regarding the evolution of reinsurance regulation in the United States.
There is a new generation of US regulators. Many of the current regulators have never experienced a hard market or the type of solvency concerns that rocked the industry in the mid 1980s. They will begin to ask questions about and probe the details of reinsurers' relationships with ceding companies, the operation of reinsurance intermediaries and the structure of new reinsurance products. Reinsurers will ignore this rejuvenated curiosity at their peril.
As the prolonged adverse underwriting conditions begin to take their toll, we will likely see an increase in the number of insolvencies of both ceding companies and reinsurers. This is going to ignite further controversy concerning the reinsurer's obligations to pay reinsurance claims to an insolvent cedant (including the old issues of a reinsurer's right of offset and demands for accelerated payments by liquidators).
Although US regulators will increase their security of reinsurance transactions, this will be done at a time when US regulators have a far better understanding of foreign reinsurance markets and much greater cooperation with foreign regulators. This is due to the fact that US regulators have significantly increased their participation in the activities of the IAIS, the OECD and in world trade discussions. Establishing an efficient and effective regulatory regime for international markets is one of the greatest challenges facing these regulators. They must try to create rules which will accommodate global players. At the same time, emerging markets pose unique challenges to create a regulatory system which will encourage the support of strong industry leaders and yet avoid the predatory practices of shady opportunists who may pounce upon a nascent industry and regulatory environment.
At the same time that they grapple with international issues, US regulators must address the fact that capital markets have begun to participate and compete with reinsurers. Capital markets are increasingly being used as risk management and risk financing tools and there is a blurring of lines between traditional reinsurance and other financial products. This poses significant challenges for insurance regulators in the US and elsewhere, who must establish a rational set of standards for all participants in the market.
In summary, it appears that regulators are once again rediscovering reinsurance. It is most likely that there will be renewed debates concerning proper reinsurance regulation in the United States. This will take place with many new commissioners now in positions of significant responsibility. It will be important, therefore, for the reinsurance industry to work hard in educating the current regulators. As noted above, however, it is encouraging that US regulators have become increasingly understanding of and interested in international markets. One may hope, therefore, that the debates will be constructive and will achieve rational responses to those concerns raised by the regulators and yet leave the industry relatively free to pursue their commercial goals.
William C. Marcoux is a senior partner in the insurance practice group of LeBoeuf, Lamb, Greene & MacRae. He is based in his firm's San Francisco office.