The issue of full collateralisation for unauthorised reinsurers with US cedants continues to exercise the market Ernst Csiszar explains the National Association of Insurance Commissioners' latest thinking on the matter.
Representatives of non-US reinsurers, including Lloyd's of London, are seeking a reduction in reinsurance collateralisation requirements required by the states. All US jurisdictions currently require unauthorised reinsurers to post 100% collateral against reinsurance obligations underwritten in the US, whether or not those insurers are based in the US or elsewhere. This 100% requirement has been in place for many years owing to regulatory concerns for marketplace solvency and consumer protection. Reinsurance capital moves quickly worldwide in search of attractive returns.In the wake of the terrorist attacks of 11 September 2001, billions of dollars in capital and several new reinsurers based their operations offshore, beyond the jurisdiction of US insurance regulators. These reinsurers were capitalised in Bermuda, with full knowledge that any US business written would have to be collateralised. US regulatory requirements have not impeded the flow of capital into the reinsurance marketplace. In addition, non-US reinsurers typically enjoy significant structural, tax, capital and regulatory advantages over domestic reinsurers.
Prominent issueReinsurance liabilities have been increasing dramatically in the insurance industry, which is precisely why this issue has taken on increased importance for all parties involved. The financial stability of the global insurance and reinsurance industry has been questioned by a number of international agencies including the Financial Stability Forum (FSF) and G7 Ministers of Finance. In an environment of increased claims (primarily due to catastrophes, asbestos, pollution, medical malpractice and, most recently, directors' and officers' liability insurance), low interest rates and low equity prices, even recent increases in insurance prices have not been able to fully restore the financial viability of the worldwide insurance and reinsurance industries. Moreover, there appears to be increasing evidence, at least of the anecdotal kind, that disputes between ceding companies and reinsurers are more frequent. Rating agencies have downgraded the vast majority of reinsurers and continue to give the industry a negative outlook. US insurance regulators are considering carefully whether this would be the appropriate environment in which to reduce the protections available to ensure that US reinsurance recoverables are paid to US insurers and on to US policyholders.A number of different groups at the National Association of Insurance Commissioners (NAIC) have undertaken the task of evaluating the potential reduction of collateral requirements. Early in the process, the Insolvency Task Force expressed reluctance to make any sort of change. Nonetheless, the NAIC Reinsurance Task Force continues to evaluate the merits of a proposed 'approved reinsurer' listing. This list would allow certain 'top tier' unauthorised reinsurers to reduce their current collateral requirements.To further evaluate this proposal, two sub-groups of the Reinsurance Task Force are actively studying issues related to the enforceability of foreign judgments and international accounting standards.Nine core considerations are part and parcel of this study process:- the current system is not biased against non-US reinsurers and does not affect capital;
- collateralisation is only one of several options available to non-US reinsurers;
- current collateralisation requirements are not a barrier to trade or the US market;
- timely recoverability is a regulatory concern and impacts a ceding company's surplus position;
- collateral requirements are not arbitrary; they are for stated contractual liabilities;
- potential consequences of an approved reinsurer listing;
- accounting/regulatory rules differ significantly on worldwide basis;
- enforceability of foreign judgments is a real problem; and
- the US direct insurance industry and reinsurance industry support the current collateral requirements.
1) The current system is not biased against foreign companies and does not affect capital - State insurance laws require that reinsurers domiciled in the US be subject to the same financial regulation standards that apply to primary insurers. US reinsurers file quarterly and annual financial statements, are subject to financial examinations, pay licensing fees, and comply with the full spectrum of corporate and regulatory laws concerning insurance companies nationwide. The regulatory approach to reinsurance in the US has traditionally been focused on the ceding company's reinsurance arrangements and the specific provisions in its reinsurance agreements.From the regulator's perspective, the overriding concern is company and marketplace solvency and the impact of reinsurance on the ceding company's financial condition. State insurance regulators act to ensure solvency for the benefit of ceding insurers, creditors and, ultimately, consumers of insurance products.A US ceding company will not be permitted to take statutory credit (reduce liabilities by the amount ceded to reinsurers) or claim amounts recoverable from reinsurers as an asset on its balance sheet, unless its reinsurers meet one of the following requirements:- the reinsurer is licensed in the same state of domicile as the ceding company for a like kind of business;
- the domiciliary insurance department of the ceding company accredits the reinsurer. Requirements of becoming accredited include:
- submitting to enacting state's jurisdiction;
- submitting to enacting state's examination authority;
- reinsurer must be licensed in at least one state;
- reinsurer must file its annual financial statement in ceding company's domiciliary state; and
- maintain policyholder surplus of at least $20m;
- the reinsurer is domiciled and licensed in a state with substantially similar credit for reinsurance laws as the state of the ceding company;
- the reinsurer maintains trust funds in the US; and
- to the extent that the ceding company withholds funds or security from the reinsurer.
2) Collateralisation is only one of several options available to non-US reinsurers - Non-US reinsurers have a variety of options aside from posting collateral when seeking to assume reinsurance business from US ceding insurers. These options include obtaining a license, and establishing a multiple beneficiary trust fund which secures its obligations to all US cedants plus a surplus amount of $20m for an individual assuming reinsurer.Lloyd's of London has a $100m surplus amount and a multiple beneficiary reinsurance trust valued at $8.27bn, which is broken down by individual Lloyd's syndicate.Unauthorised reinsurers can also provide individual collateral (through a trust, letter of credit or other acceptable security) to each ceding insurer without requiring a surplus amount in addition to its obligations.3) Current collateralisation requirements are not a barrier to trade or the US market - State reinsurance collateralisation rules are not a barrier to trade or the US reinsurance market. In 1996, non-US reinsurers wrote approximately 38.8% of the total ceded premiums with US unaffiliated cessions accounting for 61.2% of premiums. In 2002, the non-US share had increased to 45.8%, according to the Reinsurance Association of America.When including US licensed reinsurers that are owned by non-US insurers, the non-US market share jumps from 54.2% to 77.1%. It seems implausible that US reinsurance collateral requirements represent a significant barrier to trade since more than three-quarters of the US ceded premiums ultimately goes to non-US entities.4) Timely recoverability is a regulatory concern and impacts a ceding company's surplus position - The ultimate recoverability of reinsurance balances by the ceding company, and the timeliness of recoveries, has also become a matter of regulatory concern over the last several years.State insurance regulators require that reinsurance balances recoverable from a company's reinsurers be evaluated the same as any other receivable.This evaluation is based on the perceived financial condition of the reinsurer, the likelihood that the company will recover all of the amounts recoverable from that reinsurer in a timely manner, consistent with the actual payment of claims under the policies reinsured, or under the terms of the reinsurance agreement with respect to aggregate or catastrophe reinsurance protections.Several revisions to the annual statement reinsurance schedules serve to provide strong motivation to ceding companies to do everything possible to accelerate the collection process. These penalties apply both to authorised US licensed reinsurers as well as unauthorised reinsurers. Recoverables that are in excess of 90 days overdue incur a 20% penalty. In addition, overdue recoverable amounts that exceed 20% of all recoverables on paid losses create an annual statement penalty of 20% of those recoverables.These penalties directly impact the ceding company's surplus position. The ceding insurer can draw on a trust fund or other collateral in order to avoid the penalty.5) Collateral requirements are not arbitrary; they are for stated contractual liabilities - The current US system of collateralisation requires unauthorised reinsurers, both US and non-US, to fully fund claims that have already occurred within the US and will be paid out to US policyholders. Currently, 1,017 US licensed insurers have posted nearly $7bn in collateral on reinsurance business written with other US licensed companies.Proponents for a reduction characterise collateral requirements as a form of arbitrary additional capital obstacle for doing business in the US. In fact, this requirement should have no effect whatsoever on a reinsurer's capital since state regulators only require collateralisation of amounts that the reinsurer is already contractually liable to pay, and therefore presumably amounts for which the reinsurer should already have made provision.If collateral requirements were reduced for qualified professional reinsurers, what would these reinsurers do with those funds earmarked to pay claims of US policyholders? One likely scenario of concern to regulators is that the reinsurers would leverage those funds in writing additional business globally, thus putting at risk precisely those monies ultimately owed to US policyholders.6) Potential consequences of an approved reinsurer listing - What would happen if the NAIC group that administered the approved reinsurer listing wanted to delist a company? The current proposal would automatically delist a company that fell below an 'A-' rating from rating agencies Standard & Poor's (S&P) or AM Best. For example, the French reinsurer SCOR was recently downgraded below this threshold level. SCOR (US) has $530m in reinsurance recoverables, of which the vast majority ($467m) is affiliated business being ceded back to the French parent. Therefore, if it funded the unaffiliated portion at 50% and the affiliated business at 30%, US insurance regulators would be asking them to post an additional $358m in collateral precisely at a time when it is financially vulnerable. Would any remaining unfunded amounts be denied on delisting? What if that pushed some domestic ceding companies into RBC action levels due to significant uncollateralised balances?7) Accounting/regulatory rules differ significantly on worldwide basis - Efforts to harmonise international accounting and regulatory standards are progressing, but more work needs to be done before the International Accounting Standards Board (IASB) will implement accounting guidance.Many regulators oppose changes to the current regulatory system until such time as discrepancies between international accounting systems are remedied. There is a lack of transparency between proposed international GAAP and the US Statutory Accounting Principles (SAP) system required of the domestic insurance industry. For example, the ING Group of the Netherlands shocked financial markets by reporting a EUR9.6bn ($10.4bn) loss in 2002 under US GAAP accounting rules. The report came just weeks after the Dutch insurer posted a EUR4.3bn ($4.7bn) profit for 2002 under Dutch rules. In 2002, AXA estimated a loss of EUR1.3bn under French GAAP and then reported a EUR2.9bn loss using US GAAP.Since US SAP is usually more conservative than US GAAP accounting guidance, these results would likely have been even worse if those non-US entities had to report their financial results on the same basis as every US insurer.8) Enforceability of foreign judgments is a real problem - Commissioner Mike Pickens (AR) posed the following question to Jeffrey D Kovar (Assistant Legal Adviser for Private International Law for the State Department): "Are there public policy concerns you believe US insurance regulators should consider as we evaluate proposals to reduce the collateral required of foreign companies to support their US obligations?"Mr Kovar responded: "In the several decades in which the Department has been engaged in the pursuit of an enforcement of judgments convention - both at the multilateral and the bilateral level - we have experienced a significant amount of suspicion, prejudice and hostility toward the US legal system from our foreign counterparts. This has expressed itself in efforts to limit the obligation to enforce US judgments and efforts to change US rules of personal and subject-matter jurisdiction. We have found that US attempts to generate goodwill and to lead by example by establishing an extremely liberal domestic enforcement regime through state legislation and federal and state judicial precedents have not provided much benefit in these negotiations. In fact, our generous approach through unilateral action may have hindered our negotiating position by removing any significant leverage to encourage our foreign colleagues to compromise."As an example of problems that may occur, Gerling Global Re, formerly the world's seventh largest reinsurer, discontinued writing reinsurance at the end of 2002. It is feared that Gerling may not possess enough funds to pay all outstanding claims. Consequently, US insurers might be coerced into settling any uncollateralised reinsurance at less than 100% of ultimate estimated liabilities. Without US collateral requirements, many US insurers would find themselves in a more difficult financial position. In cases where non-US reinsurers are unwilling to meet their financial obligations, the costs involved in pursuing legal action across international borders are often prohibitive. In addition, many non-US jurisdictions do not enforce all US judgments abroad, particularly those involving default judgments, punitive damages and arbitration awards. In February 2002, S&P rated Gerling Global Re at AA-, meaning any uncollateralised recoverables attracted a 1.2% capital charge according to S&P's non-life insurance capital adequacy model. Twelve months later it was unrated and incurred a 25% capital charge.In a letter to the NAIC, AM Best has also expressed its view regarding the proposed collateral reduction. The letter indicates that the level of collateral in place is part and parcel of the firm's evaluation of whatever rating to assign to a particular company.9) The US direct insurance industry and reinsurance industry support the current collateral requirements - As part of its review process for the proposed change in collateralisation requirements, the NAIC received comment letters from insurance trade associations representing over 2,000 US primary insurers and reinsurers, in favour of maintaining current US collateral requirements. Virtually all US insurers consider that requiring unauthorised reinsurers to post collateral for 100% of their estimated liabilities represents a prudent solvency measure that has been employed by the US insurance regulatory system for many years. The 100% funding requirement is only the primary insurer's currently estimated future liabilities.Depending on the long-term viability of the reinsurer and potential changes in the US judicial system (such as asbestos reform), the current 100% collateral estimate might ultimately be found to be inadequate to pay claims that come due many years into the future.At the most recent NAIC National Meeting in New York in March, the Reinsurance Task Force passed a resolution, against a backdrop of these nine considerations.In the resolution, the Reinsurance Task Force: "Resolved that, to assure the solvency of US insurers and for the reasons set forth in the NAIC background paper, the NAIC will defer further consideration of any proposals to amend the NAIC Model Law on Credit for Reinsurance to reduce the collateral requirements to allow time for the interested parties to work on alternatives for the regulators to consider. The goals of any future deliberations related to this issue should be to ensure consumer protections, enhanced solvency and security of insurers and encourage equitable treatment for both authorised and unauthorised insurers. At that time, if appropriate, the NAIC will evaluate related issues such as:1. The existence and implementation in key countries of comprehensive regulation of reinsurers, including but not limited to such fundamental solvency tools as risk-based capital requirements.2. Whether US judgments in favour of cedants or their receivers are consistently enforced in the courts of key countries.3. The adoption and implementation of international insurance accounting standards that are also recognised and adopted for statutory accounting.The task force will make NCOIL (National Conference of Insurance Legislators) aware of these deliberations and will continue to work with insurance legislators, as necessary, on this important issue." Hence, for the time being at least, the matter is not under active consideration.
Table 1: Non-US reinsurers other than Lloyd's that maintain multiple beneficiary trust funds in the USAXA Global Risks SA
CX Reinsurance Co Ltd
St Paul Reinsurance Co Ltd
Markel International Insurance Co Ltd
Unionamerica Insurance Co
Zurich Specialties London Ltd