Why does the US push for the removal of trade barriers not apply to US credit for reinsurance rules? asks William Marcoux.

It is time to update US credit for reinsurance laws. The current rules were established decades ago when the regulation and structure of the reinsurance industry was profoundly different. Revising these rules will benefit the US insurance market and would be consistent with US policies which strongly support free trade.Current US credit for reinsurance rules essentially divide the world's reinsurers into two groups:

  • those with a US licence, which are viewed as good credit risks and therefore are not required to provide collateral for their obligations; and
  • those without a US licence, all of whom are viewed as poor credit risks and who must fund 100% of their gross liabilities.
  • This regulatory dichotomy is simple, but has little else to recommend it.A strong argument could be made that the US should eliminate their collateral requirements completely. (Standard & Poor's recently observed that such a move might ultimately lead to a stronger reinsurance market in the US.) Virtually no other insurance market has such draconian requirements. The UK, Bermuda, Germany, Switzerland, to name a few, operate without any funding requirements and without undue problems with reinsurance collections. France and Canada are the only two jurisdictions I am aware of that have similar collateral requirements. Importantly, France applies its collateral requirements to both domestic and non-domestic reinsurers, a prospect which would likely alarm US reinsurers.

    Collateral expenseThe current collateral rules are expensive. They cost non-US reinsurers more than $500m per year. These costs are passed on, in whole or in part, to US ceding insurers. Collateral requirements also restrict capacity, as prudent reinsurers must manage their aggregate exposures not only in terms of ultimate loss, but in light of their ability to fund their liabilities in the US on a gross basis. As demonstrated after the horrific losses of September 11, these funding requirements create needless cashflow and liquidity burdens. It is also true that US regulators currently accept billions of dollars of uncollateralised debt obligations (including non-US issuer obligations) as admitted assets. Remarkably, US regulators will accept an uncollateralised debt obligation from an (A-) rated non-US reinsurer but not uncollateralised reinsurance recoverables from that same reinsurer. It is difficult to justify such disparate treatment on the basis of solvency regulation.Although the elimination of all collateral requirements might be the best step to take, a more modest proposal has been put forward by a coalition of reinsurers represented by the International Underwriting Association in London, Lloyd's and the Comité Européen des Assurances. This proposal calls for the creation of an approved list of reinsurers. To be on this list reinsurers would have to have a minimum rating of A-, meet other financial requirements and make significant financial filings with the US regulators. Reinsurers on this approved list would be permitted to post collateral in an amount less than 100% of gross liabilities, with the minimum collateral requirement at 50% of gross liabilities (30% for affiliate reinsurance). The new variable collateral requirements would only be applied prospectively and ceding insurers would be free to negotiate higher collateral requirements on a commercial basis.This proposal deserves careful consideration. It is a modest step down a road towards a more rational regulatory standard. Fortunately, US regulators and legislators have committed themselves to working on this proposal. US regulators and legislators have also acknowledged the critical role non-US reinsurers play in the US insurance market, providing essential capacity, underwriting expertise and beneficial competition to the domestic reinsurance market. They also recognise that reinsurance helps spread US losses - particularly catastrophic losses - throughout the capital markets of the world, a benefit that is severely undermined by the current collateral requirements. To date, two key issues have arisen in connection with the variable collateral proposal:

  • accounting principles for the financial statements filed with the US regulators; and
  • whether US ceding insurers can be confident that non-US courts will enforce US judgments against a reinsurer that does not pay a valid claim.
  • The approved list proposal resolves the accounting issue by providing that financial statements would be in US or UK GAAP - both readily understandable by US regulators. The enforcement of valid US judgments by their domestic courts will also be a precondition to listing a reinsurer. Meeting this standard, particularly for EU reinsurers, should not be a problem, particularly when the reinsurance agreements in question have (as they must) US choice of law, choice of forum and service of process clauses. Accordingly, the enforcement of judgment should be resolved. The variable collateral proposal put forth to the regulators might need some amendments or enhancements, and those supporting it are open to discussion with US officials. It might also be that prudent solvency regulation will lead regulators to require that weak reinsurers post collateral and that strong reinsurers operate without collateral. The litmus test for these two classes, however, cannot be their postal code.The US insurance industry and the US government have been in the forefront of calling for free trade in financial services and for the elimination of unnecessary or excessive regulation which can act as trade barriers, to the detriment of all insurers and the consumers they serve. The current US credit for reinsurance rules, when applied to all non-US reinsurers indiscriminately, is an example of excessive regulation. It is time for a change.By William C MarcouxWilliam C Marcoux is a Partner in the London office of law firm LeBoeuf, Lamb, Greene & MacRae.