Are US collateral rules for "alien" reinsurers fair?

Charles Chamness is president & CEO of the National Association of Mutual Insurance Companies (NAMIC)

No observer or expert of sound mind presumes to know every combination of adverse financial circumstances that can occur in the world economy or the property/casualty insurance industry. National Association of Insurance Commissioners’ (NAIC) members, large and small, understand that they are not infinitely wise in this respect, and for that reason they choose to have the comfort of full collateral for obligations owed them by what are known in this country as “alien” or unauthorised reinsurers. Full collateral is good business and a reasonable measure for protection of solvency.

Primary insurers are the market for reinsurance in the United States, but they have been told by some regulators and foreign reinsurers that they should migrate to a promised land where, somehow, everything will be worked out if unauthorised reinsurers cannot or choose not to fulfil their promises to cedents.

In an industry that deals with risk, our primary insurer members observe with complete clarity that they are left with more solvency risk or the potential for more guaranty-fund assessments when collateral requirements are weakened. And just like every other business, foreign reinsurers also experience lean times along with the fat times.

Can we request more collateral from an unauthorised reinsurer in the process of sliding from financial strength to weakness and expect compliance, especially compliance in a timely manner? It should be noted that recent - and presumably prospective - NAIC plans for collateral reduction allowed zero collateral for top-ranked foreign reinsurers. Unfortunately absent from these proposals is recognition that reinsurers’ fortunes change and that anything less than full collateral adds risk for the cedent.

And the quid pro quo for a primary insurer accepting more risk? It is suggested to us by a few regulators that loosening collateral requirements will result in a broader and deeper reinsurance market offered to domestic cedents and that more assuming companies will be willing to handle catastrophe risk at affordable rates.

There are two things we know about unauthorised reinsurer collateral requirements: The cost of collateral, which is experienced only after the cedent’s covered losses, to “alien” and other unauthorised insurers is not great and is easily priced into reinsurance; and capital for reinsurance risk is abundant but must have its tribute; an arbitrary decree will not cause such capital to serve, for example, coastal risks or to serve them cheaply.

As we witness the growth of “alien” or unauthorised reinsurers’ participation in the US market - indeed the dominance of foreign reinsurers in this market - we wonder at the contradiction presented by an NAIC that raises the bar on primary-insurer solvency but is ready to accommodate European reinsurers by serially proposing to loosen credit for reinsurance.

Collateral reduction has been a goal of foreign reinsurers for years, particularly those in western Europe that do huge amounts of US business. Always baseless, in NAIC’s opinion, are assertions that collateral, especially full collateral, is an international restraint of trade. The NAIC consultation with the US Department of Treasury on this stance finds no official or even unofficial position. Similar rattling from Congress seems also to have no footing or champion. A companion question, which has been discussed but never seems to be resolved is whether, and in what degree, collateral might be required for non-EU reinsurers’ assumptions from EU-domiciled primary insurers.

“Full collateral for foreign and unauthorised reinsurers' obligations to US-domiciled cedents has served the purpose of solvency very well

What would be reasonable in making the reinsurance market more accessible for those entities choosing not to be domiciled in one of the states and perhaps in broadening what is available to primary insurers? Perhaps it is a form of centralisation of licensure that minimises the friction costs for a reinsurer in doing business in many states.

A fundamental responsibility would be judging those alien and unauthorised reinsurers fit to do business in this country. With solvency and integrity of the industry underlying its purpose and function, the NAIC might have a strong role in its operation, but governance should comprise representatives of the primary insurance industry, the states, the federal government, and the policyholder sector.

Full collateral for foreign and unauthorised reinsurers’ obligations to US-domiciled cedents would continue to be a condition for operation in this country. Cessions concluded between insurance entities already regulated by the states, whether intra-company or between separate insurers, would not be subject to any central licensure.

In summary, we must observe that full collateral for foreign and unauthorised reinsurers’ obligations to US-domiciled cedents has served the purpose of solvency very well and that its degradation inevitably transfers solvency risk, and its attendant cost, to the primary sector of the industry.

Were there proof that the reinsurance industry would be broadened and deepened by the reduction or elimination of the minimal cost of full collateral, perhaps that change would be useful. There is no credible proof in any measure, however, that collateral reduction accomplishes this.

Reinsurers’ entry into the US market might be eased through centralised licensure, but the current collateral regime for credit for reinsurance is good business for cedents and best for solvency and should be maintained.

Sean McGovern is director and general counsel at Lloyd’s.

It is hard to believe that the US does not offer a level playing field for global reinsurance businesses. Lloyd's writes $12bn of business in the US and provides coverage for perils from terrorism to natural catastrophes. Lloyd's has paid $8bn in gross claims following the atrocities of 9/11 and $10bn from claims arising from hurricanes Katrina, Rita and Wilma. We currently have $9bn tied up in collateral trust funds. Not only is this unnecessary, grossly inefficient and unfair, but the costs involved are ultimately passed on to the US consumer.

The National Association of Insurance Commissioners (NAIC), the body which represents the state regulators, has been looking at this issue for nearly eight years and seemed to acknowledge finally that serious reform to these barriers was necessary and that reinsurers should be assessed not on domicile but on financial strength.

“The failure to reform will damage US interests both domestically and internationally

Unfortunately, a recent proposal for reform fell well short. A European reinsurer rated “AAA” is still required to post at least 60% collateral whereas a US reinsurer with a “BBB” rating does not have to post any. And all the while the opponents of reform attempt to distract attention away from the US by criticising the European Union.

Europe is an open market and is therefore right that the European Commission is demanding the same openness from the US. Evidence of the openness of the EU’s reinsurance market is demonstrated by the EU’s acceptance of the GATS Understanding in Financial Services. This understanding includes a requirement that each signatory has to permit non-resident suppliers of reinsurance and retrocession services to supply such services under national treatment terms and conditions.

The fact of the matter is that discrimination does not apply when US reinsurers trade cross-border into the EU. By contrast, EU and other non-US reinsurers face massive financial discrimination under the current US reinsurance collateral rules when trading cross-border into the US. That is the real issue at the heart of this debate.

Granted, gaining consensus among 50 state regulators is undoubtedly challenging and it is hardly surprising that the industry is questioning the viability of the state system. There are a number, such as the New York Insurance Department's Superintendent Eric Dinallo and his Florida counterpart, Commissioner Kevin McCarty, who appreciate the wider context and are taking a more progressive view.

As Superintendent, Dinallo has stated: “There is a growing need for reinsurance in New York to deal with risks from terrorism and from natural catastrophes such as hurricanes. We cannot afford to maintain outdated and unnecessary standards for the international market for reinsurance.”

Commissioner McCarthy, who realises the benefits of altering the rules for his state, has also stated: “Allowing foreign reinsurers to conduct business with Florida insurers without requiring them to post millions of dollars in collateral will lead to increased capital and competition in our state. These factors will help to stabilise and potentially reduce property insurance rates.”

The failure to reform will damage US interests. The domestic damage will come as the country's need for reinsurance capacity grows with the increase in risks associated with man-made and natural catastrophes. Access to the international reinsurance market will therefore become increasingly important in meeting the insurance needs of the American people. The damage to US interests internationally will come from the failure to remove these barriers to trade.

With the co-operation and mutual recognition that is being achieved between US and EU financial supervisors in other sectors of the financial services industry, it is disappointing that no progress is being made in the area of reinsurance regulation. What we need is action and leadership before further damage is done.

Lloyd’s remains committed to reform of the rules governing reinsurance funding. There is a good level of engagement on the issue among regulators and government both in the US and outside it. There is general acceptance that the current rules are inappropriate and unfair but differing views on how reform should be delivered. We will continue to engage with all interested parties in working towards a resolution