The battle to remove restrictions for foreign reinsurers in the US has taken another twist. The NAIC is now advocating a review of all regulations governing insurers. Ronald Gift Mullins looks at the pros and cons
Until recently, it looked very likely that a proposal that would assuage if not nullify the 100% collateral rule for non-US reinsurers would be accepted. Then, the National Association of Insurance Commissioners (NAIC) hesitated at their summer meeting, directing a taskforce to study the proposal further, examine the entire set of reinsurance regulations and to develop recommendations for creating a new model act to govern how insurance companies assign credit for reinsurance.
While this may be a setback for those campaigning for the elimination of the 100% collateral rule, the forces exerted on both sides of this effort could generate a substantially increased role for the regulation of insurance by the US federal government, as well as the increase in the globalisation of reinsurance.
This latest collateral proposal, as developed last year and since revised, calls for the creation of a reinsurance evaluation office (REO) to alter the current rule that non-US reinsurers have to post 100% collateral on their US liabilities in order to write reinsurance in the US market. The REO idea would require each reinsurer, both US and foreign, to be evaluated and assigned a rating, similar to the manner in which insurers and reinsurers are currently rated by rating agencies. A reinsurer’s rating would determine the amount of collateral it would be required to post for liabilities in the US.
There was opposition to and endorsement of the proposal from trade organisations and insurers and reinsurers. Those opposed were suspicious of the reliability of foreign reinsurers’ financial data and predicted more insolvencies, which would burden guaranty funds.
Those for the proposal said the posting of billions of dollars in trust funds ties up huge amounts of capital that could be used for other purposes. It also creates an unfair advantage for US reinsurers who don’t have to abide by the rule. But those advocating retaining the collateral rule said it hasn’t prevented foreign reinsurers from currently controlling more than 50% of the US market, so why the need for change? For most non-US reinsurers, it is not the cost of providing the collateral, but rather the lack of ability to manage its capital in the most effective manner.
Apparently, elimination of the collateral rule would not have a strong derogatory influence on US insurers. AM Best examined 895 US property/casualty ratings that are assigned Best’s capital adequacy ratio and found only 45 companies, or 5%, would have been materially affected by the elimination of the 100% collateral rule. Those companies that have ceded leverage of greater than 2.0 or face sizeable recoveries from unrated non-US reinsurers would have experienced the greatest impact.
Lawrence Mirel, partner at Wiley Rein and a principal architect of the REO proposal, believes the domestic industry and the ceding companies have long been complaining that the entire system needs an overhaul, and that setting up an REO is not going to solve the “systemic problems of who and how reinsurers should be regulated”.
“What they really want is a federal regulator,” he says. “I’ve never been sure whether the argument was simply a stalling tactic to delay or defeat the REO idea, or whether they want to use the debate over collateral reform to push for the idea of a federal regulator.”
New model act
“Those for the proposal said the posting of billions of dollars in trust funds ties up huge amounts of capital that could be used for other purposes
The reinsurance taskforce will continue to refine the REO proposal and develop changes to reinsurance model law and regulation. The taskforce will submit a progress and feasibility update to the Financial Condition Committee at the fall national meeting in September 2007. Compounding the struggle to alter the collateral rule is the difficulty of changing a model law.
Mirel explains that for approval of a new model law, it now requires a 2/3 vote of the commissioners and a commitment from those who vote in favour to try to implement the model in their states. “That makes eventual adoption of the REO proposal as a model law much less likely,” he says.
The new model enactment rule, however, does allow for the approval of “statements of principle” on a majority vote, with no commitment to implement it into state law. “My own view is that the NAIC may be able to come up with a statement of principles but is not likely to get a model law approved,” Mirel says.
Another route for enacting a different collateral rule is for states to make their own changes. Florida has already enacted a law that allows the commissioner to waive the 100% collateral requirement when he believes the full collateral is not necessary. “The Florida legislature acted under pressure of trying to maintain a market for windstorm insurance in the state,” he said, “but other states may follow its lead,” says Mirel.
“We are not seeking to do away with state regulation in any way,” says Debra Hall, senior vice president, group legal at Swiss Re. “We think there should be a choice.” She adds that regulations need to be based on characteristics and the nature of individual companies. A local regional company is one thing, she observes, but Swiss Re is a very different company.
Addressing the collateral rule only is the wrong way to go, according to Joseph Sieverling, senior vice president at the Reinsurance Association of America. “There needs to be a look at the overall regulation of reinsurance,” he insists. “Anything to get a more uniform basis for regulations. We would entertain a reduction in collateral but only if from a broader and more uniform perspective.”
Swiss Re believes a collateral rule should be based on the strength of the reinsurer. “Rules as they now exist served well when there was a lack of understanding of accounting systems and there wasn’t the kind of cooperation between regulators then as there is now,” says Hall. “Greater global regulation has come about in the last decade. The world has changed and we believe it is time that collateral rules should be in concert with the changes in the reinsurance industry.”
Just as the NAIC meeting in San Francisco was taking place, CEOs of three reinsurance companies downplayed the urgency of altering the 100% collateral rule at the 2007 Standard & Poor’s insurance conference in New York. They strongly urged that much of the difficulties associated with regulating reinsurance would be solved with the creation of an optional federal charter for insurers and reinsurers.
Nikolaus von Bomhard, CEO of Munich Re, says allowing reinsurers to choose federal regulation would be a strong first step to the “mutual recognition” of regulatory standards globally, and may be easier to achieve for reinsurers than for primary insurers. “Reinsurance could be like a Trojan horse – a test case for getting that,” he offered. Having an optional federal charter could “solve many more problems beyond the fairness of collateral requirements”.
“Florida has already enacted a law that allows the commissioner to waive the 100% collateral requirement when he believes the full collateral is not necessary
Joseph Brandon, CEO of General Re, says the reform of regulation is not a plea for less regulation “but an increase in the effectiveness of regulation that’s out there”. He said reinsurance is a global industry today that is being regulated by 50 states in the US and this is a “fundamental mismatch”.
Citing the need for some kind of coherent regulation, Patrick Thiele, CEO of PartnerRe, says he favours “regulation that recognises the global nature of this industry.” He advises reinsurance companies to find ways to be more transparent so they can assure all the regulatory bodies throughout the world that “we know what we’re doing in terms of risk assumption, that we’re transparent about where the risks lie on the balance sheet”.
One reason for the NAIC’s decision to take a broader view of reinsurance regulation in the US may be the approaching implementation of the European Union’s Reinsurance Directive in December 2007. The act prohibits all EU member states from retaining or introducing systems of pledging of assets from reinsurers authorised in the EU. This prohibition has to be accepted by the 28 countries in the EU.
Once a reinsurer is authorised in one EU country, it is free to conduct business in any of the other EU states. Supervision of a reinsurer’s financial condition is conducted by its home state. The primary intent of the Reinsurance Directive is to secure proper and adequate protection for insurers and to encourage a fully functioning market within the EU. Further, having a strong unified system in place may convince US regulators and legislators that the US 100% collateral rule will no longer be necessary.
“I think there is a growing recognition among regulators that there needs to be some modernisation efforts in regulation,” Hall says. “We do support the optional federal charter for reinsurers. I think there is certainly a hope in Europe that the direction of reinsurance will help bring about more uniformity in the US insurance and reinsurance regulation.”
Dream to reality
Bringing the reality of an optional federal charter closer, in June 2007 a new version of the National Insurance Act was introduced in the House of Representatives. The bill would create a federal office of national insurance, with a commissioner appointed by the president. The office would have the power to grant federal charters to property/casualty, life, reinsurance and surplus lines companies. A similar bill has been introduced in the Senate. Both bills grant brokers and other producers a national license that would permit them to sell insurance anywhere in the US.
The house bill enables the office to police unfair competition, deceptive practices and insurance fraud by federally chartered insurers or licensed producers, and could suspend or revoke federal charters if necessary. The bill also sets out a solvency review process to apply standards to federal chartered insurers and reinsurers or risk-based capital and investments, and asset and liability valuation requirements. While the NAIC and agents’ associations oppose passage of the bill, the sponsors in Congress vow they and their supporters will work to establish this federal alternative to state-by-state insurance regulation.
Ronald Gift Mullins is an insurance journalist based in New York City.