Third-generation industry executive shares insight on regulatory matters

Sullivan discusses reinsurance collateralization, surplus lines regulation reform

Gerald Sullivan, chairman of Los Angeles-based The Sullivan Group, has been said to have grown up reading insurance rating manuals instead of Mother Goose books. He is the third generation to enter the insurance business in his family who hold mores than 35 years of industry knowledge alone.

Sullivan is no stranger to the industry or its regulators. He has served in numerous capacities for the National Association of Insurance Commissioners (NAIC), as have many of his family members. “My great uncle was commissioner in the state of Washington from 1932-1960, and had been president of the NAIC,” Sullivan said.

Sullivan recently sat down with Insurance Journal at a recent meeting of the NAIC in San Antonio to talk about some of the issues affecting insurance regulators today, including a proposal for reinsurance collateralization, surplus lines insurance modernization reform efforts at the state and federal level, and his views on how the organization has changed in his 35 years of attending their annual meetings.

To view the complete video interview with Sullivan, visit Insurance Journal’s Web site at www.insurancejournal.com/broadcasts.

One of the more important issues discussed at the NAIC is the Reinsurance Task Force’s proposal for reinsurance collateralization. Please explain this proposal?
Sullivan: Under the current regulatory scheme in the U.S., any reinsurer that is not domiciled in the U.S. has to place 100 percent collateralization of its liabilities under the contract it has with a company or another reinsurer.

Alternatively, a U.S.-domiciled reinsurer is not required to put up collateralization. Now the problem is that reinsurance is an international business. It always has been an international business. It is international for two basic reasons. First of all, there is no economy in the world, including the US, that has all the capacity or all the capital that it needs to meet all the risks that are generated by its economy. So, you’ve go to look around the world to find the amount of capital that you need to handle those risks.

Secondly, insurance is an international business that must spread risks. I reiterate that risks must be spread among many, many different parties and the reinsurance mechanism is an extremely important tool that allows that to happen. For example, all of the 9-11 losses and the major three hurricanes in 2005 were covered, for the most part, from the funds that came from non U.S.-based reinsurers. When you consider that fact it is clear how important the issue of collateral reinsurance is.

What exactly is the proposal before the committee right now?
Sullivan: The proposal is to establish the Reinsurance Evaluation Office (REO). The proposal says that reinsurers, regardless of whether they are domiciled here or abroad, should be measured based on their financial capability. The proposal says that collateralization would be a function of that financial capability and not an issue of where the reinsurer is domiciled.

Essentially most of the reinsurance in the world that is non U.S.-based comes from the UK, Germany, Switzerland, France, and Bermuda. There are others, but those are essentially the main countries involved. All of those countries have fairly strong and effective regulatory communities. It is really a matter of U.S. regulators and the non-U.S. regulators working together to effect a real solution.

If this proposal would be accepted, then the issue is a matter of reviewing the financial strength of each reinsurer–as opposed to “where” the reinsurer is domiciled.

Is this an issue of “us versus them?”
Sullivan: You’ve got a lot of people on both sides. There are many ceding companies here in the U. S. that are expressing a fair amount of discomfort with the approach. They naturally would much prefer to have 100 percent collateralization, but the fact is that in the trading world today that is not realistic. Reinsurers throughout the world, including U.S. reinsurers, do make decisions about where they are going to commit their capital. They will commit capital in areas where there is a better chance of return and where it is not as expensive as it might be elsewhere. The current collateralization process does discourage the willingness of non-U.S. reinsurers to commit capital to this market.

On another issue, the surplus lines industry obviously had some problems in the past dealing with multi-state risk and complying with laws and regulations in various states. Can you tell us a little bit about this issue?
Sullivan: Let me put a little history to your question first. We’ve been debating this issue of multi-state risks in the surplus lines area for many, many years. As a matter of fact as long as I have been coming to NAIC, which is 35 plus years, nothing has ever really been done about it.

The problem today is that if you are dealing with a multi-state risk, say a major oil company or a major manufacturer with multiple locations in eight or even 20 states, it is virtually impossible today to place that risk and comply with the surplus lines laws in all the states.

You have the placement requirements. You have taxation. You have numerous issues. Now, people work at it, they work around it. They find ways to make it happen, but it is still a real major problem.

At the NAIC meeting six months ago, a group met which included a number of regulators. It included some surplus lines company people. It included brokers. It included a lot of representatives from surplus lines stamping offices in those states that have stamping offices and a proposal was suggested whereby one would take the multi-state risks and handle it with a different set of rules than you handle single state risks.

This proposal has made some fairly good progress and will be presented to the Surplus Lines Task Force with the suggestion that this is a proposal that should be looked at very seriously. There is still work to do to get the details in, but a great deal of progress had been made in the last six months. Frankly, I am quite encouraged at where we are moving on this.

Is this NAIC proposal similar to the current legislative bill that passed House of Representatives regarding the regulation of surplus lines? Any crossover on the issue?
Sullivan: There is a great deal of crossover. Actually, what is being proposed here would allow the NAIC to deal with this issue as opposed to having it handled with on the federal level. It is a very positive step forward for NAIC to pursue this and, it would be an interstate compact which unfortunately will take a couple of years to get into place.

Is there more interest among the regulators to move quickly because of the federal bill?
Sullivan: Absolutely. I would hope that all regulators recognize the need to move that issue forward because it is a very important issue for regulators to handle. The NAIC is changing.

It is moving forward and it may even have to pick up its speed at doing what they are doing–just as the world around them is moving more quickly.

What do you think is the most pressing issue for the NAIC today?
Sullivan: Oh, they have a plethora of issues. Because of the work that our group does, we take particular focus on surplus lines issues and the reinsurance issues. Probably the biggest overall issue that the NAIC has to deal with is the matter of its need to change and move more rapidly on all issues.

Change is never easy. It doesn’t come quickly. There are a lot of different thoughts and ideas as to how things need to be done, but the NAIC needs to keep moving forward.

Lastly, you mentioned you have been attending the NAIC meetings for 35 plus years. How has the organization changed over the years?
Sullivan: Well, the NAIC has changed quite significantly. The change is a direct reflection on the speed with which business in general moves. The NAIC has had to adapt to that and allow insurers to get products to insureds more quickly, more effectively.

Solvency and capitalization issues have changed, as the need for reinsurance. In fact, there are all kinds of changes coming about in that regard. There are sidecars. There are other fancy ways of acquiring capacity, getting capital brought to bear to back up risk. The regulators are modifying what they are doing to reflect those changes. The NAIC is changing and modifying. It is a difficult process but it does happen and it is occurring here. In fact, it is occurring behind us right now as we speak.