States may scrap full collateral requirements for ‘alien’ reinsurers

The change may make it easier, more attractive for non-U.S. based reinsurers to write more U.S. business

In an abrupt departure from procedures that have been in place since World War II, the National Association of Insurance Commissioners took a first step at its recently concluded meeting in Washington, D.C., towards scrapping the “full collateral” requirements imposed on non-U.S.-based reinsurers.

In a motion tabled by NAIC President Al Iuppa, attending regulators voted unanimously to explore an alternative to full collateralization for alien reinsurers. In asking for comments from interested parties the NAIC stressed that the proposal, which would replace collateral requirements with a ratings based system, was aimed at “not only alien, but all reinsurers, based on their financial strength.”

The proposal seems to have a real chance of adoption. A NAIC bulletin noted: “The high proportion of principal regulators participating in the meeting of the NAIC’s Reinsurance Task Force underscored the importance of issues accompanying a possible departure from the NAIC’s current rule that alien reinsurers fully collateralize their writings in this country.”

Lloyd’s outspoken
The existing requirement is particularly onerous for Lloyd’s, whose structure as an insurance market rather than a single company precludes it from setting up U.S. subsidiaries that are regulated domestically. Lloyd’s Chairman Lord Peter Levene has been a persistent and outspoken advocate for changing the trust fund requirements, repeatedly calling for U.S. regulators to assure “a level playing field.” The NAIC seems to have heeded his plea.

“We’re very pleased that the NAIC has demonstrated leadership on this issue,” said Lloyd’s Director of Worldwide Markets Julian James in a telephone interview. “They’ve recognized where the debate should be focused, and I think there’s a good chance of success.”

Good, perhaps, but by no means assured, as there are powerful forces, led by the American Insurance Association, opposing any change in the current requirements.

“This measure allows certain influential foreign reinsurers to reduce the capital they are currently required to post in order to back-up the reinsurance contracts they write in this country,” stated Phillip Carson, AIA senior counsel, in the association’s response to the proposal. The AIA is urging state regulators to “defend the interests of Americans who rely on insurance and their insurers in international negotiation,” added David Snyder, AIA vice president and assistant general counsel.

Other critics
Lloyd’s isn’t the only one cheering.
Debra Hall, a vice president and regulatory counsel for Swiss Re, who acknowledged the rift in the interested parties’ group between a cedents’ group and others, supported both a “ratings option” and a “pooling option,” according to an assessment of the NAIC proceedings by the National Association of Mutual Insurance Companies. The latter option would see alien reinsurers participate in a fund to indemnify cedents in case of a reinsurer’s insolvency.

Hall apparently didn’t acknowledge the main concern of the non-Lloyd’s reinsurers; i.e., to be able to repatriate the money they earn in the U.S. without having to replace a good portion of it as security in the trust fund.

However, from an international point of view the trust fund collateral requirements are being seen as increasingly indefensible. There are only two major companies based in the U.S. that actually write P/C reinsurance — Berkshire Hathaway and AIG. This makes America’s primary carriers increasingly dependent on foreign, or alien, reinsurers, mainly located in Europe and Bermuda. They argue that requiring them to have more of their capital lie idle in a U.S. trust fund eventually means they write less U.S. business. That, the argument continues, makes primary insurance more expensive.

The focus on security is also seen as something of a “red herring,” especially in Europe. “The E.U.’s openness is exemplified in our decision to adhere to high quality global standards,” stated the E.U.’s Internal Market and Services Commissioner Charlie McCreevy in an address to the INFINITI Conference on International Finance on June 12 in Dublin. “To give just two examples, since Jan. 1, 2005, listed companies throughout the E.U. have been obliged to prepare their financial statements in compliance with IFRS. And next year, the Capital Requirements Directive, which implements the Basel II regime, will enter into force.”

He further noted that since 2004 the European Commission “has been engaged in the highly productive and co-operative Financial Markets Regulatory Dialogue with legislators and supervisors in the U.S.” Among the issues discussed, McCreevy pointed to the “continuing need for European reinsurers to post high levels of collateral for their business in the U.S., the general theme of foreign takeovers, co-operation on auditing supervision, and of course the big issue of accounting standards convergence, which is also high on the agenda in our dialogues with partners in Japan.”

Harmonizing accounting standards should make it relatively easy to assess the financial strength of a reinsurance company with a greater degree of accuracy than ever before. The AIA and a number of U.S. insurers say they are concerned that reinsurers — alien or otherwise — should be required to maintain adequate reserves to meet claims. But, as the NAIC seems to have recognized, penalizing non-U.S. based companies by requiring them to fully collateralize those reserves in a trust fund may no longer be the only way to achieve that goal.

Munich Re, Swiss Re and Lloyd’s withstood the losses from the Sept. 11 attacks, and the hurricanes of 2004 and 2005 in stride, unlike several domestic insurers. Using closely defined ratings applicable to all reinsurers to determine financial strength might actually result in more security, not less, according to the non-U.S. reinsurers.

Proponents of the change like to point out that a change in the collateral requirements could free up capital and boost capacity that is presently needed in a number of lines.