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The National Association of Insurance Commissioners is expected to decide next month whether state regulators should change the current collateral requirements for reinsurers doing business in the United States.
The current dual approach to reinsurance regulation has been the focus of much debate pitting U.S.-licensed ceding insurers and reinsurers, which generally favor the current system, against reinsurers that are not part of the U.S. licensing and regulatory regime, which favor a more flexible approach.
Under the current system, reinsurers that are licensed in the U.S. do not face a collateral requirement, while other reinsurers must post collateral equal to 100% of their U.S. liabilities before a ceding company can take full credit for the reinsurance.
In general, those in favor of the current system say collateral requirements protect cedents and U.S. policyholders against the risk of unrecoverable reinsurance; non-licensed companies say the current rules increase frictional costs and inhibit better capital utilization, and that reforming the rules may increase capital.
After years of discussion and debate, NAIC leaders in June adopted a motion to explore the feasibility of an alternative ratings approach. In general, under this concept, state regulators would assign ratings based on the reinsurers' financial strength and other operational factors. Collateral requirements, if any, would then be based on the rating.
Key players in the debate over reinsurance collateralization are the American Insurance Association, which opposes changes to the existing requirements, and the International Underwriting Association, which represents London market reinsurers and is arguing for reform to the system. Business Insurance Senior Editor Sally Roberts and Business Insurance Europe Deputy Editor Stuart Collins recently spoke with representatives of both organizations.
American rules are costly
Dave Matcham, chief executive of the International Underwriting Association, and chairman of the reinsurance working party for the international committee at the Comité Européen des Assurances.
Q: Why should state regulators in the United States change their collateral requirements for non-U.S. reinsurers?
A: Gross funding of U.S. liabilities for foreign reinsurers is in the billions of dollars and this is unsustainable. There is a real need for efficient and effective regulation of reinsurance. The current U.S. system is too skewed toward consumer protection and does not allow reinsurers to be cost-effective and competitive enough in the marketplace.
The regulation is also costly and the regulatory burden of compliance in the United States is more than any other jurisdiction that I have come across. Intellectually, you would think that with the elimination of inherent cost, the product would become cheaper. If the regulatory burden is costing money, and those costs reduce, the product should be cheaper.
Also current collateral rules do tie up capital. If that capital were available, then reinsurers would be able to offer more capacity to U.S. cedents. There is a capacity crunch in Florida at the moment and the Florida supervisor is considering a rating proposal to attract more capacity for cedents in the state.
Q: What would European reinsurers like to see U.S. state insurance supervisors change?
A: Assuming there will continue to be a collateral system, we would like to see that collateral required on an as-needed basis. Collateral should be based on risk assessment and not the mailing address of the reinsurer. We would like to avoid one-size-fits-all.
Q: What outcome does the European reinsurance sector expect and what does it think about the ratings solution favored by the National Association of Insurance Commissioners?
A: The rating approach appears to be the focus of U.S. regulators at the moment and that is the outcome that we are expecting. However, we would prefer in the long run that the U.S. cedent [rather than the regulator as proposed by the NAIC in its rating-based approach] takes responsibility for the evaluation of the credit risk of their reinsurer, as is the case with European regulation. But we will go with what we get."
Q: Is the rating approach an amicable compromise for all sides?
A: There has been plenty of opportunity for everyone to make their views [known] as this has been going on for six years. Some proposals have been amended to address the concerns of U.S. insurers and regulators. For example, the rating-based approach calls for a prospective [and not retrospective] change, only affecting the collateral requirements for new policies and not historical policies, that was a concession--as was the introduction of a sliding scale for reducing collateral requirements gradually, rather than straight down to 50% of liabilities as originally hoped for by European reinsurers."
Q: Why is now the right time to seek these changes?
A: The European [Union's] Reinsurance Directive has helped address U.S. concerns over varying levels of regulation in Europe by establishing a single standard of reinsurance regulation in the E.U. More importantly there is a greater awareness and understanding of regulatory regimes and much greater dialog between U.S. and European regulators. And that has built trust. Also in that time we have seen large catastrophes such as 9/11 and Hurricane Katrina: These have shown the value of the non-U.S. reinsurance market.
Q: If collateral requirements are changed, do you see this as the start of more cooperation and ultimately mutual recognition between the U.S. and European regulators in the long term?
A: I do believe that is the case, but not at this stage. The European Commission has commented that this is a priority. And a step by step approach should lead to mutual recognition, and we support that. Cooperation between the U.S. and E.U. regulators is already streets ahead of where it was years ago and at the International Association of Insurance Supervisors; they are working together on standards and guidance. Mutual recognition is the ultimate goal.
'No sign of crisis' in U.S.
Steven A. Bennett, assistant general counsel for the American Insurance Association in Washington.
Q: What is your position on United States regulators requiring unlicensed reinsurers to provide collateral for U.S. policyholders' risks?
A: Our position consistently has been the important issue of effective regulation of reinsurance. Where there are issues where reinsurance can be more effectively and efficiently regulated, we would support such changes. As far as the current system, it allows an option for all entities that want to sell reinsurance in the U.S. to either be regulated by U.S. regulators or, if you choose not to, you can post collateral. We believe that's a prudent and reasonable response to the issue. You could create a system where only regulated reinsurers could sell reinsurance in the U.S. market. That's the system that they have in most European countries. Allowing for collateral allows more capacity in the U.S. market. So we believe it's a very pro-competitive option for all reinsurers, whether they are U.S.-based or foreign-based.
Q: Why isn't it time for a change?
A: We cannot see any crisis or problem right now that this is in response to, so we don't believe it's time for a change. With that said, anything that would help improve the regulation of reinsurance, we would be in favor of. But what we would first need is some particular specific problem to be identified and then work toward a solution. But as far as collateral, I don't think a problem has been identified yet that this is in response to.
Q: If more foreign reinsurers were allowed access to the U.S. market-through the easing of collateral requirementswouldn't that benefit primary insurance buyers as the ultimate capacity for U.S. risks would likely increase?
A: It's speculation, but a good argument is that it would hurt capacity in the primary market. If all that was being offered to U.S. primary insurers was uncollateralized reinsurance offered by entities not regulated, it might be financially prudent for primary insurers to reduce their amount of reinsurance purchases, because there would be more questions on solvency. If U.S. primary insurers purchase less reinsurance, they offer less primary insurance in the U.S. markets. So if they change the collateral system from what it currently is, a possible scenario would be reduced capacity in the U.S. primary market, which I don't believe any regulator is looking to create.
Q: Do you view the ratings approach, which regulators are exploring, as a feasible alternative to the current collateral requirement?
A: First off, we don't believe it's responding to any particular problem or crisis. Any time you make a change, you would think a change would be responding to a specific problem and would be offering a solution. We don't believe this is a solution, but we also do not see what problem it's responding to.
As far as the specifics to the proposals, there are lots of questions as to how it would operate in practice. For example, how are they going to rate all the different reinsurersboth U.S.-based and foreign-based reinsurers? That's hundreds and hundreds of entities. How would they have credible ratings when they're also looking at subjective issues like the country of origin and how it influenced insurance regulation? It seems like there would be a lot of subjective decisions being made on insufficient data that I would have some real questions about the operational aspects.
Another problem, even once you got past the practical issues, is that all the risks are borne by the U.S. primary insurance industry. If a reinsurer is downgraded, the U.S. primary insurer loses its credit for its reinsurance and the reinsurer doesn't really face the problem. They would be requested to put up more collateral for the downgrade, but if they refuse to do that or fail to do that, all the risks and penalties are borne by the U.S. primary insurers.
In addition, when there is a downgrade in the financial condition of a reinsurer and it is required to post new or additional collateral, that would be at the worst time for the reinsurer, which is not in a financial position to post collateral. It seems it would not actually work in practice very well.
Q: Why do you believe your position on collateral requirements is in the best interest of policyholders?
A: I think it's in the interest of all stakeholders, policyholders, U.S. primary insurers, reinsurers, regulators and U.S. taxpayers to have an efficient, effective reinsurance system. Something that would create potential insolvency or lessen a chance of repayment of reinsurance would have a deleterious effect on all the stakeholders in the system, including U.S. policyholders. It would not be good for U.S. policyholders if U.S. primary insurers have problems collecting their reinsurance. There could be a solvency crisis and liquidations, and certainly when there are liquidations, it's bad for U.S. policyholders because they have to [recover] from a guarantee fund system. And when that happens, there are increased assessments and tax liabilities on U.S. taxpayers. As a general statement, a smooth, well-run reinsurance system is good for taxpayers, good for policyholders and good for regulators. We believe that reducing collateral for reinsurers that choose not to be regulated would add a lot more risk to the reinsurance industry, which would then trickle down to U.S. policyholders and taxpayers.