Reinsurance collateral rule change won't benefit U.S. cedents, buyers

The current reinsurance collateral debate has been characterized as an effort to "level the playing field" for non-U.S. reinsurers.

But a level field already exists. Foreign reinsurers can forgo the 100% collateral rule by becoming admitted reinsurers. They need only submit to tri-annual audits and meet U.S. capital and surplus requirements.

Solvency, not free trade, is the heart of the collateral question. U.S. regulators are nonetheless being pressured to implement measures that could lead to "lawful insolvencies" and an exponential shortfall of funds on the balance sheets of U.S. insurers.

The National Assn. of Insurance Commissioners Reinsurance Task Force's response to this Lloyd's of London-led, pan-European lobbying effort--a plan to establish a new regulatory bureaucracy to rank nonadmitted reinsurers--has fundamental shortcomings. The proposed Reinsurance Evaluation Office:

• Is based on rating agencies' subjective analysis of unverified data from foreign reinsurers.

• Assumes incorrectly that current U.S. reinsurance solvency standards duplicate foreign reinsurers' home-country regulation.

• Extends an alternative collateral structure to foreign entities, even if they are not in compliance with U.S. law on reinsurance collateral.

• Permits collateral rules to diminish without requiring transparency to rise to the standard that U.S. companies meet.

• Provides loopholes for more of the special treatment that the Lloyd's syndicates and market have already been receiving from the New York State Insurance Department.

• Proposes rating Lloyd's as a whole, even though all of its syndicates do business on an individual basis.

Lloyd's is the prime mover and the least transparent participant in the effort to emasculate collateral rules. Yet nothing in the proposal requires an accurate portrayal of Lloyd's syndicates' financial condition to U.S. cedents, their policyholders or U.S. regulators.

Perhaps this is the result of Lloyd's seven-plus years lobbying the NAIC to relax U.S. collateral rules, and orchestrating the development of a straw-man U.K. insurance regulator.

Fact or fiction

The following points are offered to help sort out what is truth and what is fiction in the push to weaken trust fund collateral requirements for overseas reinsurers, and especially Lloyd's:

• When the NYSID conducted the first and only audit of Lloyd's U.S. trust funds in 1994 and published its report in May 1995, a deficiency of $18.5 billion had accrued. Repeated calls for the NYSID and/or the NAIC to conduct another independent examination of Lloyd's syndicates' actual financial data--not a review of practices and procedures--have been ignored.

• Advocates of collateral reduction portray it as a needed, prospective reform, when in actuality it is a cover-up for regulations that have already been effectively compromised.

• The NAIC has discussed collateral reduction since at least 2000. Meanwhile, the NYSID has quietly amended regulations on when cedents can take credit for reinsurance due from nonadmitted reinsurers.

  "Effective on an emergency basis since 9/15/01, and adopted on a permanent basis effective 4/9/03, the 8th Amendment to Regulation 20 (11 NYCRR 125)" gives the New York superintendent discretion to grant U.S. cedents full credit for reinsurance from Lloyd's and others, whether or not those entities' U.S. reinsurance trust fund balances meet or exceed their outstanding liabilities.

• As of Dec. 31, 2005, U.S. cedents declared an aggregate of $11.7 billion in reinsurance recoverables from Lloyd's syndicates in Schedule F of their convention statements. Based on this verified measure of unmet reinsurance liabilities--not on Lloyd's self-serving estimates--funds in Lloyd's U.S. Credit for Reinsurance Trust Funds are far below its syndicates' outstanding reinsurance obligations

• According to Lloyd's Treasury Department, the USCRTF balance as of Dec. 31, 2005, was $8.2 billion. There is no public disclosure, however, of how much of that is funded by cash or letters of credit. The NYSID's 9th Amendment to Regulation 20, "adopted on a permanent basis effective 4/2/03," lets Lloyd's post letters of credit, instead of cash or equivalent, in its USCRTF. This permits double use of syndicates' funds, or its Central Fund, depending on which entity procures the letter of credit. An additional twist is that Citibank, the trustee of the USCRTF, is permitted to issue letters of credit to Lloyd's entities that then post them as collateral in Lloyd's U.S. trust funds at Citibank.

• The Berkshire Hathaway/Equitas deal doesn't change the fact that Lloyd's syndicates have huge unmet liabilities on coverage issued after 1992.

• Lloyd's executives state they "can do more with the money when it's not tied up in U.S. trust accounts." How? A transparent explanation of the alternate uses envisioned--and how such redeployment raises the likelihood that U.S. cedents' claims will be paid timely and in full--is needed.

• Accounting and regulatory standards in non-U.S. jurisdictions do not yet justify mutual recognition. For example, in 1998, the U.K. government issued plans to bring Lloyd's under "external regulatory scrutiny" for the first time.

  c A careful reading of the Financial Services and Market Act 2000 and its subsequent modifications, though, shows the FSA's remit is merely to ensure that Lloyd's ruling council has guidelines for overseeing the agents, brokers and underwriters at Lloyd's. Rhetoric aside, the FSA delegates regulation of Lloyd's back to the marketplace itself.

• Following Sept. 11, 2001, and the U.S. hurricanes of 2005, Lloyd's said it was suffering "a temporary liquidity crunch," or cash-flow crisis. Lloyd's just-not-in-time capital structure required waivers of rules and extensions by U.S. insurance regulators to legitimize Lloyd's continued writing of coverage in the United States, while it figured out how to fund its syndicates' huge losses and unfulfilled collateral obligations.

Months after Katrina, Rita and Wilma ravaged the Gulf Coast, Lloyd's took its new U.K. GAAP accounting for its inaugural spin. Despite $15.06 billion in gross losses in 2005, and with $10.1 billion in reinsurance outstanding, Lloyd's declared by April 2006 that it had virtually broken even in 2005 (BI, April 10, "Lloyd's bent, not broken by '05 storms"). According to Lloyd's, its nominal net loss figure--announced prior to paying the bulk of claims or recovering reinsurance--"proved the resilience of the 300-year-old market."

Verifying reinsurers' solvency, not their competitiveness, is what best serves the interests of U.S. ceding insurers and their policyholders, not to mention their shareholders. No alternative to the current U.S. reinsurance regulatory regimen--admitted and audited under U.S. standards, or nonadmitted but fully collateralized--has been proposed that brings more benefit than risk to U.S. cedents and their policyholders.

Jack Shettle Sr. is chairman of the American Names Assn. in Rancho Santa Fe, Calif. He has 43 years' experience as an insurance and reinsurance broker, company executive and has served as an insurance/reinsurance consultant since 1996.

Jeffrey C. Peterson is the executive director of the American Names Assn., a post he has held for the past 12 years.