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Reinsurer collateral reforms advance

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SAN ANTONIO—After years of debate, U.S. insurance regulators have committed to overhaul the nation's regulatory regime for reinsurance with the introduction of a rating-based system that may eliminate collateral requirements for some non-U.S. insurers and impose collateral requirements on some domestic companies.

In a key move in a nearly 12-year on-and-off discussion, the National Assn. of Insurance Commissioners' Financial Condition Committee last week agreed to refine a proposal to establish a Reinsurance Evaluation Office, which is intended to be the foundation for a risk-based evaluation process that would amend state laws concerning credit for reinsurance.

Under the proposed process, the REO would review each reinsurer doing business in the United States using rating agencies' financial assessments as well as other information about each reinsurer, including its claims-paying history. The REO then would assign one of six ratings to a reinsurer (see chart, page 21). The rating would determine, in increments of 20%, whether the reinsurer must post collateral that would range from zero to more than 100% of its U.S. liabilities.

The move, which will take at least several months to finalize, has been condemned by many U.S.-based insurance and reinsurance groups, cautiously supported by the Risk & Insurance Management Society Inc. and welcomed outright by several non-U.S. reinsurance groups.

Under the current system, reinsurers authorized in the United States do not have to post collateral, but unauthorized reinsurers must post collateral worth 100% of liabilities to allow a ceding insurer to take credit. The NAIC estimates that the proposal would eliminate $55.09 billion in collateral from the top 60 unauthorized reinsurers, but require U.S. authorized reinsurers to post $20.26 billion. That would mean a decrease of nearly $34 billion in collateral supporting U.S. reinsurance business.

"U.S. insurance regulators recognize the need to move from the current system of reinsurance regulation...(which) is too simplistic, has arbitrary barriers...and ignores differences within and outside the United States," said Alessandro Iuppa, immediate past-president of the NAIC and Maine's insurance superintendent.

On Jan. 15, 2007, Mr. Iuppa will join Zurich Financial Services Group as a senior government affairs representative for two units (see box).

During the NAIC's winter meeting in San Antonio, the organization's Reinsurance Task Force voted 15-5 to adopt the REO proposal and send it on to its parent committee--the Financial Condition Committee--for refinement and development of "commercially reasonable" implementation plans, but only through September 2007.

Financial Condition Committee Chair Al Gross, the Virginia insurance commissioner, said he plans to oversee a broad-based review of the reinsurance regulation and seek participation by relevant NAIC subgroups. While he considers the proposal's deadline important, he said "we can't have a bad proposal."

The plan is for the Financial Condition Committee to present a final proposal to the NAIC's membership for adoption in December 2007, Mr. Iuppa told the committee last week.

Among the issues that regulators are expected to consider are the legal basis for delegating authority to the REO, affiliate transactions and the effect of downgrades on reinsurers who are required to post collateral.

Risk managers are "cautiously supportive" of the proposal, said Janice Ochenkowski, vp of New York-based RIMS and a managing director of Jones Lang LaSalle Inc. in Chicago.

"The theoretical outline of the REO and its safeguards is very positive," she said. It imposes "what seem to be good standards on reinsurers," while providing safeguards such as using rating agencies' financial analysis and requiring non-U.S. reinsurers to sign a form accepting the authority of U.S. courts.

"If we have a more open market with proper safeguards, risk mangers should benefit because there will be additional capacity and competition," Ms. Ochenkowski said.

But U.S.-based insurance and reinsurance organizations generally disagree with the idea of reducing collateral for unauthorized reinsurers.

"This is the most contentious issue the NAIC has dealt with regarding reinsurance in recent years," said Debra J. Hall, vp and regulatory counsel for Swiss Re America Holding Corp. based in Armonk, N.Y., who co-chaired the task force's interested persons group. A majority of participants in that group "have serious concerns about the REO proposal," Ms. Hall said in letter to task force chair Julianne Bowler, the Massachusetts insurance commissioner.

Representatives of ceding insurers and guaranty funds have voiced their opposition to Ms. Bowler. They include major trade associations as well as individual insurers.

"We oppose the reduction of collateral in any way, shape or form. It is a solvency issue and will ultimately affect the ceding companies," said Michael Koziol, assistant vp and counsel of Des Plaines, Ill.-based PCI.

Martin F. Carus, AIG's senior state relations officer, wrote in a recent letter to Ms. Bowler that "the proposed collateral requirements will decrease the viability of reinsurance programs provided to small to midsized and regional carriers and will reduce the overall reinsurance capacity in the U.S. marketplace."

The proposal "will increase costs to guaranty funds because of the inability to collect reinsurance from some foreign reinsurers," said Kevin Harris, senior vp and general counsel of the Indianapolis-based National Conference of Insurance Guaranty Funds. U.S. policyholders ultimately will bear those increased costs, he said. If enacted, the REO plan will cause a flight of capital from the U.S. to lower-cost jurisdictions, Mr. Harris said.

Meanwhile, non-U.S. reinsurers were generally pleased with the actions.

"It's a significant step forward--a breakthrough after many years of debate," said Dave Matcham, London-based chief executive of the International Underwriting Assn.

The task force's support of the REO structure "represents an important affirmation" that is the appropriate way to proceed, said Joseph P. Gunset, general counsel of New York-based Lloyd's America Inc.