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State insurance regulators are facing more questions than answers in the proposed overhaul of the nation's regulatory regime for reinsurance through the introduction of a rating-based system that may eliminate collateral requirements for some non-U.S. reinsurers and impose collateral requirements on some domestic companies.

More than six months have passed since the National Assn. of Insurance Commissioners' Financial Condition Committee agreed to refine a proposal to establish a Reinsurance Evaluation Office as the foundation for a risk-based review process to determine which reinsurers would have to post collateral.

The apparent lack of progress is causing some observers to question the NAIC's commitment to its timetable as well as to question the NAIC's authority to make the changes that it is considering.

While the NAIC has made "good" progress in reviewing the collateral issue overall, progress since its December commitment to refine the plan "leaves something to be desired," said Dave Matcham, chief executive of the International Underwriting Assn., a London-based trade association.

The NAIC's Reinsurance Task Force is expected to refine the proposal by September, but as of early June "virtually nothing has been accomplished," Mr. Matcham said. "We believe that many--both U.S. and E.U. regulators and industry--are disappointed and surprised by this," he said.

Michael Koziol, assistant vp and counsel for the Des Plaines, Ill.-based Property Casualty Insurers Assn. of America, also is concerned.

"The expectation of a finalized REO by the September meeting is quite ambitious, and we are concerned that there will not be sufficient time for thoughtful vetting of proposals to flesh the REO out," said Mr. Koziol, who often speaks for U.S. ceding insurers, among the PCI's 1,000-plus member companies.

At a meeting last month, Georgia Insurance Commissioner John Oxendine, this year's chair of the task force, questioned whether the group should discuss the REO proposal first or as part of a broader review of reinsurance modernization issues. Its parent committee had given it both assignments. He now plans to address the REO issue first.

One of the key issues he and other regulators are considering is how best to balance the concerns of those most impacted by the proposal.

Under the current system, reinsurers authorized in the United States do not have to post collateral. However, reinsurers that are not authorized must post collateral equal to 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 and 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 businesses.

Supporters of modernization, who include European reinsurers and those favoring more competitive markets, consider the current rules to be excessive and want fewer barriers to doing business in the United States.

Opponents include most domestic ceding companies and guaranty funds that do not want to lose the security provided by collateral, especially since international accounting standards are not yet uniform. Also opposing some changes are U.S.-regulated reinsurers that oppose devaluation of their U.S. licenses and may lose the market advantage of not having to post collateral.

Under the proposed process, the REO would review each reinsurer doing U.S. business 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.

The ratings would determine, in increments of 20%, whether the reinsurers must post collateral that would range from zero to more than 100% of its U.S. liabilities.

At the recent task force meeting, Mr. Oxendine said, "Let's focus on how we can make things better."

The mirel draft

One of the newest modifications was introduced at the meeting by Lawrence H. Mirel, an attorney in the Washington office of Wiley Rein L.L.P. He said he vetted the ideas to a small but broad-based group of companies. Although Mr. Mirel declined to identify the participants, sources indicated they included primarily proponents of change--IUA, the Assn. of Bermuda Insurers and Reinsurers as well as Hannover Re, one of his clients.

Parts of the REO proposal are "unwieldy, difficult to implement or expensive," Mr. Mirel said. He recommended the following changes:

  • Make the rating system voluntary, but unrated companies would post 100% collateral.

  • Allow the ceding company's domestic regulator to decide whether--and how much--credit to grant the ceding company.

  • Give the REO authority to determine which non-U.S. jurisdictions have financial solvency regulatory systems that are comparable to the U.S. system.

  • Compare a reinsurer's claims-payment history with an industry benchmark and performance that is more than 20% off the standard would affect the reinsurer's rating.

    "It is an interesting proposal and deserves consideration," especially as a way to further the discussion, Mr. Matcham said.

    "The Mirel draft is an effort to streamline, to make commercially reasonable, the REO approach," said Bradley Kading, Washington-based ABIR's president and executive director. "It's an attempt to make the system work in the state regulation framework."

    Opponents say idea 'flawed'

    To opponents of the REO proposal, Mr. Mirel's ideas create problems as well as questions.

    Tracey Laws, senior vp and general counsel of the Washington-based Reinsurance Assn. of America, said Mr. Mirel's draft contains many of the same problems as the NAIC's REO proposal, including the fact that it is not comprehensive reform.

    "The voluntary features of Mirel's draft perpetuate the patchwork system of state regulation," Ms. Laws said. The RAA supports comprehensive--not piecemeal--reform, she said.

    "The draft reflects some improvements...but the structure of using the NAIC to achieve a rating system is still flawed," said Debra Hall, senior vp, group legal for Swiss Reinsurance Co. The company favors rating reinsurers based on their financial strength and that of their domiciliary jurisdiction. It also says that federal regulation through an optional federal charter approach is better than the REO structure through the NAIC, said Ms. Hall, who also heads an NAIC interested persons' group on the issue.

    Mr. Koziol said one positive aspect of Mr. Mirel's proposal is that it "has the merit of domiciliary deference as the single regulator," but "still has the problem of the NAIC determining the status of foreign nations."

    Contrastingly, Jeffery C. Alton, vp-financial regulation and capital analysis for Chicago-based CNA Financial Corp., proposed requiring all reinsurers writing U.S. business to participate in the REO, which would operate as a pool with a guaranty fund. If each reinsurer were jointly and severally liable for losses, ceding insurers would know that all their claims would be paid, he said.

    Such a pooling proposal "will never fly," Mr. Matcham said after the meeting.

    REO supporters point to an A.M. Best Co. Inc. announcement in late May that the REO proposal would have little impact on the financial strength ratings of U.S. property/casualty and life/health insurers.

    The findings, which are consistent with the findings of Fitch Ratings and Standard & Poor's Corp., "amply demonstrate that the current collateral rules are excessive and that new rules can be imposed without any real solvency risk," Mr. Matcham said.

    Mr. Kading agreed, noting that major rating agencies have said "as long as collateral reduction is applied on a prospective basis, it should not be viewed as a measure that affects the ratings of U.S. insurers."

    "The agencies have also pointed to the positive effects of the collateral alternative proposals--that being that they further focus ceding insurers on the credit quality of the reinsurers with whom they are dealing," Mr. Kading said.

    From a ceding insurer's perspective, Mr. Koziol said Best looked at one aspect of the issue. "A rating doesn't help should a reinsurer become impaired or insolvent," he said. In that case, a troubled reinsurer should be asked to provide more collateral, but would be unlikely to post it, he said.

    If a reinsurer becomes insolvent, then the ceding company takes a hit to its surplus, he said. "To the extent that impairs the ceding company, the guaranty funds may have to pay claims and policyholders would not be covered," he said.

    Questions also have been raised about whether the NAIC has the authority to operate an REO-type entity.

    The Kansas City, Mo.-based NAIC is a trade association of insurance commissioners, who are either appointed or elected representatives of individual states or territories.

    "The NAIC is not a regulatory body and can't make binding decisions," Mr. Mirel said. The single-regulator approach he proposes is similar in concept to that which Congress previously approved for risk retention groups, he said.

    In addition, any major changes to states' credit for reinsurance laws would have to be approved by the individual states.

    Legal analysis 'confidential'

    The interested person's group asked the NAIC last year to review and seek advice, as needed, about the feasibility of an REO-type entity, Ms. Hall said. "I understand that an analysis was prepared and, on behalf of the interested persons, I requested a copy of that analysis, but was advised by the NAIC that it was confidential," she said. "These are important issues to many stakeholders and the analysis and consideration of them should be transparent."

    Regulatory modernization "is a difficult assignment, both substantively and politically, and probably inevitably leads to federal legislation as a necessary implementation tool," Mr. Kading said.

    Some insurers are already supporting federal involvement.

    For example, Swiss Re believes that a change in collateral rules is "appropriate," but also believes that global reinsurers need to have the option of being federally regulated, Ms. Hall said.

    "If state regulators cannot resolve this important regulatory debate, it will just become another argument for when federal regulation is needed," Mr. Kading said. "The states have to demonstrate that they are up to the task of regulatory modernization."


    In search of answers

    The National Assn. of Insurance Commissioners is facing questions about the proposed Reinsurance Evaluation Office, including:

  • Does the NAIC, a trade association, have authority to establish the REO or is federal approval needed?

  • Should U.S. and non-U.S. reinsurers be required to participate in the REO or should it be voluntary?

  • Who should determine how much reinsurance credit to grant a ceding company--the REO or a ceding company's domestic regulator?

  • Who should evaluate the comparability of financial solvency regulation in non-U.S. jurisdictions to that in the United States?