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Collateral conundrum: To change or not to change

N.Y. steps out as first state to deliver level playing field for all reinsurers

New York State Insurance Superintendent Eric Dinallo’s proposal that the highest rated U.S. and non-U.S. reinsurance companies, not authorized or accredited to do business in New York, be treated the same as New York reinsurance companies has triggered a real discussion of the issue after many false starts.

Before Dinallo acted, the National Association of Insurance Commissioners, in a motion tabled in June 2006 by then President Al Iuppa, suggested scrapping the “full collateral” requirements imposed on non-U.S.-based reinsurers.

A recent Associated Press article examined the pros and cons of such an abrupt departure from procedures that have been in place since World War II. As the reinsurance industry increasingly moves offshore, regulators like Iuppa and Dinallo have been rethinking the current rules that require only non-U.S. reinsurers to post collateral equal to the full amount of their liabilities to U.S. insurers.

Foreign reinsurers have long fought against the rule, which Lloyd’s has called “outdated and anti-competitive.” The 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, and thus avoid the full burden of the collateral mandate.

Lloyd’s Chairman Lord Peter Levene has been a persistent and outspoken advocate for changing the trust fund requirements. He has never missed an opportunity to call for U.S. regulators to assure “a level playing field.” His latest attack came on Oct. 17 in an open letter to the Financial Times.

Although Lloyd’s was quite pleased when the NAIC motion passed, it’s not satisfied with what the commissioners came up with last September. Levene wrote that those proposals don’t materially change anything, as a “European reinsurer rated ‘AAA’ would still be required to post at least 60 percent collateral whereas a U.S. reinsurer with a ‘BBB’ rating would not have to post any collateral.”

Dinallo’s proposals to drop the collateral rule for the best-capitalized foreign reinsurers and adopt a sliding scale for others has been welcomed at Lloyd’s, but with caution. “We will study the proposal in detail but it appears to be a significant step forward towards U.S. and non-U.S. reinsurers being treated equally,” commented Lloyd’s general counsel, Sean McGovern, in a brief statement. He praised Dinallo for his “leadership on the issue,” but reiterated that abolition of the requirements throughout the U.S. “must continue to be the goal.”

N.Y. first in line

Although New York is the first state that says it will drop the restriction, it also has the backing of the NAIC, and most experts expect that other states will follow New York’s lead.

The proposed change in New York, which could take effect next year after a public comment period, “will help attract more capital to the New York reinsurance market, which should help lower costs and benefit consumers and businesses purchasing insurance,” Dinallo said in a statement.

He cited a growing need for terrorism and natural catastrophe reinsurance in New York. Dinallo estimated that foreign reinsurers had around $120 billion in collateral posted in the United States in 2005, costing them $500 million a year in transaction expenses. The rule change would free up that money to cover risk, he said.

Andrew Barile, principal of Andrew Barile Consulting Corp. of Rancho Santa Fe, California, said it was just a matter of time until the change is adopted in more states. “The reinsurance industry is global, and we have to take that into consideration, no matter how big our egos are,” Barile said.

He noted that a flood of international capital is coming into the reinsurance market, with potential new entrants from China and Dubai reinforcing the dominance of foreign reinsurers. The U.S. increasingly depends on that capital. Excluding Bermuda’s reinsurers, the U.S. now has only two large P/C reinsurance companies — The Berkshire Hathaway Group (Gen Re, National Indemnity, etc.) and AIG through its 59.3 percent ownership of Transatlantic Re.

Florida, which has experienced an insurance crisis as insurers cut back in the state after two record storm years in 2004 and 2005, has sought to bring more reinsurance capacity into the market by doubling the size of its own, state-funded reinsurance pool. A spokesman for Florida’s office of insurance regulation said that the state also will give strong, well-regulated foreign reinsurers more lenient treatment regarding reserves.

State insurance regulators largely favor dropping or relaxing the rule in the expectation of bringing more capital to the market to help cover risks from hurricanes, earthquakes and terrorism, especially as some U.S. insurers have begun cutting back their exposure in catastrophe-prone areas.

U.S. carriers opposed

Although the foreign reinsurers and the NAIC are strongly in favor of following New York’s model, that position has put them at odds with at least two of the major associations representing U.S. insurance companies, the primary customers for reinsurance coverage.

In a recent paper, Steven Bennett, assistant general counsel of the American Insurance Association, said the rule should stay in place because it “plays a critical role in securing U.S. ceding insurer solvency and in persuading reinsurers to pay recoverables due in a prompt and appropriate manner.”

The Property Casualty Insurers Association of America reacted to Dinallo’s proposals with a statement that it is “strongly opposed” to any such changes. “The current financial requirements help protect the solvency of U.S. primary insurers by ensuring that non-U.S. regulated reinsurers fulfill their promise to pay,” stated PCI assistant vice president and counsel Mike Koziol. “The New York proposal, as outlined in their recent news release, contains a number of significant concerns. The proposal exposes U.S. ceding companies to a lower level of security than under the existing collateral requirements, it contains too many provisions that appear not to be clearly defined and it should not be adopted.”

According to the Reinsurance Association of America, foreign-owned reinsurers, including life reinsurers, collected 84.5 percent of reinsurance premiums paid by U.S. insurers in 2006, a slight decrease from the year before. In 2006, the total of net reinsurance recoverables owed to U.S. ceding insurers was $242 billion. Of that, $114 billion, or 47 percent, was recoverable from foreign-owned reinsurers.

Those foreign reinsurers take the overall view that the “security issue” is 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 European Union’s Internal Market and Services Commissioner Charlie McCreevy in an address to the INFINITI Conference on International Finance on June 12, 2006, in Dublin.

Using closely defined ratings, applicable to all reinsurers to determine financial strength might result in more security, not less, supporters claim. Freeing up capital would increase capacity that is presently needed in a number of lines, and that could well make reinsurance less expensive, thereby lowering the cost of the primary policies for consumers, Dinallo indicated.

Associated Press and Lavonne Kuykendall, a correspondent of Dow Jones Newswires, contributed to this article.

Topics Carriers USA New York Excess Surplus Europe Reinsurance Market Lloyd's