After years of discussion, the National Association of Insurance Commissioners (NAIC) has moved one step closer to a substantial revision of collateral requirements for reinsurers. In a move that caught many by surprise, regulators at the NAIC Summer Meeting took measures to advance a new, rating-based proposal designed to ease collateral requirements for non-U.S. reinsurers. Unlike existing collateral rules, the NAIC proposal calls for collateral obligations to be tied to a reinsurer’s financial strength and would apply to all reinsurers, regardless of their licensing or accreditation status.
Current Collateral Requirements
Current reinsurer collateral requirements are imposed under state credit for reinsurance regulations. Generally speaking, thes regulations require U.S. insurers to obtain acceptable forms of collateral from non-licensed or non-accredited reinsurers in order to take financial statement credit for reinsurance ceded to these reinsurers. In these situations, credit for reinsurance is permitted only in an amount equal to collateral posted by the reinsurer. Conversely, ceding companies that cede risks to reinsurers that are licensed or accredited in the ceding company’s state of domicile are permitted to take full financial statement credit without obtaining any collateral from the reinsurer. In other words existing regulations focus exclusively on a reinsurer’s licensing or accreditation status with no consideration given to the reinsurer’s financial strength or stability.
Proposed Collateral Requirements
The collateral requirements contemplated under the NAIC proposal take the opposite approach and focus on the financial strength of a reinsurer rather than its licensing or accreditation status. These requirements would apply to domestic and non-domestic reinsurers alike.
Under the proposal, procedures would be established for evaluating the credit risk of reinsurers through a rating-based system. Reinsurers placed into the highest rating category would be exempt from posting any collateral whereas reinsurers falling into the lowest rating category would be required to secure 75% of their liabilities. Reinsurers that do not receive a rating would be required to secure their obligations in order for U.S. ceding companies to take financial statement credit.
The proposal calls for the NAIC Reinsurance Task Force (or its successor) to have primary jurisdiction to implement the rating process. The Task Force would also be responsible for two important semi-annual assessments that would serve in part to determine a reinsurer’s rating. First, the Task Force would be responsible for publishing a list of those countries and states that they view as adequately regulating domestic reinsurers. Reinsurers domiciled in those jurisdictions identified as adequately regulating reinsurers could potentially receive a higher rating than a similarly situated reinsurer domiciled in a jurisdiction that does not make the list. Second, the Task Force would publish a list of those reinsurers who, in its judgment, fail to engage in the prompt settlement of undisputed reinsurance claims. Reinsurers appearing on this "slow-pay" list would automatically drop one rating category.
A reinsurer’s rating would be determined based on its Standard & Poor’s rating or an equivalent rating from another nationally recognized rating organization. This rating would then be subject to adjustment depending on whether a reinsurer appears on the "slow-pay" list or is domiciled in a recognized regulatory jurisdiction.
The proposal calls for the new collateral requirements to be imposed on a prospective basis (i.e., only to reinsurance contracts that incept after the rules become effective). The proposal also addresses the consequences of a change in or revocation of a reinsurer’s rating after a reinsurance agreement goes into effect.
Industry Reaction To Collateral Proposal
The collateral proposal has received strong, mixed reactions within the insurance industry. Proponents of the proposed collateral requirements assert that the new rules will eliminate unnecessary costs and disincentives for non-domestic reinsurers to write U.S. business by eliminating collateral requirements where they are not reasonably required. They also claim that the new rules are necessary to ensure that U.S. credit-for-reinsurance requirements are consistent with developments in international reinsurance standards. Not surprisingly, most non-U.S. reinsurers favor the proposed ratings approach, which they view as leveling the playing field with their U.S. competitors.
Most insurers and reinsurers based in the U.S., on the other hand, have opposed the proposed rules. Some claim the collateral proposal would undermine the financial security of U.S. ceding companies and diminish the incentive of non-U.S. reinsurers to become licensed in the U.S. Others assert that the new collateral requirements would put U.S. reinsurers at a disadvantage because they would be required to comply with the collateral obligations at the same time they are subject to U.S. licensing requirements. Opponents favor maintaining the current collateral requirements or exploring different alternatives.
At this time, the new collateral requirements remain in the proposal stage. The NAIC’s leadership, however, has requested that a formal proposal be presented to the membership by the winter quarterly meeting. Given the strong opinions voiced on both sides of this issue, the collateral proposal is certain to be the subject of lively discussion at the NAIC Fall Meeting.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.