RAA: Reg Reforms Need Balance Of Efficiency,Security

As Congress continues to hold hearings on ways to bringefficiencies to the regulation of insurance, its important that thereforms maintain a critical balance between efficiency andfinancial security.

One policy under consideration is a proposal to usher innational regulation for reinsurers. Reforms and efficiencies can beachieved by the states acting to enact federally adopted standards.Such a system would not abandon state regulation, but would providea sole regulator for reinsurers, whether that regulator is at thestate or federal government level.

Under this proposal, federal preemption would ensure that areinsurer domiciled in a state that enacts the federal standards isfree from insurance regulation by all other states.

The plan would provide that an optional federal charter systemfor reinsurers would take effect as a backup should an insufficientnumber of states adopt the federal standards. The plan wouldbenefit from the expertise embodied in state insurance solvencyregulations by incorporating important model acts from the NationalAssociation of Insurance Commissioners within both the federalstandards and the optional federal charter regulatory schemes.

Along these lines is the recognition of the need for greaterefficiency in the regulation of reinsurance in the United States,particularly in the area of extraterritorial application of statelaws, which results in legal and regulatory inconsistencies andconflicts.

As a result of the state system of regulation, significantdifferences have emerged with respect to reinsurance regulatoryrequirements. The costs associated with addressing the deviationsamong the states, in addition to the basic expense of a multistatesystem, are ultimately reflected in the premiums paid byconsumers.

While the NAIC and state regulators are to be applauded fortheir efforts toward greater uniformity in the adoption of modellaws and regulations and the creation of the accreditation system,problems remain with states pursuing varying and sometimesinconsistent regulatory approaches. An example of this is theextraterritorial application of state laws.

Approximately 15 states apply at least some of their regulatorylaws on an extraterritorial basis, meaning that the state law notonly applies to the insurers domiciled in that state but toinsurers domiciled in other states if the extraterritorial statehas granted a license to the insurer.

For example, an insurer domiciled in a state other than New Yorkbut licensed in New York will find that New York law applies to theway it conducts its business nationwide. This extraterritorialapplication of state law results in inconsistencies and conflictsamong state laws. As Congress proceeds in reviewing the currentregulatory structure and considers a new one for the future, itshould contemplate prohibiting the extraterritorial application ofstate laws.

Regulation of reinsurance can also be improved on theinternational stage. Reinsurance is a global business. It has longbeen recognized that the level of reinsurance regulation variessubstantially in countries throughout the world.

The United States, which imposes a very highly structured levelof regulation upon licensed reinsurers, stands in stark contrast tocountries like Belgium, where reinsurers are subject to no directreinsurance supervision, and Greece, where reinsurers are subjectto no supervision whatsoever. There is no globally recognizedmethod of conducting reinsurance regulation.

An effort is under way in several forums, including the NAIC,the International Association of Insurance Supervisors and theWorld Trade Organization, to create a system of mutual recognitionof regulation among countries.

This effort, led by foreign trade associations, seeks toestablish a system where a country recognizes the reinsuranceregulatory system of other countries and allows reinsurers toconduct business without the additional imposition of regulatoryrequirements.

If such a system were established, foreign reinsurers would bepermitted to assume reinsurance risk in the United States withouthaving to obtain a U.S. license and without having to providecollateral for their liabilities to U.S. ceding insurers. Thiswould be the result even if the foreign reinsurer were domiciled ina country with far less reinsurance regulation than that imposed byU.S. regulators on U.S.-licensed reinsurers.

The concept of mutual recognition is laudable because of thevalue created by a more efficient reinsurance regulatory systembutonly if certain prerequisites are met. Mutual recognition cannot beaccomplished on a worldwide basis, or even a regional basis, untilthe following prerequisites have been implemented:

There needs to be created and implemented an internationalaccounting system, which provides more transparency betweendifferent existing systems. That effort, though under way, is yearsfrom becoming a reality.

There must first be mutual recognition among the states withinthe United States. It makes no sense whatsoever for regulators toplace trust and confidence in the regulatory systems of foreignjurisdictions before and until they afford that trust andconfidence to their counterparts in the United States.

There needs to be established a predictable and consistentmethod for the recognition and enforcement of U.S. judgmentsabroad. The RAA research on this subject demonstrates that whilethe U.S. regularly recognizes and enforces the judgments renderedin other nations, U.S. judgments are often not given reciprocaltreatment. The United States is not a party to any treaty for therecognition and enforcement of judgments, and some countries refuseto recognize or enforce judgments absent such a treaty.

Other countries refuse to enforce punitive damages and trebledamages, while still others review the fairness of compensatorydamages in light of their own public policy.

Any level of foreign regulation, which is mutually recognized bythe United States, must become the new cap for the level ofregulation imposed by U.S. regulators on U.S. licensed reinsurers.There is no legitimate rationale for imposing a higher level ofregulation on U.S. reinsurers than that which U.S. regulators areprepared to accept from those who are regulated abroad.

While there is no need to export the U.S. reinsurance system toother countries, there is a need for the same level of regulationto be imposed upon reinsurers assuming business from the UnitedStates on a mutual recognition basis. Federal legislative proposalsmust protect against the adoption of mutual recognition until theseimportant safeguards are in place.

Another area where regulatory efficiencies could be enhanced isin the receivership of insolvent insurers due to their inconsistenttreatment across the United States.

Unlike individuals and many commercial entities, insurancecompanies are not subject to U.S. bankruptcy laws. Instead,insurance company receiverships are administered on astate-by-state basis. While the nature of insurance companies thatbecome insolvent has changed over the years, state receivershiplaws have failed to keep up with those changes and are nowgenerally outdated and inadequate to handle the administration oflarge sophisticated entities.

Reinsurers are keenly interested in receivership laws becausereinsurance recoverables are oftentimes the largest asset in theestate of an insolvent insurer. Issues such as setoff, arbitration,cut-throughs, insolvency clauses, claim estimation/acceleration andvoidable preferences dominate the litigation involving reinsurersand insolvent estates. State laws with respect to the matters areboth deficient and inconsistent.

Several years ago, the Insurance Receivership Interstate CompactCommission appointed a group of receivership experts from stateinsurance departments, guaranty associations, and the insurance andreinsurance industry in an effort to develop a better quality andmore balanced receivership law. That effort resulted in the UniformReceivership Law (URL), which has the support of a number ofregulators, receivers and industry associations.

The adoption of the URL on a national basis, administered by thestates, may represent the best chance for achieving the uniformity,equity and predictability that creditors are entitled to expect andreceive from government. The administration of impaired andinsolvent insurance companies should be fast, efficient andpredictable.

Debra J. Hall is senior vice president and general counselfor the Washington, D.C.-based Reinsurance Association of America,while Cynthia J. Lamar is the RAAs vice president and assistantgeneral counsel.

Reproduced from National Underwriter Edition, July 7, 2003.Copyright 2003 by The National Underwriter Company in the serialpublication. All rights reserved. Copyright in this article as anindependent work may be held by the author.