Alien vs. Domestic Battle On Collateral Remains Unsettled

Combatants re-emerge from their corners as debate heats up after two-year break

Since the domestic and alien reinsurers began debating over collateralization requirements a century turned, the World Trade Center collapsed, and the property-casualty industry has gone through wild gyrations of underwriting profitability.

The combatants are just now emerging from their corners after a nearly two-year break when an attempt to reach a behind-the-scenes consensus came to naught.

A proposal from what became known as the Ad Hoc group will be introduced at the meeting of the Reinsurance Task Force at the National Association of Insurance Commissioners this month. But it will not in all likelihood go very far since the panelists have committed to writing a White Paper by the end of the year and will be reluctant to take action before its completion.

For the past several years, reinsurers based outside the United States (called alien, since foreign in insurance lingo means out-of-state) have maintained that the requirement calling for them to put up collateral for 100 percent of their liabilities in advance gives them an unfair disadvantage and ties up capital without good reason.

The domestic primary and secondary carriers maintain that such collateral is necessary due to varying degrees of the quality of insurance regulation throughout the world, and the fact that differing accounting systems will always preclude full transparency.

While the debate has gone with all the seeming repetitiveness of the Coke vs. Pepsi conundrum, shifts in the wind have been taking place. But the question remains if the shifts are strong enough to move the issue to anything close to fruition.

District of Columbia Insurance Commissioner Larry Mirel, who will leave office at the end of the month, chaired the Ad Hoc group that was first formed in 2003 at the suggestion of then New York Superintendent Greg Serio.

"My gut feeling is that most regulators don't care one way or the other," Mr. Mirel said. "Only about a dozen or so really feel strongly about this, but most regulators will just sit there and see what happens."

But he feels that most commissioners believe the 100 percent collateralization can be improved upon. "I have not heard any dissent from that view," he said.

Originally, it was supposed to be a cooperative effort. "But it is hard to cooperate with an industry that says 'we don't want to change,'" Mr. Mirel said.

North Dakota Insurance Commissioner Jim Poolman is also impatient and would like to see some resolution soon. "My hope is that we start the deliberations because we have been working on them for quite a while and it is time to have the debate," he said.

Commissioner Poolman said that he has not reached a conclusion but feels a debate will clarify the issues. And he is not sure what purpose an NAIC study on the issue will bring.

Reinsurance Task Force Chairman and Massachusetts Commissioner Julie Bowler was not available for comment.

The domestic industry representatives have targeted the Ad Hoc process as unnecessarily exclusive with U.S. primary trade associations not allowed to take part. "It is an anomaly that the roundtable permits, for example, Lloyd's and Alea London, Ltd. to pontificate on how U.S. state guaranty funds would be impacted by the two proposals, yet at the same time would deny a voice to the National Conference of Insurance Guaranty Funds, the entity that actually provides assistance and support to the U.S. state guaranty funds," said Bill Boyd, financial regulation manager for the National Association of Mutual Insurance Companies.

Essentially, the Ad hoc group has offered a plan to put all reinsurers on the same playing field, regardless of country of domicile, to be rated by some yet-to-be-determined mechanism set up within the NAIC framework. The so-called "geographically agnostic" plan is something of an offshoot of White List proposals that aliens have pushed for the past few years, in which companies could gain some reprieve, up to 50 percent, if they pass muster with some NAIC panel.

A second proposal would set up a pool among the alien companies with contributions based upon the worldwide rate of default of reinsurers. This would serve as an option to those that do not want to meet collateral requirements, and provide a cushion in the event of the insolvency of any pool members.

The domestic reinsurers disagree with the proposals on substance also.

Mike Koziol, assistant vice president of the Des Plaines, Ill.-based Property Casualty Insurers Association of America, called the measures a "rehash of proposals with little substance to assure the level of security that collateral has given the ceding companies and for that matter the regulators."

For example, a cedent could suddenly find itself with a suddenly disapproved reinsurer and lose credit for reinsurance, Mr. Koziol said.

Essentially, domestic concerns about alien reinsurers boil down to the issue of enforceability of U.S. judgments in foreign jurisdictions and lack of transparency and standardization of world accounting systems. On both fronts, efforts are underway to assuage these concerns, such as the Hague Convention of the Treaty of Enforceability of Judgments.

"The work done by the Hague Conventions has provided a starting framework," Mr. Koziol said. "However the Hague Convention has potential holes in the enforceability guardrail through which a truck loaded with punitive damages, asbestos claims and default judgments could drive."

Thor Valdmanis, vice president, Lloyd's America Inc., said the enforcement of judgments issue has been blown way out of proportion by the domestic companies, as evidenced by the $1 billion-a-day volume of trade between Europe and the United States that has resulted in few problems of such a nature.

"The vast majority of reinsurance agreements have arbitration clauses," Mr. Valdmanis said. "Arbitration awards are particularly easy to enforce pursuant to existing international treaties. This is a point even the opponents acknowledge."

Europe has committed to adopting a full set of accounting standards for insurance contracts by 2008. In addition, insurers will be affected by new standards being developed for other financial instruments.

But domestic representatives wonder just what accounting standards the NAIC will implement and how long it will take before reaching a common one.

Mr. Valdmanis noted that U.S. regulators currently review the financial statements of many alien surplus lines insurers and that almost all the major reinsurers maintain financial statements in accordance with either U.S or U.K. Generally Accepted Accounting Standards.

The U.S. domestic regulators and industry could face new pressure from free- trade forces at home and abroad, pointing to collateral requirements as a barrier to global commerce. But so far U.S. trade negotiators have chosen not to include it among issues to be discusses and maintained. It is purely a state regulatory and solvency concern.

That could change, particularly in light of recent EU directives that could produce greater standardization of reinsurance regulation within that realm than currently exists in the 50 states, according to Franklin Nutter, president of the Reinsurance Association of America.

The National Conference of Legislators gave preliminary approval for the alien White List proposal three years ago, but held off on a final OK while the parties tried to work things out.

Ultimately, it seems not a question of "if" but "when" collateralization requirements will undergo modification or be eliminated. With non-U.S.-based reinsurers assuming nearly 50 percent of the U.S. risk, according to the RAA, any change might not seem too dramatic, since these companies seem to have adjusted to the requirements.

"The U.S. insurance industry recognizes that some form of mutual recognition between the United States and the European Union and other foreign states might, in time, be appropriate," Mr. Nutter said.

"My hope is that we start the deliberations because we have been working on them for quite a while and it is time to have the debate."

Jim Poolman, North Dakota Insurance Commissioner

Mike Koziol, assistant vice president of the Des Plaines, Ill.-based Property Casualty Insurers Association of America, said the measures have "little substance to assure the level of security that collateral has given the ceding companies and for that matter the regulators."

"The U.S. insurance industry recognizes that some form of mutual recognition between the United States and the European Union and other foreign states might, in time, be appropriate."

Franklin Nutter, President, Reinsurance Association of America

Special Reports /

Alien vs. Domestic Battle On Collateral Remains Unsettled

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