Fighting Fire With Fire

RAA: Reg Reforms Need Balance Of Efficiency, Security

As Congress continues to hold hearings on ways to bring efficiencies to the regulation of insurance, its important that the reforms maintain a critical balance between efficiency and financial security.

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

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

The plan would provide that an optional federal charter system for reinsurers would take effect as a backup should an insufficient number of states adopt the federal standards. The plan would benefit from the expertise embodied in state insurance solvency regulations by incorporating important model acts from the National Association of Insurance Commissioners within both the federal standards and the optional federal charter regulatory schemes.

Along these lines is the recognition of the need for greater efficiency in the regulation of reinsurance in the United States, particularly in the area of extraterritorial application of state laws, which results in legal and regulatory inconsistencies and conflicts.

As a result of the state system of regulation, significant differences have emerged with respect to reinsurance regulatory requirements. The costs associated with addressing the deviations among the states, in addition to the basic expense of a multistate system, are ultimately reflected in the premiums paid by consumers.

While the NAIC and state regulators are to be applauded for their efforts toward greater uniformity in the adoption of model laws and regulations and the creation of the accreditation system, problems remain with states pursuing varying and sometimes inconsistent regulatory approaches. An example of this is the extraterritorial application of state laws.

Approximately 15 states apply at least some of their regulatory laws on an extraterritorial basis, meaning that the state law not only applies to the insurers domiciled in that state but to insurers domiciled in other states if the extraterritorial state has granted a license to the insurer.

For example, an insurer domiciled in a state other than New York but licensed in New York will find that New York law applies to the way it conducts its business nationwide. This extraterritorial application of state law results in inconsistencies and conflicts among state laws. As Congress proceeds in reviewing the current regulatory structure and considers a new one for the future, it should contemplate prohibiting the extraterritorial application of state laws.

Regulation of reinsurance can also be improved on the international stage. Reinsurance is a global business. It has long been recognized that the level of reinsurance regulation varies substantially in countries throughout the world.

The United States, which imposes a very highly structured level of regulation upon licensed reinsurers, stands in stark contrast to countries like Belgium, where reinsurers are subject to no direct reinsurance supervision, and Greece, where reinsurers are subject to no supervision whatsoever. There is no globally recognized method of conducting reinsurance regulation.

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

This effort, led by foreign trade associations, seeks to establish a system where a country recognizes the reinsurance regulatory system of other countries and allows reinsurers to conduct business without the additional imposition of regulatory requirements.

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

The concept of mutual recognition is laudable because of the value created by a more efficient reinsurance regulatory systembut only if certain prerequisites are met. Mutual recognition cannot be accomplished on a worldwide basis, or even a regional basis, until the following prerequisites have been implemented:

There needs to be created and implemented an international accounting system, which provides more transparency between different existing systems. That effort, though under way, is years from becoming a reality.

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

There needs to be established a predictable and consistent method for the recognition and enforcement of U.S. judgments abroad. The RAA research on this subject demonstrates that while the U.S. regularly recognizes and enforces the judgments rendered in other nations, U.S. judgments are often not given reciprocal treatment. The United States is not a party to any treaty for the recognition and enforcement of judgments, and some countries refuse to recognize or enforce judgments absent such a treaty.

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

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

While there is no need to export the U.S. reinsurance system to other countries, there is a need for the same level of regulation to be imposed upon reinsurers assuming business from the United States on a mutual recognition basis. Federal legislative proposals must protect against the adoption of mutual recognition until these important safeguards are in place.

Another area where regulatory efficiencies could be enhanced is in the receivership of insolvent insurers due to their inconsistent treatment across the United States.

Unlike individuals and many commercial entities, insurance companies are not subject to U.S. bankruptcy laws. Instead, insurance company receiverships are administered on a state-by-state basis. While the nature of insurance companies that become insolvent has changed over the years, state receivership laws have failed to keep up with those changes and are now generally outdated and inadequate to handle the administration of large sophisticated entities.

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

Several years ago, the Insurance Receivership Interstate Compact Commission appointed a group of receivership experts from state insurance departments, guaranty associations, and the insurance and reinsurance industry in an effort to develop a better quality and more balanced receivership law. That effort resulted in the Uniform Receivership Law (URL), which has the support of a number of regulators, receivers and industry associations.

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

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

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