N.Y. Moves To Unilaterally Alter Foreign Reinsurance Collateral Mandate

New York Insurance Superintendent Eric Dinallo–breaking from other states on a regulatory controversy that has been debated nationally for years–announced a proposal to unilaterally do away with or at least lower collateral requirements for foreign reinsurers with good financial ratings.

The proposed regulation–which some U.S. insurance groups called risky and radical–would go into effect in July 2008.

Under the new rule, the highest-rated U.S. and non-U.S. reinsurance companies not authorized or accredited to do business in New York would be treated the same as New York reinsurers.

Discussions about a change in the requirement for nonaccredited reinsurers to post collateral have been underway for years at the National Association of Insurance Commissioners. Earlier this year, an NAIC task force considered a Reinsurance Evaluation Office proposal to establish a system for reinsurer collateral to be based on its financial strength. That initiative is still in the lengthy NAIC bureaucratic process.

“There is a growing need for reinsurance in New York to deal with risks from terrorism and from natural catastrophes such as hurricanes,” Mr. Dinallo said in a statement. “We cannot afford to maintain outdated and unnecessary standards for the international market for reinsurance.”

New York's current regulation, he said, requires a strongly capitalized, non-New York reinsurer to tie up capital by posting substantial collateral while not imposing a similar burden on a “weaker” New York reinsurer. Currently, any U.S. or non-U.S. reinsurance company not authorized or accredited to operate in New York or other states must post collateral equal to 100 percent of its share of policyholder claims.

Under the new regulation, the highest-rated reinsurers would no longer have to post any collateral. Companies not as strong would have to post collateral on a sliding scale from 10-to-100 percent. This would apply to both U.S. and non-U.S. reinsurers not authorized or accredited in New York.

Foreign reinsurers had an estimated $120 billion in collateral posted in the United States in 2005, on which they pay about $500 million a year in transaction costs, according to the New York Insurance Department.

Mr. Dinallo said adoption of the New York regulation will reduce this transactional cost and increase reinsurance capacity. It will also bring New York in line with global insurance markets and worldwide accounting standards governing reinsurance contracts. Most foreign jurisdictions do not require collateral from nondomestic reinsurers for their insurers to get credit, the department noted.

Mr. Dinallo said the regulation would not prevent “insurance companies from negotiating their own collateral requirements or from choosing to do business with reinsurers who are willing to put up collateral, if that is what the insurance company prefers.”

He said the current requirements for 100 percent collateral are “making everyone carry an umbrella,” when in fact cases of insolvency involve 1 percent of insurance companies.

Mr. Dinallo believes his new proposed rule on collateral requirements is good for regulators and the insurance industry. “Sometimes it's good for one state to put a stake in the ground and take a position and say, 'Let's discuss this,'” he said.

For dealings with domestic reinsurers that now do not have to provide collateral, the proposed New York regulation imposes principles-based credit risk management on primary insurers. These ceding companies would now have full responsibility for credit risk management and compliance.

The department said it will be circulating a working draft of the proposed regulation to the insurance industry and consumers and will take comments.

The collateral move was Mr. Dinallo's second bold regulatory initiative this month. On Oct. 4 he announced a proposed regulation to require that insurers set up special reserve funds for catastrophes to avoid rate surges after big losses, regardless of the immediate federal tax implications.

Lloyd's of London–a major proponent for years of lowering, altering or eliminating the collateral requirements (which are established in a model law set by the National Association of Insurance Commissioners)–reacted positively to the latest New York proposal.

“We commend Superintendent Dinallo for providing leadership in trying toaddress the U.S. collateral issue,” said Lloyd's General Counsel Sean McGovern. “We will study the proposal in detail, butit appears to be a significant step forward toward U.S. and non-USreinsurers being treated equally. This must continue to be the goal.”

However, U.S. insurance officials responded negatively to the news. Mike Koziol, assistant vice president and counsel for the Property Casualty Insurers Association of America, called Mr. Dinallo's action “radical” and said PCI is “extremely concerned.”

The big worry, he said, is the solvency of primary insurers that deal with reinsurers qualified by New York. He wondered how other states would treat such companies when “everyone else in their state has to have 100 percent collateral.”

He said there is no proof that ending collateral requirements will increase capacity, and there were no companies on record saying they would reduce rates as a result.

The American Insurance Association's assistant general counsel, Steve Bennett, said the New York proposal is unnecessary and “potentially very risky. It would threaten and impair the solvency of U.S. insurers and ultimately add costs to U.S. policyholders.”

Basing solvency on rating agencies is a questionable move, he said, noting the fiscal troubles that have hit previously triple-A-rated firms involved with the subprime mortgage market. He said the European Union “Passport” regulation only allows reinsurers to operate without collateral if they have opened a local subsidiary.

Frank Nutter, president of the Reinsurance Association of America, said RAA was analyzing the proposal and planned to respond with a letter this week. He said the 30 companies that make up RAA have been asked to provide input.

“We have it under study,” he said–adding, however, that “we would prefer a more comprehensive, rather than a state-by-state approach.” He noted that “for some period of time, we felt the current system is a pro-competitive one.”

Most recently, he said, RAA has taken the approach that it would be better off to have a more comprehensive reform for reinsurers–either through an optional federal charter, or by having the NAIC serve as a port of entry for reinsurers that want to do business in the United States, with a system of mutual recognition between U.S. regulators and the foreign reinsurer's regulator. Once that was done, he said, the collateral requirement could be eliminated.

NAIC President Walter Bell, Alabama's insurance commissioner, reacted with a statement saying his group recognized that New York operates as a sovereign regulatory authority. “We applaud the New York Department for its leadership and innovation in this first initiative of reinsurance modernization,” he added. “We look forward to working with them in the ongoing national dialogue to modernize U.S reinsurance regulation.”

Mr. Bell noted that the NAIC Reinsurance Task Force is meeting on the topic next month in Atlanta.

Before putting out his latest proposal, Mr. Dinallo said he had alerted Mr. Bell, as well as Georgia Insurance Commissioner John Oxendine–who chairs the NAIC's Reinsurance Task Force. He said he had given them “a head's up,” and was glad that they were both in Florida for a regulators' meeting so they could discuss it.

On the issue of rating agencies, Mr. Dinallo noted that when the NAIC evaluates assets of a primary insurer, they are given 100 percent credit for triple-A-rated securities from a reinsurer, but the same reinsurance company has “zero credit as a reinsurer.”

Robert P. Hartwig, president of the Insurance Information Institute, said the opposition to ending collateral requirements “is couched in terms of being [fiscally] conservative, and the other side says it's protectionist pressure.”

U.S. reinsurers argue it would be far more difficult to collect from a foreign source, while overseas an entity such as Lloyd's sees itself as a proven institution with a 300-year history that would be able to function more effectively and provide more coverage to the U.S. marketplace without the requirement.

Mr. Hartwig said Mr. Dinallo is trying to increase the flow of capital into the New York market and has tried to address solvency issues, “but this does not assuage the fears of companies opposed to this.”