When the 2008 legislative session ends, it might be considered the year that legislators discovered the definition of reinsurance and the impact it has on insurers' abilities to write business. That may be the number one lesson that came out of the hearings of the Senate Select Committee on Property Insurance Accountability, which while refraining from making formal recommendations to the legislature, none-the-less put the role of placed reinsurance squarely in the middle of any future property reform debates.
The focus on reinsurance is also reflected in Chief Financial Officer Alex Sink's proposal to roll back the market's reliance on the Florida Hurricane Catastrophe Fund by $3 billion, a proposal that recognizes that last year's move to expand the fund by $12 billion could lead to large policyholder assessments. It also raised the question of whether it is even feasible for the fund to raise that kind of money in the capital markets.
These factors were part of the reason that legislators last year enacted a provision changing the collateral requirements placed on reinsurers. Under the previous law, any U.S. or non-U.S. reinsurer that entered into an agreement to cover a portion of an insurer's risk had to post collateral equal to 100 percent of the risk. The law was designed to ensure that a carrier's financial solvency and claim-paying ability would not be jeopardized in the event a reinsurer failed to meet its financial obligations to a carrier. Legislators and regulators concluded that the collateral requirement served as a barrier or disincentive for reinsurers looking to do business in the state. This led to a question of whether it was necessary for reinsurers to meet the 100-percent collateral requirement if they had high financial ratings and substantial holdings.
As a result, legislators enacted the new law granting the insurance commissioner the discretion to reduce the collateral requirements on reinsurers if they meet certain prerequisites. Insurance Commissioner Kevin McCarty said that the new law would expand the options for insurers and remove some of the pressure on the Cat Fund by opening the door wider to the private reinsurance market. "Allowing foreign reinsurers to conduct business with Florida insurers without requiring them to post millions of dollars in collateral will lead to increased capital and competition in our state," he said. "These factors will help to stabilize and potentially reduce property insurance rates."
The Reinsurance Market
Under a proposed Office of Insurance Regulation rule that would implement the new law, a reinsurer could enter into a contract to assume part of an insurer's risk without posting 100 percent collateral if it meets certain standards. First, it must have a surplus in excess of $100 million. Secondly, the reinsurer must hold a financial rating from at least two of the insurance rating agencies, including A.M. Best, Standard & Poor's, Moody's Investor Service, Fitch Ratings, or any other rating agency as designated by the OIR. The amount of the reduction would be based on the ratings assigned to the reinsurer. Those reinsurers with an "A" rating would be eligible for credits ranging from 80 percent to 100 percent. "B"-rated entities could also see credits of 50 percent.
The OIR rule has its genesis in a long-running effort by the National Association of Insurance Commissioners to create a reinsurance model act, which would streamline the regulation of reinsurers and take into account the workings of the global financial markets. Reinsurance is a big business that primarily operates offshore in order to avoid the maze of regulations it could face as capital moves from state to state and country to country. More than 2,300 offshore reinsurers assumed financial risks from carriers within the U.S. in 2006. Just how much money are we talking about? The numbers tell the story:
Offshore reinsurers held 51.3 percent of the U.S. unaffiliated premiums in 2006. The term "unaffiliated premiums" indicates risks that are ceded between an insurer and reinsurer that have no other corporate ties. It is not unusual for some reinsurers to also back primary insurers.
The market share of offshore companies, and U.S. subsidiaries of offshore companies, represented 84.5 percent of the unaffiliated reinsurance premiums totaling $54.7 billion.
The Reinsurance Association of America reported that in the first nine months of 2007, association members accounted for $17.9 billion in net written premiums with a combined ratio of 95.4 percent. As of Sept. 2007, policyholder surpluses reached a reported $80.2 billion.
NAIC and Congress
Florida's approach to loosening the collateral requirements on reinsurers tracks a similar approach taken by New York Insurance Superintendent Eric Dinallo. Both proposals are also part of a broader effort to streamline the regulation of reinsurers. The NAIC's Reinsurance Task Force has long debated the issue, which is now the subject of legislation circulating through Congress. The NAIC proposal, however, would go much further and substantially change the regulatory framework for state oversight of reinsurance.
One goal is to establish a single collateral requirement in all 50 states, which would probably look something like what New York and Florida are trying to implement. The more controversial piece, however, deals with issues over "extraterritorial" jurisdiction. The extraterritorial issue is part of the ongoing debate over the modernization of insurance regulation and whether that regulation is tipped in the balance of each state or the federal government.
Broadly speaking, the NAIC proposal would create a single system to evaluate U.S. reinsurance regulations so that they move closer to the regulations used in other parts of the world. A single-state regulator, or designated port of entry, would then be the gateway for offshore reinsurers looking to do business in the U.S. More controversial, the proposal would allow a reinsurer that meets those criteria to operate like a domestic carrier and choose a single state in which to be domiciled. The reinsurer could then do business across state lines without having to follow other states' solvency requirements and other laws.
Reinsurance Association of America General Council Tracy Laws said Florida and New York's move to change the collateral requirements is "a first step in a need for robust reform." She also said the NAIC proposal and legislation in Washington reflected the next piece of the overhaul in regulation. "We need to streamline the rules so they reflect how global business is transacted."
McCarty has a much different take on the issue. He said he could not support any move by Congress to remove the state from the regulation equation. "I see no advantage to taking away the ability of the regulatory system in order to protect the citizens of Florida," he said.
Insurers are not exactly lining up to support the RAA. And even the Florida rule has some taking pause. "We're concerned that it could leave insurers high and dry," said William Stander with Property Casualty Insurers Association of America. "How do we collect reinsurance offshore whose operations are totally non-regulated?"
Legislature Eyes Reinsurance Changes
Even as OIR moves forward with its efforts to change the collateral requirements for reinsurers, legislators remained focused on reinsurance largely due to the hearings by the select committee. During those hearings, much was made of how insurers utilized reinsurance and its subsequent impact on rates. One issue of note was the practice of some insurers to, in effect, purchase overlapping coverage, meaning that different reinsurance treaties applied in some part to the same risk. Committee members challenged insurers, saying that the practice drove up rates even though insurers may only need one source of reinsurance to cover losses. This was particularly aimed at reinsurance levels covered by the Cat Fund.
The committee's proposal would prohibit rates from including the cost of reinsurance that duplicates any coverage provided by the Cat Fund, regardless of the effective date of the coverage. As a result, insurers would have to make sure that their private reinsurance contracts allow for any variations in Cat Fund coverage.
Another proposal aims at Florida subsidiaries that are reinsured by a parent or affiliated company.
Under the recommendation, the parent company couldn't charge the subsidiary any brokerage fees or require a reinstatement premium as the result of any losses. Finally, the committee called for establishing an allowable reinsurance expense factor in rate filings. One suggestion is that the factor be a minimum percentage of expected recoveries, unless an insurer demonstrates the need for a higher factor.
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