Lloyd's Sees Treasury Modernization Call As Boost For Reinsurance Collateral Shift

There were occasions during the last eight years when George Washington's words: “Be not tedious in discourse, make not many digressions, nor repeat often the same manner of discourse”–Washington's Rules of Civility, Number 88–rang particularly true for anyone involved in the credit-for-reinsurance debate.

Future generations, however, may judge 2008 as a defining year for international insurance regulation, even if the economic climate and rating environment has created competing priorities for both industry and regulators.

The need for comprehensive reform of the current credit-for-reinsurance regulatory framework is more important than ever for international reinsurers and for industry in the United States as a whole.

Treasury Secretary Henry Paulson recognized this need in launching Treasury's blueprint for regulatory reform, by stating that “insurance presents a clear case for regulatory modernization.”

The Treasury's intervention on the question of regulatory reform is both considered and timely. It reflects changes occurring in Europe and international dialogue at the International Association of Insurance Supervisors and in the U.S./European Union Transatlantic Economic Council.

In the past, Lloyd's has made public its support for those state regulators in New York, Florida and elsewhere looking at avenues for reform of reinsurance collateral requirements. The National Association of Insurance Commissioner's Reinsurance Task Force, under the leadership of New Jersey Commissioner Steven M. Goldman, continues with its methodical review that, at a minimum, will inform the direction of reform at the federal or state level.

The main challenge, however, will be in ensuring effective implementation. The reinsurance task force appears to recognize that a mechanism to deliver uniform implementation would be a key requirement for any proposal that the NAIC produces.

As New York Superintendent Eric Dinallo, speaking on behalf of the NAIC before the House Committee on Financial Services, recently said: “We recognize that certain fundamental improvements to state-based oversight may require federal assistance or empowerment.”

The Treasury blueprint clearly recognizes the need to deliver a national solution. Federal empowerment of the U.S. regulatory framework is now a point of agreement for many–regulators and insurers, domestic and international alike.

While the possibility of federal involvement may have focused minds on the implementation of reform domestically, emergent international issues, such as the European Union's Solvency II, have shown the need for U.S. regulators to be empowered to tackle the challenges of the international reinsurance industry.

The blueprint proposes establishment of an Office of Insurance Oversight. Under these proposals, such an office would be empowered to act as the U.S. spokesperson and facilitator on international insurance regulatory issues.

It would benefit both the U.S. industry and foreign insurers trading in the United States in many areas, including discussions on the European Union's Solvency II regime. The precedent of the Office of International Affairs within the U.S. Securities and Exchange Commission demonstrates the value of this concept in enabling the United States to take a lead in regulatory dialogue and to cooperate with other regulators overseas.

The importance of this from an international perspective cannot be overstated. Although the NAIC's involvement in international discussions is very important, neither the NAIC's officers nor individual state regulators have the power to negotiate agreements internationally, nor to implement international standards across the country.

Until a U.S. insurance interlocutor is established and empowered to deliver on U.S. commitments, the most economically powerful nation on Earth cannot play its proper part in international exchanges with other nations–and cannot take a leading role in formulating international regulatory policy.

With that danger in mind, it is encouraging to see that Congress, regulators and industry are setting about the challenge of framing a new role for an Office of Insurance Oversight-type structure.

The bill recently proposed in the U.S. House of Representatives by Rep. Paul E. Kanjorski, D-Pa., with bipartisan sponsorship for an Office of Insurance Information, shows that forward-looking legislators across the political spectrum see the value of regulatory reform and the value of federal leadership on international insurance issues. Lloyd's applauds and supports that work.

Does this therefore herald a breakthrough on issues like reinsurance collateral? The arguments on credit for reinsurance are well rehearsed and have been frequently made. But they have often understated the damage done to U.S. interests by a failure to reform.

The cost to the industry of maintaining collateral is estimated at $500 million per year. That is a cost borne indirectly by U.S. cedents and insurance consumers.

Also, the potential diversion of capital resources away from the business of underwriting imposes an opportunity cost. (It is worth remembering that the opportunity in this case is equally for the cedent to buy, as for the reinsurer to sell on economically efficient terms.)

Put in the context of regulatory reform, the debate about reinsurance collateral might seem esoteric to some. But it strikes at the heart of questions for the industry about whether the United States faces up to the regulatory changes underway internationally. Current credit-for-reinsurance arrangements do not offer the level playing field that a modern regulatory system should create.

The resulting market distortion can only be detrimental for Americans and their own interests overseas. Indeed, one of the touchstones of the Treasury blueprint and NAIC comment alike is the market advantage that an efficient U.S. system of regulation could bring.

The health of the American market, shedding of unnecessary costs, increased demand for capacity, and the use of reinsurance by the U.S. economy are all powerful arguments for regulatory reform. An Office of Insurance Information and a revised framework for credit for reinsurance would be a boost to the U.S. market's ability to adapt to a changing international environment.

These benefits may seem obvious, but the case is worth repeating, given the unflattering noises about globalization being made in the American political arena at the moment.

With the emotive protectionist language of presidential candidates, the time is right to make the case for the reinsurance industry being treated as the global industry that it is.

The freedom to operate globally is an inherent feature of our industry and vital for its efficient functioning. The flexibility for international regulators to develop consistent and complementary approaches to the regulation of this industry is equally vital.

In an election year, we need to be realistic about the timetable for reform, but the work currently being undertaken by legislators, regulators and the industry could shape the American regulatory environment for a generation, and perhaps for longer.

Sean McGovern is director and general counsel at Lloyd's of London.