On September 16 the Florida Cabinet, sitting as the Financial Services Commission, adopted a potentially far-reaching rule providing for an alternative ratings-based approach to the reinsurance collateral requirement applicable for ceding insurers to take credit for reinsurance. In essence, this rule provides for lower collateral requirements for certain reinsurers that are determined to be "eligible" by the Florida Insurance Commissioner after an application process. The amount of collateral required to take credit for the reinsurance will be based upon the credit ratings of the insurer.
This is a significant issue for the industry and all agents and industry professionals should understand the rule and the implications involved. The following is a summary of Florida's newly adopted ratings-based reinsurance rule:
What is the general background on reinsurance credit in Florida?
Under the current system in Florida – and for that matter throughout the United States – insurers are permitted to take credit on their financial statements for the reinsurance they cede, based upon meeting certain conditions. The credit for the reinsurance is available if the reinsurer is authorized or accredited in the State of Florida. Otherwise, the credit for reinsurance is available only if the reinsurer posts appropriate collateral under the reinsurance agreement to secure its obligations under the reinsurance agreement. This would normally include losses and loss adjustment expenses, as well as unearned premium.
Typically, the assuming reinsurer, if not licensed or accredited in Florida, would be required to post money or assets into a trust fund or arrange for the issuance of a bank letter of credit, both for the benefit of the ceding insurer. This law remains in place now and provides an appropriate mechanism for the insurer to obtain credit for reinsurance.
A new ratings-based regulation was recently adopted in Florida pursuant to a change in state statutes, which occurred in 2007. Under the 2007 amendment to the statutes, the Insurance Commissioner has authority to establish lower collateral requirements for unauthorized and unaccredited foreign and alien reinsurers that have certain financially secure ratings from at least two nationally recognized rating organizations and also meet the eligibility standards of the rule.
What precipitated this rule change and who advocated in favor of it?
This rule is targeted to benefit alien reinsurers. Most alien reinsurers do not want to be licensed or accredited in the United States. Accordingly, they traditionally have been required to post 100 percent collateral for their obligations under reinsurance contracts entered with United States ceding insurers.
For years, alien reinsurers have challenged the need for 100 percent collateralization, which has existed regardless of the financial stability of the reinsurers and the level of regulatory scrutiny imposed by their domiciliary states. In addition, there has been strong sentiment that standards in the United States are more stringent than in many other nations and that the increasing globalization of the reinsurance industry calls for a level of standardized regulation of reinsurance. It also has been argued that freeing the reinsurer's capital, which has been tied up in posted collateral under traditional reinsurance arrangements, will increase the capacity of the reinsurance market.
With regard to Florida, reinsurance capacity and pricing became significant issues after the 2004 and 2005 hurricane seasons. In the wake of these storms, the Florida Legislature created a Task Force on Long-Term Solutions for Florida's Hurricane Insurance. After multiple hearings, the task force found that matters pertaining to the capacity, availability and pricing of reinsurance in Florida needed to be addressed, and any artificial barriers to competition in the reinsurance market should be restricted so long as insurer solvency would not be jeopardized. At the same time, the National Association of Insurance Commissioners (NAIC) was pursuing its own initiative for the modernization of the reinsurance collateral rules.
During a Special Session in January 2007, the Florida Legislature changed its statute pertaining to reinsurance by providing that the Office of Insurance Regulation (OIR) could waive or reduce the collateral requirements for eligible reinsurers that are not authorized or accredited in Florida. This culminated with the adoption of the new ratings-based rule by the Florida Cabinet on September 16.
What is required for the reinsurer to be authorized to post less than 100 percent collateral?
The reinsurer must be determined to be "eligible" by the Florida Insurance Commissioner. In addition, the ceding insurer must maintain satisfactory evidence that the reinsurer meets the solvency standards of the reinsurer's domestic regulator. Finally, the reinsurance contract must contain certain required provisions relating to solvency, service of process, and the reinsurer's submission to Florida jurisdiction.
What is required for the reinsurer to be determined to be "eligible" by the Florida Insurance Commissioner?
The reinsurer must have surplus over $100 million, it must be authorized in its domiciliary jurisdiction for the kinds of insurance to be ceded, and its domiciliary jurisdiction must be determined to be "eligible" by the Insurance Commissioner. After review of all appropriate information, the Insurance Commissioner must decide whether the reinsurer is "eligible" and the amount of credit that may be taken without posting collateral, based on the best interests of market stability and the solvency of the ceding insurers.
What benefit does an "eligible" reinsurer derive under the rule?
That depends on the credit ratings of the reinsurer. Under the rule, the reinsurer would still be required to post 100 percent collateral for its reinsurance obligations unless it has and maintains certain minimum ratings from at least two nationally recognized credit rating agencies, such as A.M. Best Company, Standard and Poor's, Moody's Investors Service or Fitch Ratings. The rule contains a schedule of percentages of collateral required depending upon the reinsurer's credit ratings: The higher the credit ratings, the less collateral that must be posted. The highest-rated reinsurers would not be required to post any collateral; lower-rated reinsurers may have to post 10 percent, 20 percent, 75 percent, or 100 percent collateral.
How does this rule impact the industry?
The rule will readjust how reinsurance collateral is handled in the future. This rule will apply only to those reinsurers that are not already authorized or accredited in Florida. For those reinsurers, they will have the option to petition the Insurance Commissioner for a determination that they are an "eligible" reinsurer so that the amount of collateral they are required to post will be reduced or eliminated depending upon their credit ratings. This will significantly alter collateralization requirements for those reinsurers.
Some argue that increased capacity of foreign capital will be available to be reinvested in Florida and other states that adopt a ratings-based rule. Others have disputed that this will occur, and support the rule for sending a positive message to the international reinsurance community that Florida is actively promoting competition in its reinsurance market.
Some have argued that this change will potentially jeopardize the integrity and solvency of ceding insurers impacted by the rule. This could be particularly true for smaller, single-state insurers that may not have the negotiating leverage to require collateral without a state mandate, or be forced to pay a premium for that benefit.
The current collateral requirements provide assurance that reinsurance collectables will be paid. If 100 percent collateral is not required, ceding insurers may be required to pursue reinsurance claims to recover the sums due. They also may be required to proceed in non-United States jurisdictions to collect on those claims. In addition, the assets that would have otherwise been posted as collateral for reinsurance recoverables may be utilized for other purposes, which may jeopardize the solvency of certain reinsurers. Potentially, this could affect the solvency of certain ceding insurers. It is argued by some that this will occur even though it is unlikely that reinsurance rates will drop as a result of this rule.
What should agents be aware of?
Agents should consider how the lower collateral requirements affect the insurers with which they do business. In the final analysis, the payment of claims by insurers is based to a large degree upon the ability of insurers to collect their reinsurance recoverables from their reinsurers. The extent to which any particular reinsurer has payment issues may impact the insurers that do business with that reinsurer. Agents should monitor the reduced collateral standards and any issues that may arise regarding the failure of any reinsurers in paying their full reinsurance obligations on a timely basis.
Where is the NAIC on this issue?
The Reinsurance Task Force of the NAIC has been holding meetings and considering comments on its proposed rule, which would provide for a reduction in the collateral requirements applicable to "eligible" reinsurers. The updated Reinsurance Regulatory Modernization Framework Proposal was approved by the task force during the NAIC Fall 2008 National Meeting held in September. The proposal also was approved by the NAIC Financial Condition Committee at the same meeting. The proposal will now proceed to NAIC Plenary for consideration during the next scheduled NAIC meeting in December. In many respects, this rule is very similar to the Florida rule.
How does this impact other states?
The rule is specifically limited to Florida. It provides that it does not affect the laws of any other state and all insurers must comply with the laws in any other states in which they do business.
New York and Texas are proceeding with rule development on comparable ratings-based reinsurance collateral rules. Other states will be closely watching the results in Florida and New York, as well as NAIC developments on its model law. It appears this ratings-based reinsurance collateralization approach is gaining momentum and all within the industry need to be familiar with it and be ready to address these changes.
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