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Credit for reinsurance laws

Lloyd's chairman decries inequitable treatment of foreign insurers

By Phil Zinkewicz

“This illogical demand for collateral based on ZIP code, not financial health, has helped drive up the costs of reinsurance and restricted critical capacity … the current rules distort the operation of the U.S. insurance market, leaving U.S. customers as the biggest losers.”

—Lord Peter Levene
Lloyd’s of London

Last January, at a meeting in New York, Lloyd’s of London’s Chairman Lord Peter Levene spoke before the Downtown Association and Insurance Brokers Association of New York. During his presentation, which embraced the global insurance industry’s performance in the wake of Hurricane Katrina and other natural catastrophes, Lord Levene once again raised an issue that has been a cause célèbre at Lloyd’s for many years. That issue is U.S. “credit for reinsurance laws,” which Lord Levene said, place foreign reinsurers at a competitive disadvantage when competing with U.S. licensed reinsurers.

First, let’s examine Levene’s position: “These rules regard all U.S. licensed reinsurers as good credit risks and permit them to reinsure U.S. insurance companies without securing their liabilities with collateral—even if these reinsurers are not financially strong. By contrast, all ‘alien’ or foreign reinsurers are required to post collateral equal to 100% of their gross liabilities to U.S. companies. This illogical demand for collateral based on ZIP code, not financial health, has helped drive up the costs of reinsurance and restricted critical capacity—especially in key areas such as medical malpractice. Neither effective nor efficient, the current rules distort the operation of the U.S. insurance market, leaving U.S. customers as the biggest losers.”

Levene said that conservative estimates suggest that the annual costs of meeting the U.S. collateral requirements are in excess of half a billion dollars a year for foreign reinsurers. For Lloyd’s alone, he said, the price tag stands at more than $150 million. Levene went on to say this system is “out of step” with the world’s other leading insurance markets, and regardless of whatever value it had when it was first established, it is obsolete today.

“The events of 9/11 and, more recently, Katrina only underscore the unacceptable burden and unintended consequences of these requirements,” said Levene. “Immediately after 9/11, Lloyd’s was required to provide over $3 billion to top up its funds, a significant sum for any business, but especially when money is needed to make immediate claims payments. Katrina has given rise to a similar situation requiring Lloyd’s to top up its funds to over $10 billion. Yes, $10 billion which cannot be employed elsewhere. In the 21st century, many European reinsurers find it difficult to interpret the current rules as anything other than sheer protectionism and we expect to see a definitive change in 2006.”

Those were tough words, indeed, from Lord Levene. However, the U.S. insurance industry is no less emphatic about its views of the situation. “The fact of the matter is that, without the credit for reinsurance laws for alien reinsurers, U.S. reinsurers would be at a competitive disadvantage,” says Phillip Carson, senior counsel-financial reporting for the American Insurance Association. “These collateral laws are a mechanism by which a level playing field is created. The most important function of U.S. regulators is to make certain that companies doing business in their jurisdictions are solvent. Consequently, U.S. reinsurers are subject to the most careful scrutiny in terms of financial statements and other requirements in order to retain their licenses. Alien reinsurers have an option to register with insurance departments and obtain a license to operate. If they do, then the collateral is not necessary. I don’t know why, but many of them choose not to follow this course. Therefore, U.S. regulators must have some other means of protecting buyers of reinsurance from companies that might not be financially secure. The collateral system, whether by letters of credit or the fund approach, is essential to U.S. regulators in doing their jobs.”

Andrew Barile, president of Andrew Barile Consulting, offers another view of the need for the collateral approach to credit for reinsurance. Barile, an expert on the reinsurance arena from various vantage points, says that primary companies today are having difficulties collecting on their reinsurance contracts. “Levene has a point about collateral arrangements taking money out of the market place and, therefore, tying up much-needed capacity; but until there is a solution to the reinsurance uncollectible problem, regulators are going to insist that foreign reinsurers put up collateral. Without that collateral, what do you do when a reinsurance contract is not clear and the reinsurer refuses to pay? These days, there are a good many disputes between primary insurers and their reinsurers. With the collateral, primary insurers have the money to draw down on until the dispute is resolved.”

Frank Nutter, president of the Reinsurance Association of America, says that Lloyd’s has been in the forefront of trying to bring about change in the U.S. credit for reinsurance laws for some time. “The laws as they stand now say that, in order to write reinsurance business in the U.S., a reinsurance company must either be licensed or put up collateral. Insurers have uniformly argued to retain the present system.”

Looking at the issue from the standpoint of the buyer of reinsurance, Steven Ader, director of Standard & Poor’s, says that primary insurers must show reinsurance purchases on their balance sheets. “If they have bought reinsurance from a company that is licensed in the U.S., then they can get a credit for reinsurance purchases on their balance sheets. If they have purchased reinsurance from a company that is not licensed, then they get no credit unless the alien insurer puts up a letter of credit or puts into a fund.”

For all these reasons, then, it appears that Lord Levene may be fighting an uphill battle. U.S. insurers insist that current laws are fair to both U.S. licensed reinsurers and alien insurers that want to operate here. Primary companies want to get that credit for reinsurance on their balance sheets. But, most important, the relationship between primary insurers and reinsurers has changed in recent years, as Barile points out. Where once it was a partnership relationship, one of trust, today it has become a contractual relationship, and all contracts are subject to interpretation. Regulators are most likely going to make certain the money is here to pay when a dispute arises. *

The author
Phil Zinkewicz is an insurance journalist with some 30 years’ experience. He was the insurance editor of the Journal of Commerce for a number of years, handling all their domestic and international supple-ments. In addition, he regularly writes for a number of London publications.