# Icy tensions slow glacial collateralisation talks

The stand-off over the rules for non-US collateralisation continues. Marc Jones looks at the situation

The deadlock continues in the ongoing debate over collateralisation rules for foreign companies that wish to participate in the US (re)insurance market.

At the moment, as US law now stands, foreign (re)insurers cannot trade in the US market without posting 100% collateral to cover their liabilities, a rule that has been attacked in Europe as being unfair.

Although the National Association of Insurance Commissioners (NAIC) has released the results of the last meeting into the debate over this issue, progress towards any kind of a resolution of the debate remains glacial, with no sign of an agreement on the subject any time soon.

Unfortunately, agencies and companies in Europe and the UK have been protesting against the law for some years now without making much progress and substantial obstacles remain in the path of progress.

The biggest supporter of the current state of US law is the US (re)insurance industry itself. According to the Reinsurance Association of America (RAA), there are a number of reasons why the present system should stay in place.

The RAA, which along with the American Insurance Association and the National Association of Mutual Insurance Companies (NAMIC) is a member of the US Coalition to Protest Unauthorised Reinsurance Collateral, has even listed a number of these reasons on its website, citing just why the 100% collateral requirement is so important.

The first and biggest reason for the Coalition is a claim by NAIC that there is a $26bn 'credit risk' affect for US insurers and their customers. It points out that the NAIC insolvency committee says that without the collateral: "Insurers or receivers would first have to litigate in the US; and then seek to enforce the judgements abroad to collect the money. No treaty to enforce judgments exists between the US and other jurisdictions. The current US collateral requirements ensure that reinsurance can be collected when a US judgement is entered. NAIC's insolvency committee has unanimously voted to keep the collateral requirements and has documented problems in collecting judgements abroad." It also claims that collateral protects consumers and prevents larger guarantee-fund assessments, ensures reinsurance collectibility since judgements in foreign countries may not be honoured and is consistent with free trade since the US collateral requirement is not a barrier to entry into the market. In addition, the Coalition claims that state law allows non-US reinsurers a choice of how to do business with US insurers, with many of the former taking advantage of those choices. Business can be transacted in three ways: through a US subsidiary or branch, through a multiple-beneficiary trust fund or by posting collateral for each reinsurance transaction. In fact, according to the Coalition, more not less collateral is likely needed as the amount owed by reinsurers is subject to wide variations over time. It points out that 100% funding does not allow any margin for error, so collateral requirements should not be reduced. It adds that reducing collateral will not reduce reinsurance rates and that reducing collateral does not guarantee increased capacity. The Coalition's position is supported by further pressure from the US domestic market. The Alliance of American Insurers, the American Association of State Compensation Insurance Funds, the National Association of Independent Insurers and others including the RAA and NAMIC, which represent approximately 85% of the property and casualty premium written by more than 2,000 primary insurers in the United States, have taken a broad-front approach to this issue and have openly appealed to NAIC to keep the existing rules. In a joint letter sent to NAIC, the above organisations said that: "We believe that security for primary insurers is the foremost issue in the Working Group's consideration of the alien reinsurers' proposal to diminish collateral requirements. Departure from full collateralisation of risks written by alien reinsurers brings potential disadvantage to primary insurers, who are promised no reciprocal advantage in compensation of alien reinsurers and who may additionally become liable to make whole the estates of failed companies in which uncollateralised reinsurance was uncollectible." On the other hand, the London-based International Underwriting Association (IUA) disagrees with these fears. Although in 2003, Stephen Cane, chairman of the IUA said that: "Collateral requirements can represent an extraordinary burden. As an industry, we must be extremely careful about imposing them without first thinking through all possible implications," the IUA has been pressing for reform of the US collateralisation rules for almost four years. Two other organisations that have been pressuring for a relaxation of the rules are the Comite Europeen des Assurances (CEA) and Lloyd's of London. The CEA is especially keen for some form of resolution on this point as it points out that the US is the European Union's major trading partner and that an agreement is crucial as the two combined make up some 70% of the world insurance market. The CEA's stance is almost directly opposite that of the US Coalition. In a statement released by the CEA in December 2004, it said that the current US reinsurance rules treat non-US reinsurers proving reinsurance protection to US cedants less favourably than US reinsurers and therefore places non-US reinsurers "at a significant competitive disadvantage". It added that: "Under the current US rules, the funds of non-US reinsurers must be reserved at 100% of the liabilities assumed from US insurers (together with a surplus of$20m, or in the case of Lloyd's, £100m). These funds have to be localised in the US. Non-US reinsurers' liabilities are therefore funded 'gross' and no credit may be taken for the retrocession protection that they purchase, even if this is from US-based reinsurers and even when such assets are accorded full-value on their own balance sheets.

"The US rules also require non-US reinsurers to hold their funds as regulatory deposits in semi-static trust accounts in the US. US reinsurers, on the other hand, are permitted to reserve their liabilities on a 'net' basis, i.e. taking credit for their own reinsurance protection. US reinsurers have no obligation to hold funds in trust and, paradoxically, are permitted to hold their statutory assets in foreign accounts."

In direct contrast to the Coalition, the CEA claims that the current rules drive reinsurance rates up as they inhibit the efficient use of capital to support the efficient spread of risk and have a significant frictional cost impact on pricing, with the costs involved ultimately being borne by the consumer. According to the CEA, it is estimated that US collateral requirements amount to £45bn for non-US reinsurers and cost around £500m a year, resulting from the loss on yield of 20-25 basis points, bank charges of 75 basis points and overheads of between 10-15 basis points.

The CEA therefore wants the NAIC credit for reinsurance laws "radically and quickly reformed" to at least substantially reduce or, better still, abolish all collateral requirements for non-US reinsurers that are both financially strong and subject to high-quality domestic regulatory regimes.

It also feels that the European Union should bring more pressure onto the US on this issue.

Lloyd's of London has also been pressing hard on this issue. Chairman of Lloyd's Lord Levene has spoken out freely about the importance of changes to the current system. In one speech, made in 2003 he said: "Currently, we have around \$9bn tied up in funds in the US. We are required to deposit cash regardless of the amount or quality of reinsurance protection we have bought from other companies. This represents massive and needless over-funding of our liabilities.

"This funding burden cannot be sustained without a cost. Ultimately, that cost is passed on in the price insurance companies are charged for reinsurance cover. Insurance companies in turn must charge policyholders, so the price of these requirements are often borne by the ordinary policyholder."

"Demanding that all foreign reinsurers, whatever their size, strength or claims-paying record, lodge 100% collateral in the US, does not account for the fact that carriers like Lloyd's ... are already subject to detailed regulatory oversight in their home country."

In a counter-offensive, the IUA has joined forces with the CEA to propose a compromise, by which foreign reinsurers would be able to voluntarily apply to be included on a list of reinsurers that would be maintained by NAIC. In order to qualify for this list, reinsurers would have to prove to US regulators that they had sufficient capital resource, management expertise and integrity. This would involve making detailed financial filings, being submitted to meaningful US regulatory scrutiny and coming under the jurisdiction of the US courts. Those able to make it onto the list would be able to fund their liabilities to US cedants at less that the 100% demanded at the moment, down to a minimum of 50%.

The IUA/CEA proposals have so far met with a cool reception and the Coalition has urged the US market to turn down the plan. It claims that the proposals lack specific details, such as which standards are to be used to measure the adequacy of assets, what the required level of regulation is, which financial reporting requirements are used, who ensures compliance and which provisions provide for fair competition. As a result of US opposition, the proposals appear to be stuck firmly in neutral.

However, a little progress has been made. The National Conference of Insurance Legislators (NCOIL) has voted to consider the proposals, while NAIC's reinsurance task force is also looking at the matter. Although neither the IUA/CEA nor the Coalition has changed their positions in the meantime, the two are still debating the matter.

However, there are a few signs that times might be changing. The issue of collateralisation is too important to fade away and, sooner or later, it will have to be resolved. Furthermore, recent moves towards a harmonised reinsurance regulatory regime in Europe may strengthen the European negotiating position and give it a little more leverage in the debate.