Agreeing to disagree: in a Best's Review roundtable about U.S. collateral requirements, reinsurers clash on U.S. regulation, but unite on the need for universal rules.

Key Points

* Domestic and alien reinsurers are watching closely to see if the National Association of Insurance Commissioners moves to modify its collateral requirements for the latter by the beginning of 2007.

* Lloyd's says it will seek alternative methods of relief if adequate rule changes are not forthcoming.

* U.S. and foreign reinsurers agree that the dispute over the fairness of U.S. collateral requirements for alien reinsurers can be mitigated by the availability of an optional federal charter.

* There is also unanimous agreement that a single, global set of capital adequacy rules would make fairness in cross-border transactions a reality, but there is pessimism as to whether that goal can ever be achieved.

The long-running debate over U.S. collateral requirements for alien reinsurers may come to a head early next year, as the National Association of Insurance Commissioners' reinsurance task force works toward a draft proposal on rule changes.

But whatever the NAIC decides to do or not to do, when one listens to reinsurance business leaders talk about the collateral issue, one thing is apparent: The debate will continue until a universal set of global regulatory standards is in place. And that could take a long time.

The NAIC may vote by early 2007 to change the current rules, which require foreign non-admitted reinsurers to post 100% of their U.S. obligations in U.S. accounts as collateral. An NAIC task force on collateral requirements in September issued a report that recommends changes to the current system, including rules that would better match ceding companies' credit and assuming reinsurers' reserves and rules that would apply uniformly to reinsurers, regardless of where they are domiciled.

Not surprisingly, industry executives both foreign and domestic continue to lobby for their respective interests. And, judging by what a panel of top executives told this publication, the lobbying, like the debate, will continue.

The panel of executives who spoke with Best's Review included William R. Berkley, chairman and chief executive officer of W. R. Berkley Corp., a U.S.-based insurer and reinsurer. Berkley defends the current collateral structure as the best available method of ensuring claims payments for U.S. insurers.

Julian James, director of worldwide markets for Lloyd's of London, a tireless critic of the U.S. collateral system, argues that such requirements hamper foreign players in the U.S. market, thereby constraining reinsurance capacity and raising costs.

Pierre Ozendo, chairman and CEO of Swiss Re America Corp., sees U.S. collateral requirements as a subset of a larger issue: The need to work out a comprehensive global regulatory framework in which reinsurers can all operate tinder the same set of rules.

These executives offered viewpoints from every angle of the collateral debate, touching on topics ranging from competition, capital adequacy and recoverables to trade issues and the U.S. system as it compares with the recently-passed European Union reinsurance directive, which aims to end collateral requirements among the 25 E.U. member states.

Differences aside, these executives agreed on two main points: Optional federal regulation in the United States would help by giving reinsurers the choice of a simpler regulatory system, and complete security for buyers of reinsurance probably cannot be achieved unless a universal system of global regulation can be worked out--a system that would match the global nature of reinsurance itself.

Framing the Debate

James: What we have been pointing out with the NAIC is that existing rules for writing reinsurance business are unfair and discriminatory because one group of reinsurers is treated differently from another group. We have been suggesting to U.S. regulators that they should review the current requirements to treat all reinsurers equally. Just to be clear, the current rules differentiate between reinsurers domiciled outside the United States and those domiciled within the United States.

Berkley: As a U.S. direct writer and reinsurer, we have a view as a direct writer that collateral gives us better assurance of collection. Every one of these entities could be licensed in the United States and become subject to U.S. regulatory authorities; then they wouldn't have to put up collateral. Alien reinsurers have elected not to be within our regulator structure. We don't have that choice when we go overseas; we have to set up a subsidiary over there. They have an alternative.

Ozendo: We have a U.S. licensed company, but from a global perspective, we'd like to see the United States get access to sufficient global reinsurance capacity and quality. Right now, among the top 10 reinsurers in the United States, more than 50% of the premiums are written internationally. In our view, the collateral issue is an important one, but a subset of a larger international issue. There is a need to really look at how regulatory rules are converging. For instance, if we could move to an optional federal charter with mutual recognition, then collateral would be part of a much more significant regulatory review.

Securing Recoverables

Berkley: The whole issue with collateral is the ability to collect. Even if you have collateral, you're never adequately protected, given the historical trends of U.S. litigation. There are companies still doing business in Switzerland and the United Kingdom, for instance, that use their ability to negotiate settlements substantially below the amount required to honor their obligations. These companies didn't post adequate collateral because of developments, and when they withdrew from the U.S. market, thought nothing of going back home to become prosperous in their home market. Our ability to collect in foreign courts is at best questionable.

James: We're talking about getting a system in place that defines minimum regulatory standards. What we're not talking about is changing the base on which reinsurance relationships are made, and whether there are commercial arrangements in place that support the reinsurance program. There is nothing stopping anybody, whether there is collateral in place or not, from negotiating contracts that are in place.

Ozendo: Solvency regulation must be the means to establish standards and proper measurement for protection and payment. One cannot force something by setting rules in isolation. The regulatory environment must protect the solvency of insurance companies. It must create the best security we can have. And we have to rely on rules that would at the same time respect global standards that are at least equal to what is around today.

Federal Versus State Regulation

Ozendo: If we had an optional federal charter, the collateral issue would have to be dealt with by mutual recognition, by measurements of equivalent rules on solvency, recognition of financial strength on a more global basis, in line with those standards that apply in the United States. I think that would drive this issue, instead of having focus on a very narrow aspect of the question.

James: The collateral debate was first raised with the NAIC back in 1999. They have been through a very exhaustive process of due diligence and have invited comments from many different groups. There is nothing new today in the debate; the pros and cons have been argued. In the event the NAIC decides no changes should be made, we will need to think of other options that are available to adequately regulate the reinsurance business in the United States. And the obvious port of call for that is some form of federal solution.

Berkley: If we had a federal charter, we would be on more equal ground in dealing with other national regulators, while requiring a set of standards and the ability to really enforce the willingness and capacity to pay. The optional federal charter would go a long way toward addressing this issue, because companies would be required to be nationally licensed if they want to do business here.

International Regulation

Berkley: If you are going to have a mutual set of rules, unilateral activity can't happen; all jurisdictions have to do the same. If a Swiss or a U.K. reinsurer can do business here in the United States because they're licensed and have financial strength, you have to let me do the same in those countries, and on the same basis, which is not how the world works today. The key is mutuality; if yon want a set of rules, the rules have to work both ways.

Ozendo: The rules of engagement do need to be somehow synergized. To me, making sure we have capital availability is correct. To ensure the solvency of ceding insurers, and to ensure maximum fungibility of capital, there must be rules of engagement for measuring financial capital, recognition of solvency rules as established by other jurisdictions of equal standing to U.S. standards. We support the new E.U. reinsurance directive because it aims to create a single set of rules for all reinsurers doing business within the E.U.

James: What the E.U. reinsurance directive does is introduce a common regulatory regime for pure reinsurers who have their head office within the European Union. What it will lead to is that individual member states will abolish their collateral requirements. U.S. reinsurers will be able to write cross-border business from outside the United States, and they will not face collateral requirements.

When you look at what is happening globally, there are changes going on in regulatory standards. Looking at reinsurance, rules are being changed in a way that encourages cross-border business. Most jurisdictions in the world do not have a minimum regulatory requirement that imposes collateral for writing cross-border reinsurance. The United States is out of step with current trends, and U.S. reinsurers are not subject to the same kind of requirements as foreign reinsurers in the U.S. market.

The U.S. Conundrum 

Berkley: Keep in mind we need the capacity of the world, but the world needs our business as well. We represent almost half of the reinsurance business in the world. There would be no business for the world's insurance market, especially for many of the participants in Bermuda or London, if it weren't for the U.S. market. Supply and demand has to be somewhat in balance. They would have no place to use their capital if they can't be here. Then what would happen is a U.S. market would develop.

For all our efforts toward mutuality, we have to remember that the American market is different. We do business everywhere, and both the scale and the mix of the U.S. market are unique. The length of tail in the U.S. market is much different. Whereas in the rest of the world about 90% of reinsurance claims are settled within three years, in the U.S., it's more like 30% or 40%.The length of exposure is much longer, making the determination of future ability to pay much more important.

James: We don't have the option of setting up a licensed U.S. reinsurer because of our unique structure. If we did, maybe that would be a quick fix for the problem, but we can't do that. A second issue is what happens when a global entity wants to bring risk back into its parent company balance sheet, when it is domiciled outside the United States. To bring that risk back onto the balance sheet of the parent company requires the posting of collateral for what is essentially an intra-company transfer. That's a rather bizarre way to manage the capital of that local reinsurer.

Ozendo: The U.S. market is the largest in the world. We depend on having that presence. To ensure the solvency of ceding insurers and to ensure maximum fungibility of capital, there should be rules of engagement where people have the choice between a federal regulator or a state regulator.

End Game?

James: We have come to the point where the NAIC has said they want to make a decision by the end of this year, and I think it is right that after six or seven years of due diligence, the industry should allow the NAIC to come to that decision.

In the event that they determine no changes are required, we would need to think of other options available to adequately regulate the reinsurance business in the United States, and the most obvious port of call for that is some form of federal solution. There should be one set of rules that apply equally to the entire market, and the regulatory structure should not interfere with sophisticated parties in a business relationship.

Berkley: I think Pierre's comment about mutual agreements and shared set of rules is valid, so long as it's mutually enforceable, where we have those government entities enforcing those rules in the same way. I agree that we need one consistent policy, and it should be simple and straightforward. It should be geared to ensure the ultimate client has the greatest security of getting paid.

Ozendo: Listening to my colleagues here, we get a very clear view that the rules of engagement do need to be synergized on an effective basis, to make the standards as easy as possible, and as responsible as possible. People should have the choice between federal and state regulation. But there must be rules for measuring financial capital, recognition of solvency rules as established by other jurisdictions that are in equal standing to U.S. standards.

We clearly have very close cooperation between regulators worldwide to look at solvency-driven issues. In our view, they are perfectly able and prepared to recognize these equal standards. What we need is a format that will allow this to take place in a short amount of time. I think that would solve most of the existing problems and give us the most security for the buyers of our product.

The Collateral Debate

The National Association of Insurance Commissioners may vote by early 2007 to change the current rules, which require foreign non-admitted reinsurers to post 100% of their U.S. obligations in U.S. accounts as collateral. An NAIC task force on collateral requirements in September issued a report that recommends changes to the current system, including rules that would better match ceding companies' credit and assuming reinsurers' reserves and rules that would apply uniformly to reinsurers, regardless of where they are domiciled.

Learn More

W.R. Berkley Corp. A.M. Best Company # 04655 Distribution: Brokers, direct

Lloyd's of London A.M. Best Company # 85202 Distribution: Brokers

Swiss Re America Corp. A.M. Best Company # 18346 Distribution: Brokers

For ratings and other financial strength information about these companies, visit www.ambest.com