Commissioners Adopt Model To Create Tax-Free Cat Bonds.

State insurance regulators have approved a model law that could allow insurers to create catastrophe bonds without facing tax penalties.

The model law, adopted Dec. 6 by the National Association of Insurance Commissioners would allow insurers to set aside money from a catastrophe bond in a so-called protected cell. The money would be protected from any future insolvency and would give insurers more options to raise capital for catastrophe claims.

Regulators hope to bring securitization business, which is often placed through offshore transactions, back to the United States.

Of securitization transactions done so far, only one has been completed in the United States. In that case, Kemper Insurance Cos. handled its transaction through the Inex Insurance Exchange, based in Chicago. Transactions of this type weren't feasible until November 1998 when the Illinois Department of Insurance issued an order that allowed Inex to permit special-purpose limited syndicates to conduct insurance-securitization transactions.

Under the NAIC model, which is similar to a law passed this year in Illinois, the cells would be considered separate from the insurance company so business wouldn't be taxed by the Internal Revenue Service. It also wouldn't be subject to state premium taxes guaranty-fund assessments or other state taxes.

The NAIC also is developing a model law that would allow insurers to create catastrophe-reserve funds that meet the risks they face.

Insurers could set up funds based on probable maximum losses, or a PML cap, for events ranging from an event that could occur every 100 years, such as a hurricane, to an event that could occur every 250 years, such as an earth-quake.

Catastrophe reserves would allow insurers to set aside money they could use in case of a major catastrophe, similar to 1992's Hurricane Andrew, which left several insurers insolvent.