NAIC is studying proposal to change reinsurance rules.

The National Association of Insurance Commissioners is considering a proposal that would require insurers to identify any reinsurance contracts that have been accounted for in a nontraditional manner.

Discussed at a May 10 meeting of the NAIC's Property and Casualty Reinsurance Study Group in Chicago, the new disclosure requirements may be adopted by the group at the upcoming NAIC June meeting in Boston.

But beyond the disclosure requirements--meant to define the line between reinsurance and financing--looms the New York Insurance Department's plan to revamp reinsurance accounting.

At the direction of the NAIC, New York regulators are examining amendments to sections of the current Statement of Statutory Accounting Principles No. 62.

Under the plan unveiled at that meeting by Mike Moriarty, director of the capital markets bureau for the New York insurance department, certain reinsurance agreements would separate the accounting for what constitutes reinsurance and items that should be considered financing to more accurately reflect the economic substance of the agreement. Steve Broadie, vice president of financial legislation and regulation for the Property Casualty Insurers Association of America, is among industry representatives who believe that the NAIC should tread carefully before changing accounting principles.

In addition to running the risk of further complicating accounting standards, additional costs that might come with a change to SSAP No. 62 could force some companies to shy away from entering into reinsurance transactions, Broadie said.

"There's no rule that we're going to put in place that's going to eliminate fraud. If people are determined to lie and make false statements ... I don't know how we prevent that, Broadie said. "I think, in this case, bifurcation implies that you can draw bright lines where there really aren't bright lines to be drawn. One of the problems with bright-line-type standards is that people learn how to get around the bright line."

The new "Bifurcation of Reinsurance Agreements" section in the proposed revision of the SSAP includes:

* Separation of the part of a transaction transferring insurance risk and the part of a transaction financing losses;

* Application only to transactions that exhibit common characteristics of financing need; and

* Exemption of certain types of reinsurance agreements, such as excess per risk treaties and contracts.

The issue of insurance risk transfer also is being studied by the NAIC's Casualty Actuarial Task Force, slated to respond back to the study group in late summer. "I think certain abuses, or certain aggressive practices that some companies have engaged in, definitely would have been hindered had there been more robust accounting procedures in place," Moriarty said.

Risk Fairness

In finite reinsurance transactions, the expected ROE (return on equity) is the ratio of expected profit to allocated capital. For example, the average U.S. stock market return from 1926 to 1999 was 11%. Some in the industry feel the old 10/10 Rule, where there is a 10% chance of a 10% loss, is a fair measure of risk. The example given below shows a post-tax ROE of 11.4% and expected post-tax ROEs for other risk levels:

Size of Loss            Chance of Loss

                   10%       15%       20%

10%              11.4%      8.1%      5.6%
15%               7.7%      5.4%      3.5%
20%               5.7%      3.9%      2.3%

Source: Benfield Group