NAIC Amends Proposal On Reinsurance Collateral Requirements

For many years, the primary reinsurance regulatory mechanism in the United States has been the regulation of credit given to ceding companies for reinsurance. The regulation of credit provided to ceding companies on their financial statements indirectly regulated foreign and domestic reinsurers, as ceding companies would only choose reinsurance that would provide them with financial statement credit. A significant part of this regulatory practice was the requirement that non-U.S. licensed reinsurers had to post collateral for 100 percent of the reinsurance obligations for ceding companies to receive credit. This requirement was imposed regardless of the financial strength of the non-U.S. reinsurer or the regulatory environment where the reinsurer was licensed.

In response to a growing recognition by insurance regulators of the possible inequities of this blanket collateral rule, on March 5, 2006, the Executive Committee of the National Association of Insurance Commissioners (NAIC) asked the Reinsurance Task Force to "develop alternatives to the current reinsurance regulatory framework, including the U.S. and abroad. Consider approaches that account for a reinsurer's financial strength regardless of domicile, i.e., state or country." In accordance with this directive, on December 10, 2006, the Reinsurance Task Force presented a proposal entitled "NAIC Reinsurance Evaluation Office - Proposal to Grant Credit for Ceded Reinsurance" ("REO Proposal").

The REO Proposal sought to establish an NAIC Reinsurance Evaluation Office (the "REO"). Under the proposal, the REO would evaluate the financial condition of domestic and foreign reinsurers and assign them a rating from "REO-1" to "REO-6". Those ratings would be primarily based upon ratings from national rating organizations, such as Standard & Poors, Fitch, Moody's and A.M. Best, but also included some unspecified evaluation of "the strength of financial solvency regulation" in the reinsurer's country of domicile, the reinsurer's "reputation" for payment of claims, and the length of time that a reinsurer has assumed risks. A rating of REO-1 (which equated with the highest financial rating of the rating organizations) would require no collateral from a foreign or domestic reinsurer for a ceding company to take full credit for the reinsurance assumed by companies with that rating. Each successively lower rating band resulted in a 20 percent incremental increase in the collateral requirement, so that...