The Doubful Impact of an Optional Federal Charter On The Reinsurance Collateral Debate

Gregory S. Arnold, University of Connecticut School of Law

Article comments

Law journal article. American Bar Association.

Abstract

Article published in the Tort Trial & Insurance Practice Law Journal, Summer/Fall 2008 (Vol 43:4/44:1).

Standards and practices in the field of reinsurance regulation and supervision vary widely among jurisdictions, with prudential approaches varying from direct supervision of reinsurers, to supervision through cedants, to little or no supervision at all. The supervision of reinsurance is experiencing a convergence in significant jurisdictions, including the European Union and the United States. Important topics include the anticipated single passport to Europe and, in the United States, the reinsurance collateral debate and the potential move toward an optional federal charter. Who is behind these issues, and do the issues share common ground?

The European Union (“E.U.”) is progressing toward a single, open market for reinsurance and a federalized system of reinsurance regulation. Important principles of mutual recognition and at least minimal harmonization of rules are some of the important foundations being implemented to make that system work. If and when the Reinsurance Directive is implemented, it will result in the complete elimination of reinsurance collateral requirements among E.U. Member States, although E.U. Member States will still be able to impose such requirements on reinsurers from countries outside the E.U.

Some E.U. spokespersons have suggested that the United States (“U.S.”) should learn from the E.U.’s experience and adopt a federal system of reinsurance regulation in lieu of the current state-based system of regulation. These commentators suggest there is a likely nexus between a possible federal system of regulation in the U.S. and the eventual abolishment of U.S. reinsurance collateral requirements.

In the U.S., collateral from unauthorized reinsurers satisfies “credit for reinsurance” regulations of the insurance departments in the various states. This places reinsurers that are required to post collateral at a competitive disadvantage compared to those that are not required to post collateral, leading to capacity issues, leaving ceding insurers fewer reinsurance options.

This paper surveys the reinsurance regulatory schemes of the E.U. and the U.S. For the law of the E.U., the article discusses the Reinsurance Directive as it pertains to the ability of E.U. insurers to require the “pledging of assets” by third-country reinsurers, including those domiciled in the U.S. The analysis of law in the U.S. will include the current law of New York State, followed by a discussion of the regulatory proposal by New York State, intended to soften the collateral requirements, lead to mutual recognition, and set the ground work for minimal harmonization of rules among unauthorized reinsurers and New York State.

The balance of the article appeals to the historian and scholar of insurance law. Lloyd’s is a company with its head office in the U.K., and the U.K. is a Member State of the E.U. Because Lloyd’s is a strong proponent of elimination of collateral requirements in the U.S, this section reviews the failure of the old “Lloyd’s of London,” along with legacy issues that have concerned U.S. insurance regulators. The new “Lloyd’s” is then studied in view of its current self-regulation initiatives, its governmental oversight from the nascent, yet impressive Financial Services Authority, and the treatment given it by the rating agencies.

The article concludes with an historical overview of the arguments for and against an optional federal charter in the U.S., with an analysis tailored to the purpose of this paper, which is refuting the unfounded notion that an optional federal charter would herald the elimination of reinsurance collateral requirements.