Although the NAIC recently adopted a plan for changing the current requirement that non-admitted (non-U.S.) reinsurers maintain collateral in a U.S. bank equal to 100% of U.S. risks ceded to them, it will take a number of years for the changes approved by the NAIC to have any impact. The current 100% collateral requirement is in the model NAIC Credit for Reinsurance Act, which each state has enacted and which is a criterion for accreditation by the NAIC. Theoretically, a state that failed to maintain the 100% collateral requirement could lose its accreditation, but the NAIC has shown no interest in enforcing that requirement. Now that it has itself voted to relax the rule, it is hard to see how it could take the position that states that lower the collateral requirement before the NAIC system goes into effect should be punished.

Meanwhile, Florida and New York have taken initiatives on their own that will provide almost immediate relief for highly rated non-U.S. reinsurers. The New York and Florida changes are much simpler and easier to administer than the new NAIC system, and the impact of them should be felt within a year or even less. The Florida and New York rules, of course, only apply to risks ceded by insurers in those states, but those are important states for insurance purposes. If other states, especially those with major insurance markets, follow the lead of Florida and New York, the onerous capital requirements imposed on financially sound non-U.S. reinsurers may melt away long before the NAIC rule change becomes effective.

For help in understanding these changes, the basic elements of each of these plans are summarized below.

The NAIC Plan

The plan adopted by the NAIC has two principal elements:First, two categories of reinsurers operating in the U.S. will be recognized: national reinsurers (licensed in a U.S. jurisdiction) and port-of-entry reinsurers (not licensed in any U.S. jurisdiction). Uniform minimum standards will be established that apply to both categories and will determine the amount of collateral required of reinsurers in order to allow credit to ceding companies. The standards are to be applied to the national reinsurers by their states of domicile. Non-U.S. reinsurers are to be evaluated by a port-of-entry jurisdiction chosen by the reinsurer from among a list of state insurance departments that the NAIC determines are capable of making such evaluations. In either case, there is to be only one regulatory authority for a given reinsurer. Federal legislation will be required to preempt non-domiciliary and non-port-of-entry states from applying different standards for granting credit for reinsurers to their domestic ceding companies than those established by the authorized regulatory jurisdiction.

Second, the plan calls for the creation of a new NAIC department, to be called the Reinsurance Supervision Review Department (RSRD), which will be charged with determining which foreign jurisdictions have insurance regulatory systems that are comparable to the U.S. system. Only companies that are domestic in such approved countries will be eligible to operate in the U.S. on approval of a port-of-entry state. The RSRD will also determine which U.S. jurisdictions have the capacity to serve as port-of-entry states. Finally, the RSRD will develop the criteria for determining how much collateral will be required of reinsurers (whether national or port of entry). The proposal calls for five categories to be established. Collateral required would range from 0% for category one (most secure) to 100% for category five (most vulnerable). The basis for these categories, and the amount of collateral for each, were very strongly debated during the Reinsurance Task Force's work and are still subject to change.

Other details remain to be worked out, including whether and how a company can appeal its rating by the RSRD, what kinds of data the RSRD must or may consider in determining ratings, how the RSRD will be paid for its work, etc.

The plan is not self-executing. It does not become effective until Congress has enacted a law that preempts states that fail to adopt the reforms from imposing higher collateral requirements than the domestic or port-of-entry state requires. It is not clear how such legislation will come about. The collateral reduction proposal could be part of an overall financial regulatory restructuring that is anticipated from the Obama Administration or it could be floated as a separate bill. In either event, it is too soon to speculate on how long the legislative process will take. Meanwhile, the NAIC would have to establish a new mechanism for determining the regulatory quality of foreign regulators and deciding on the criteria for determining how qualified an individual reinsurer is for collateral reduction.

The Florida Rule

The Florida rule went into effect on September 16, 2008. It applies only to credit for reinsurance given to Florida domestic property and casualty insurers for reinsurance purchased from non-admitted reinsurers. That is, a Florida domestic p/c writer can get credit for reinsurance purchased from a non-admitted reinsurer even if the reinsurer does not maintain 100% collateral for the ceded risks in a U.S. trust account, provided the reinsurer meets the requirements of the rule as determined by the commissioner. Credit would not be given to a non-Florida company writing in that state. The preamble to the rule states that Florida does not intend to assert extraterritorial jurisdiction and that insurers that qualify under the rule will still have to comply with the laws of other states in which they operate. Thus, under the rule, a Florida domestic ceding company that can claim credit for reinsurance purchased from a non-admitted reinsurer approved by the Florida commissioner to post less than 100% collateral could not use that credit in another state that maintains the 100% collateral requirement.

The Florida rule applies only to reinsurance contracts entered into or renewed after its effective date with reinsurers that hold surplus in excess of $100 million and are rated as having "secure financial strength" by at least two of the major rating organizations. Depending on the ratings, the reinsurer could post less than 100% collateral, namely 75%, 20%, 10% or 0%. There is also language that would provide a rated reinsurer under the rule up to a year to come back to the required financial strength after suffering a catastrophic loss from a named hurricane.

To be eligible for consideration for reduced collateral requirements, a non-admitted reinsurer has to file an application with the Florida commissioner. In addition to the financial requirements described above, the reinsurer would also have to show that it is in good standing with its domestic regulator, has an agent for service of process in Florida and is willing to be bound by rulings of U.S. courts. It also has to provide financial statements for at least three years (or from inception if less than three years old), a list of all overdue or disputed recoverables and an agreement that it will post 100% collateral for its Florida risks if it resists enforcement of a valid and final ruling of a U.S. court or "if otherwise required" by the commissioner. Permission for credit to be given for reinsurance issued to Florida ceding companies by a non-admitted reinsurer must be granted by an order of the commissioner.

Note that, unlike the NAIC plan, there is no requirement for the reinsurer to be domiciled in a jurisdiction that the commissioner determines has regulatory standards comparable to those of a U.S. jurisdiction. Nor does the Florida commissioner reserve the right to review the forms of security held by the reinsurer; instead, it appears that the commissioner will rely on the asset review of the rating organizations. Moreover, the Florida rule allows financial statements to be filed either in Generally Accepted Accounting Principles (GAAP), Statutory Accounting Principles (SAP) or International Financial Reporting Standards (IFRS) accounting format, and not just in SAP. That is why the Florida procedure will be so much quicker to implement than the NAIC proposal.

The New York Rule

The New York rule has not yet been approved, but it is scheduled to be adopted early in 2009. The proposed New York rule (an amendment to Regulation 20) is similar to the Florida rule except that it contains a requirement that the ceding company must maintain satisfactory evidence that the non-admitted reinsurer meets the standards of solvency and capital adequacy of its home jurisdiction, and that it maintains a surplus of at least $250 million, calculated or reconciled to U.S. GAAP or SAP standards.