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Transcript: Three Global Insurance Execs Debate U.S. Reinsurance Collateral Requirements(BestWire Services Via Thomson Dialog NewsEdge) U.S. state insurance regulators this week are expected to advance proposals that would affect collateral requirements for reinsurers. The Winter National Meeting of the National Association of Insurance Commissioners begins Dec. 9 in San Antonio. The following is a transcript of a teleconference conducted for BestDay Audio. A recording of this discussion is available online at http://www.bestdayaudio.com. BESTWEEK: Welcome to BestDay Audio. I'm Dave Pilla. Today we are pleased to bring you an executive roundtable on collateral requirements for alien reinsurers that I think you will find highly informative. Joining us today are three distinguished leaders in the global reinsurance market: William R. Berkley, chairman and CEO of W.R. Berkley, Julian James, director of Worldwide Markets for Lloyd's of London and Pierre Ozendo, chairman and CEO of Swiss Re America Corp. Also joining us in the studio is Lee McDonald of the A.M. Best Co. We'll be back with our roundtable right after this word. As everyone in the market is well aware, the debate over collateral requirements for alien reinsurers operating in the United States is heating up this year. Reinsurers based in the United Kingdom and Europe in particular have long debated the fairness of having to post 100% of their risk exposure in U.S. accounts to guarantee claims payments, arguing instead that their track record and financial strength ratings are adequate evidence of claims-paying ability. Alien reinsurers, an unfortunate term by the way but I can think of no other than brings with it the quality and brevity, say such requirements seriously harm their competitiveness in terms of liquidity and capacity. U.S. reinsurers counter that collateral requirements for foreign companies are no more constraining than capital requirements for admitted reinsurers, enable smaller reinsurers to compete with big players and prevent the market from having to rely completely on rating agencies, which they point out have no enforcement powers, as state regulators do. In short, such requirements ensure a safe and orderly reinsurance market, they argue. Our participants can offer views which I think will cover every angle of this debate. Let's start with Julian James of Lloyd's. Mr. James, you have been a vocal critic of U.S. collateral requirements. Tell us what effect you believe it has on the market. JULIAN JAMES: Well first I'd just like to start off by saying I don't agree with the characterization of the debate. BESTWEEK: OK. JULIAN JAMES: What we have been arguing and pointing out to the NAIC is the existing rules for writing reinsurance business in the U.S. are unfair and discriminatory because one group of reinsurers is treated differently from another group and therefore what we have been suggesting to U.S. regulators is that they should be reviewing the current requirements to make sure that all reinsurers are treated equally and the existing rules, just to be clear, differentiate between a company that happens to be domiciled outside of the U.S. and a company that happens to be domiciled in the U.S. What we've been asking for is equal treatment. BESTWEEK: OK. Mr. Berkley, I believe you can give us the opposing position on this issue? Go ahead, sir. WILLIAM BERKLEY: Yes, I think that everyone looks at this from their own position, ours being a fairly simple one. As a U.S. direct writer and reinsurer we have a view as a direct writer that collateral gives us a better assurance of collection. Every one of these entities could effectively become licensed in the U.S. and subject to U.S. regulatory authorities and then they wouldn't have to put up collateral. It is only when they wish to operate as an alien reinsurer that they are put in such a position. They've elected not to be within our regulatory structure. We don't have that choice when we operate overseas. For us to do business there we have to go within their regulatory structure. So I think that in fact they are better off than we are there. They have an alternative. I welcome a debate on the overall change and the universal regulatory platform. If that were the case on a number of alien reinsurers who decided to leave the U.S. market, we wouldn't have had to compromise and settle our claims because we wouldn't have had enough collateral to collect. BESTWEEK: Mr. Ozendo, you represent a European-based company that is admitted in the United States and has U.S. subsidiaries. What's your take on the collateral issue? PIERRE OZENDO: Well thanks, Dave. Obviously we have a U.S. licensed company, but from a global perspective our interest is to insure the United States gets access to sufficient global reinsurance capacity and quality. I mean right now within the top 10 reinsurers more than 60% of the reinsurance premiums are written internationally. And so our take is the United States must have access to that capability. The collateral issue is in our view an important issue but a subset of real regulatory reform that is required. In our view it is important to take a look at the strength of reinsurers, the financial capability and all these issues. When U.S. collateral rules were set up a long time ago it was quite clear that they were to collateralize obligations under U.S. law, which is fine. But in today's landscape with global capital, there is the need to really look at how regulatory rules are converging. Our view is that you know for instance if we could move to a federal charter with mutual recognition then the collateral would be a part of a much more significant regulatory review. BESTWEEK: OK, so you're saying that if we had the optional federal charter the collateral issue would be simpler? PIERRE OZENDO: Well, if we had an optional federal charter, as an example, then the collateral issue would have to be dealt with by mutual recognition, by measurement of equivalent rules on solvency, recognition of financial strength on a more global basis in line with those standards that apply in the United States today at a minimum. So I think that would drive the issue instead of having this focus uniquely on a very narrow aspect of the question. WILLIAM BERKLEY: You know, I think that Pierre's right, that in fact a lot of this would go away if we had a federal charter. We then would be on much more equal ground dealing with the other national regulators and requiring a set of standards and also the ability to really enforce people's willingness and capacity to pay. You know, I think this does fall into that category, that optional federal charter would go a long way toward addressing this issue because then companies would be required, if they wanted to do business here, to be nationally licensed. I do think there is one other issue and that is to keep in mind we need the capacity of the world but the world needs the U.S. also. We represent almost half of the reinsurance business in the world. There would be no business for the world's insurance markets at least for many of these participants, especially in Bermuda or in London, if it weren't for the U.S. market. So supply and demand have to be somewhat in balance. They have no place to use their capital if they can't be here and then what would happen is a U.S. market would develop. BESTWEEK: I'd like to turn to Mr. James. I wanted to get your view on the idea of the optional national charter and what it might do for this. But first can I quickly ask you a follow-up question on another comment that Mr. Berkley made, that of alien reinsurers who chose that route rather than set up the U.S. subsidiary or become an admitted reinsurer. Do you have a comment on that? JULIAN JAMES: Yes, I've got a couple of comments on that. I mean looking at it from a Lloyd's perspective, we don't actually have the option available to use because of our unique structure to set up a licensed reinsurer in the U.S. and if we did maybe that would be quite a short term or quick fix to this problem. But the fact of life is as the rules are currently constituted, we cannot do that. That option is not open to us. The second issue is what happens when an entity, a global reinsurer, wants to bring the risk back into its parent company balance sheet which is domiciled outside of the U.S. For a company that has a licensed reinsurer that has a holding company outside of the U.S., to bring that risk back onto the balance sheet of the parent company requires the posting of collateral for what is effectively an inter-company transfer and that's a rather bizarre sort of way I think in terms of trying to manage the capital of that global reinsurer. I think the third point, I'd say, is that when you look at the trends that are happening globally and Pierre raises a very good point, there are changes happening in terms of regulatory standards worldwide and most of those standards, when it comes to writing reinsurance business, encourage the writing of reinsurance on a cross-border basis and most jurisdictions of the world do not have a minimum regulatory requirement that imposes collateral for the writing of cross-border reinsurance and the U.S. therefore currently is out of step with global trends and therefore it also means that U.S. reinsurers who trade cross border outside the U.S. are not subject to the same requirements that non-U.S. reinsurers are when they trade in the U.S. So those are three, I think, very important points. When we come to the issue of how we solve this debate, the Lloyd's position is quite simple. It's that we don't particularly mind whether it gets solved at a state level or a federal level. There seems to be a growing desire to impose some sort of federal solution, whether that's by having a regulatory authority that has jurisdiction on this issue that operates on a federal level or whether it's by a federal solution being pushed down into the states. What we do feel very strongly about is that this debate was first raised with the NAIC back in 1999. They have been through a very exhaustive process of due diligence. They've invited comments from many different groups, from ceding companies, from licensed U.S. reinsurers and nonlicensed U.S. reinsurers, from rating agencies, from regulators around the world, from accounting bodies and there is frankly nothing new to say in the debates. The pros and cons of the arguments have been made. We are in the stage where the NAIC has said they want to make a decision by the end of this year on this issue and I think it is right that after six or seven years of exhaustive due diligence that the industry should allow the NAIC to come to that decision. In the event that they determine that no changes are required, and I would personally find that bizarre when nine of the leading regulators signed a letter in November 2004 saying that they should actually change the existing system, we will need to think of other options that are available to adequately regulate the reinsurance business in the U.S. and the most obvious port of call for that is some form of federal solution and therefore if the NAIC fails to come up with a solution that is acceptable I think we will go and suggest that a federal route is the best route to go down. WILLIAM BERKLEY: Julian, this is Bill Berkley. As I recall, Lloyd's requires collateral or other things for a quota- share reinsurance at Lloyd's. JULIAN JAMES: We do, but we also require people writing in this market, as you know this is a large capital business. WILLIAM BERKLEY: So what you're saying is for reinsurance you require collateral also. JULIAN JAMES: Well that's because otherwise people would be able to write, and that is a special type of Lloyd's vehicle to do that. WILLIAM BERKLEY: No, no. I'm talking about insurance companies. If W.R. Berkley Corp.'s subsidiary wanted to reinsure quota-share reinsurers syndicated at Lloyd's, we're required to put up collateral. Is that correct? JULIAN JAMES: It is correct for the quota-share route but is it not correct if an entity here, a Lloyd's syndicate buys reinsurance, normal reinsurance, we would not require that liability to be collateralized. WILLIAM BERKLEY: So you think it would be OK for the NAIC to say collateral should be required for quota-share reinsurance just not excess-of-loss reinsurance. JULIAN JAMES: No, what we've been arguing with the NAIC about is that there should be one rule that fits the entire industry, bearing in mind that we're a global industry and it should not interfere with commercial relations that exist between sophisticated counterparties. Therefore there should be minimum regulatory standards and at the moment the existing standard in the U.S. is based on the lowest common denominator and actually say that in the event a company is being domiciled in the U.S. there is no requirement; in the event of a company being domiciled out of the U.S., there is 100% gross requirement and that doesn't make a lot of sense. WILLIAM BERKLEY: But for me to do reinsurance business in the U.K. for instance, or in any other country in the EU, I have to set up a licensed branch which has capital segregated in there on deposit, i.e., something very close to collateral or I have to set up a subsidiary company. You have those same options to do in the U.S. You have an additional option in the U.S. of collateralizing your reinsurance liabilities. The reason that it is more important in the U.S. than in the rest of the world is because of the scale of the U.S. market and the size of those liabilities, especially because those liabilities in the U.S. are primarily casualty in nature as opposed to property, thus the tail of the liabilities is substantially longer. So in fact, the situation in the U.S. is quite different than the situation in most of the rest of the world. You're trying to say we're exactly the same and you're also saying that quota-share reinsurance is different than other kinds of reinsurance. I agree with you. We need one consistent policy and it should be simple and straightforward and it should be geared to being sure the ultimate client has the greatest security of getting paid. PIERRE OZENDO: I think in listening to my colleagues debate a little bit, obviously we get the very clear view that the rules of engagement do need to be somehow synergized on an effective basis. To me, making sure that we have capital availability, I think Bill is correct. The U.S. market is the largest market in the world. We depend on having that presence. There is no question. To make it as easy as possible and yet as responsible as possible for companies to transact, no one is questioning the rules of engagement other than the fact that to insure the solvency of ceding insurers and to assure maximum fungibilty of capital in this marketplace. I keep coming back to the point that there should be rules of engagement where people have the choice between a federal regulator or a single state regulator. They would have the choice in our view to stay with the 50-state system, to work within it but then there must be rules of engagement for measuring financial capital, recognition of solvency rules as established by other jurisdictions of equal standing to the United States' standards. We clearly have a very close cooperation and from Swiss Re we see it on a global basis, very close and improving cooperation between regulators worldwide to look at solvency-driven issues. They are perfectly prepared in our view and able to recognize these people's standards. What we need is a format that will allow this to take place in the shortest period of time and I think that would basically solve most of the problems and give us the most security for the buyers of our product. WILLIAM BERKLEY: Pierre, this is Bill. I think you're right and I think in fact your company has always maintained its commitments and it's easy for me to accept these things when you say that. But the fact is what we need is that unilateral activity can't happen, and that is all markets have to do the same. So if you want me to let a Swiss insurance company do business here or a U.K. insurance company do business here simply because they're licensed and have financial strength, then the Swiss and the U.K. have to do the same for the U.S. and on the same basis, which is not how the world works today. So I think the key to your statement and I'm very much in favor and it would simplify Lloyd's issue greatly, with a federal charter because then they would have one place to get all of these things resolved. But the key is mutuality. If they want a set of rules, the rules have to apply both ways. But remember the American market is different, much different. PIERRE OZENDO: Bill, I fully agree. I again was referring to modernization and regulation with regard to reinsurance, yes? WILLIAM BERKLEY: Yes. BESTWEEK: OK. Mr. Berkley, did you have a thought to finish there? WILLIAM BERKLEY: It only was that I think that in all our efforts to mutuality we do have to remember the American market is different. We do business everywhere and both the scale and the mix of business in the U.S. is different and the length of tail in the U.S. So in terms of exposure, whereas 90% of the world's reinsurance liabilities are settled within three years, probably 30% or 40% of the U.S. liabilities are settled within that term. So the length of liability and exposure are much longer. Thus our knowledge and ability to forecast companies' financial strength and ability is much more important with that longer tail liability. So it's a somewhat different issue. But I think that Pierre's comment about mutual agreements and shared set of rules is perfectly valid as long as it's also mutually enforceable where we have those same governmental entitles enforcing the rules in the same way. BESTWEEK: OK, a hypothetical thought I had on the discussion about the optional federal charter. If that were an option, is it possible that collateral rules would be different between the federal and the state levels? And, if so, is it possible that reinsurers would begin to kind of shift back and forth depending on whether they're writing long-tail or short-tail business or different kinds of business. Could that introduce an extra complication into the market? I don't know. Who has a thought on that? PIERRE OZENDO: I'll take a shot at it, Dave. I certainly don't think so. If the optional federal charter and what we prefer is really a modified optional federal charter which would give a clear choice to companies to opt for a federal regulator or a single state regulator, the rules of engagement would have to be written very clearly upfront and the standards would be uniform. The question is, in a global marketplace would someone who is operating internationally and throughout the United States be able to go to one source? As we see this now there is a little bit of sometimes inefficiency within a 50-state system. From a reinsurance perspective that would actually be simplified and could be simplified on the basis of this kind of structure. BESTWEEK: I'd like to address quickly the European Union's reinsurance directive which passed about a year ago. I believe the 25 member states each have until 2008 to adjust their national rules to fit that directive. One of the big issues of that directive is that collateral requirements within the EU would be eliminated. About a year ago I spoke to Peter Skinner, a member of the European Parliament who shepherded that bill through the parliament and he suggested that the adoption of this directive and the elimination of collateral requirements in Europe would put some pressure on the U.S. regulators to do likewise. Otherwise it may devolve into a trade issue between the European Union and the United States. Do you have any thoughts on that, Mr. James? JULIAN JAMES: Well let's just be clear about what this reinsurance directive is and what it's doing. You know, as you say, Dave, it was adopted in November 2005. The way the European Union laws work is that there's now a requirement upon all the member states to implement this directive into their own laws and they need to do that by December 10, 2007. What this does, it will introduce a common regulatory regimen for pure reinsurers who have their head office in the EU. What it will lead to and what it will effectively abolish is that the existing national systems and in Europe it's only France and Portugal that have this at the moment, that they will abolish their collateral requirements and therefore U.S. reinsurers will be able to write cross border business from outside the U.S. and they will not need to post collateral requirements. Therefore it's a definition of the intention of how the regulatory framework is going to operate. WILLIAM BERKLEY: Julian, this is Bill. You mean we don't have to be licensed in any EU country? JULIAN JAMES: No, you don't. But you don't need to be at the moment, Bill. I mean if you want to write reinsurance business to an entity in the U.K. you do not have to be licensed by the Financial Services Authority to do that. WILLIAM BERKLEY: Including for quota-share business? JULIAN JAMES: Well that's a Lloyd's requirement. That's not a minimum regulatory requirement. If you offer reinsurance to, depending where you are today, to a UK primary company there is no regulatory requirement under the FSA for you to post collateral for that. That is where we are today. BESTWEEK: And that's only the case in France and Portugal, is that correct? In those two countries if you write reinsurance you do have to post collateral? JULIAN JAMES: Correct. BESTWEEK: OK. JULIAN JAMES: And what this directive is going to do is that it will effectively ban the use of collateral as a regulatory tool in France and Portugal for European reinsurers trading on a cross-border basis trading throughout European member states. BESTWEEK: Mr. Ozendo, does the Europe directive have significant effect on Swiss Re writing out of, or doing business out of Switzerland? PIERRE OZENDO: Thanks for the question. We fully support the EU directive and as a matter of fact the same regulatory framework for reinsurance is also soon to be introduced in Switzerland. As you know, the regulators in Europe work very, very closely together and it's really our back yard. The important thing to take note is this directive, in addition to getting rid of collateral requirements across member states, really establishes standardized licensing and solvency requirements. Again it mandates mutual recognition. It establishes recognition of solvency and company models and capital models and it allows for much more transparent exchange. You cannot have this mutual recognition across states by various regulators without it. I think that it is a strong position and that the EU model will work very well for Europe. I think there are many parts of it that can be applied if we adapted them into the U.S. situation but again the U.S. is a different market and it has to be taken into context of its history and to make these kind of things link. But from Swiss Re's perspective, we fully support the EU reinsurance directive and again, as I say, working very closely with the Swiss regulator we see this fully aligning. WILLIAM BERKLEY: When the British regulator was at the NAIC meeting on the collateral issue, they in fact said that for reinsurance you had to be licensed in the U.K. to write reinsurance. That may be an easier license to get but you still need to be licensed. But in fact part of the issue is collection of balances due and that's the whole purpose of collateral and the ability to collect and the system as it applies to the ability to collect and the reality is for many reinsurers the ability to collect is questionable and people go home to their home country and even when you have collateral you're never adequately protected given historic trends in litigation in the U.S. I won't name names, but there are companies that are still doing business in Switzerland the U.K. that use that ability to negotiate settlements substantially below the amount that was required to honor their obligations. BESTWEEK: And these are companies that do not have to post collateral in the U.S.? WILLIAM BERKLEY: That in fact didn't post adequate collateral because of development and when they withdrew from the marketplace you just were protected at least to the extent of their collateral. But they thought nothing of going back home and being a prosperous local insurance company, one in Switzerland I could name that everyone knows about and in the U.K. as well. JULIAN JAMES: Bill, this is Julian. I don't dispute any of that. What we're talking about here is a system. We're trying to get a system in place that defines minimum regulatory standards. What we're not talking about is changing the basis on which reinsurance relationships are made and whether there are then any commercial arrangements that support the transaction of that reinsurance program. There is nothing to stop anybody you know requiring collateral or additional security to support some of the contracts that are in place. WILLIAM BERKLEY: But that would end up disadvantaging small companies and advantaging large ones because small companies wouldn't have the power to negotiate and large ones would. So you would end up creating more of a monopoly of insurance companies. It would tremendously adversely impact all of the small companies in America and it would be fine for W.R. Berkley Corporation and the Hartford and St. Paul and Liberty and it would be really terrible for all of the small companies throughout America and then we'd grow to have a marketplace that looked like much of the rest of the world where instead of having 3,000 insurance companies we would have 50. JULIAN JAMES: It's too early I think to predict what the structural outcome is going to be based on removal of collateral, but it's quite clear that at the moment the existing rules don't actually incentivize U.S. primary companies to place their reinsurance only with the strongest and most reliable reinsurers and they also assume that just because a reinsurer is based in the U.S. that is a perfect credit risk when outside the U.S. they're not ready to be an acceptable credit risk. PIERRE OZENDO: Sorry, if I could just jump in quickly. I think again I understand both sides of this argument a little bit. The issues are you know for Bill's comment that basically solvency regulation must be the means to establish standards and proper measurement for protection and payment. At the end of the day, one cannot force something, in my view, by setting rules in isolation. The regulatory environment must protect the solvency of insurance companies. It must create the best security that we can have and we have to rely on those type of rules that would at the same time, in my view, respect the standards that have been established globally that are equal to or better than what is currently around. You know, a discussion of how one company becomes disadvantaged and there's a concentration of the market into fewer companies, I mean those are market forces, in my view. But I think the regulatory environment has to be brought up to date. It has to be modernized. It has to recognize these issues and it has to be the final arbiter of how one protects solvency in this country. BESTWEEK: OK, well thank you for all your time. I realize everybody here is busy and we really appreciate you giving us your time. What we'd like to do is bring this discussion to a close and what we'll do if we could just go around one time and just ask you if there's anything that we haven't asked you that you believe is important to bring out or if you'd care to quickly summarize some of the things you talked about and then we'll say good-bye. So Bill, could we start with you? WILLIAM BERKLEY: Sure. I think that it's great to say that this has been cooking for a long time and we should move ahead. But I think that in reality this is not the same marketplace as the rest of the world. The liabilities are for a longer duration. The scale of the liabilities are much greater and our abilities to collect in foreign courts, in foreign jurisdictions have been at best questionable. Thus, collateral, while it's not required, is one option and if we want to do away with collateral we need another mechanism that provides assurance to the U.S. insurance market for being able to collect on reinsurance balances. We do have a problem with some U.S. companies also because intent to repay is in fact an issue. But intent to pay can be dealt with in the courts if we wish to. Right now it's very frustrating when money is due and the only option is to go to a foreign system and try to collect. I think a national charter where there is real teeth in the ability to collect because of mutually agreed upon processes is something that makes sense. The need for that capacity offered globally is unquestionable. On the other hand, all those global reinsurers have no place to do business if the U.S. market is not available to them. BESTWEEK: Well thank you. And Julian? JULIAN JAMES: Well first, thanks for the opportunity to have a debate. As I said earlier, the debate has gone on for over six years now. I think the arguments have been well made throughout that time. There are pros and cons clearly of the existing system. It is time after six or seven years of debate for the regulators to make up their minds on this issue and in our belief, the existing collateralization rules as they stand now as amended in the future should apply on a geographically agnostic basis and therefore credit for reinsurance should be based on principals of safety and soundness rather than on geographic location. BESTWEEK: OK, thank you. Go ahead, Pierre. PIERRE OZENDO: Thank you very much and I also would like to thank you for the opportunity of joining in. I agree with Bill's comment that there is a very long tail in the U.S. market. Security is fundamental but again. I also feel that a real modernization and comprehensive change in the regulatory environment, allowing the best of the system to work and to recognize increasingly global standards of regulation, of solvency of capital measurement can work. I believe it is time for it to come forward. There is increasing need in our business, which is global, to make this happen. I believe that the collateral issue, a subset of the bigger issue of mutual recognition, that has taken hold in different parts of the world can take hold here and bring a stronger and more secure environment to the United States. BESTWEEK: OK. Thank you very much, gentlemen. (By David Pilla, senior associate editor, BestWeek: [email protected]) Copyright 2006 A.M. Best Company, Inc. |