Reinsurance Proposal: Big Effect on Collateral, Limited Effect on Ratings

Fitch Ratings today issued a report titled “Impact of Proposed Changes in Collateral Requirements” that discusses its views on the National Association of Insurance Commissioners’ (NAIC) reinsurance task force’s proposal to revamp regulations governing reinsurers’ collateral requirements and cedants’ corresponding ability to take reinsurance credit in their statutory financial statements.

Fitch, which is following this issue closely, does not believe that individual (re)insurers’ financial or competitive positions will be materially altered, and thus the agency does not expect to make a material number of ratings changes if the proposal is adopted in its current form. Fitch views the proposal as a credit neutral for primary insurers, a modest positive for unauthorized reinsurers and a modest negative for authorized reinsurers.

Fitch expects collateral levels to decline under the proposal as reinsurers pressure cedants to accept minimum collateral levels required to receive reinsurance credit in their statutory financial statements. In exchange, Fitch expects primary insurers to negotiate corresponding price reductions as the cost of funding collateral requirements declines and available capacity increases. Fitch’s expectation is that this decline will occur over time since collateral requirements for reinsurance transactions entered into prior to the proposal’s effective date will not change.

The dollar amounts involved are significant. Collectively, U.S.-domiciled life and non-life (re)insurers reported US$605 billion of ceded reinsurance recoverables and US$218 billion of collateral on recoverables from unauthorized reinsurers at year-end 2005. Although Fitch expects that over time the proposal’s implementation would reduce the collateral supporting primary insurers’ reinsurance assets, the agency believes that the proposal’s minimum collateral requirements are well in excess of historical default rates and thus provide more than adequate default protection.

In the report, Fitch discusses its views on the proposals:

–Probable effect on existing collateral levels;

–Minimum required collateral levels relative to historical corporate bond defaults;

–Credit implications for primary insurers and reinsurers.

Fitch also provided comments on the proposal to the NAIC in January 2007, the content of which is included in Appendix C of the Special Report.

Source: Fitch