Lloyd’s Counsel Decries ‘Red Herring’ Objections to Collateral Reform

Sean McGovern, Lloyd’s Director and General Counsel, accused the opponents of reforming the U.S. collateral trust rules on reinsurance of introducing the “latest red herring” into the debate.

In a strongly worded article on the Lloyd’s web site (www.lloyds.com) he saluted the opponents “for their ingenuity,” but described their strategy as originating in the “attack to be the best form of defense” mode. Specifically McGovern wrote that “over the past eight years of prolonged debate they have come up with a series of diversionary reasons and debates as to why the current US collateral rules should not be reformed and why the discriminatory status quo should be maintained.”

He summarized the collateral rules as mandating that “US cedants can take no credit whatsoever in solvency statements for reinsurance purchased from ‘alien’ reinsurers, regardless of the reinsurers’ financial strength, rating, claims payment record or the quality of their domestic regulatory regimes, unless the alien reinsurers collateralize their outstanding liabilities at 100 percent.”

U.S. reinsurers, however, have no such requirement “whatever their rating and financial strength.” The situation persists, despite a NAIC study – “US Reinsurance Collateral White Paper-” issued in March last year, which noted that “many of the largest, oldest and financially strongest reinsurers are located abroad, and the capacity they provide is very important to US ceding companies.”

A prefious objection claimed that “there were difficulties with the enforcement of US judgments in respect of reinsurance contracts in foreign courts,” McGovern noted, but that objection was also a “red herring.” It “rested on a fundamental fallacy, namely that alien reinsurers would only be willing to meet their contractual debts if collateral was deposited in a jurisdiction: in fact, collateral requirements exist in very few countries worldwide and yet, mysteriously, international reinsurers seem to meet their contractual debts.”

McGovern described the “the latest red herring, as a claim by opponents of reform that the European Union “is not open to participation by US reinsurers.” He cited remarks by Commissioner Oxendine, Chairman of the NAIC’s Reinsurance Task Force, “as saying ‘I have some serious questions and concerns about reciprocity’ and ‘I’ll be honest. I’m not convinced that the EU is as open as some people may imply.'” McGovern noted that no such doubts had been officially voiced “during the many sessions of the EU/US regulatory dialogue that have been held over recent years.”

He maintained that the “the EU is indeed open. We are not aware that any EU Member State requires third country (non-EU) reinsurers to be licensed if they wish to enter into reinsurance contracts with EU reinsurers while operating outside the EU.” He added that only three of the EU’s 27 Member States even have collateral requirements, “and even then the same rules apply to all reinsurers, unlike the U.S.”

True reciprocity with Europe, would, according to McGovern require that the following steps be taken:
– the immediate removal of collateral requirements for reinsurers from the 24 EU States that currently impose no collateral requirements on US reinsurers; and
– a non-discriminatory collateral system in the US (unlike the current US system which, as stated above, only imposes collateral on ‘aliens’) for reinsurers from the three EU States which currently have collateral rules.

He also said that opponents’ fears that EU Member States “may choose in the future to alter their laws to require collateral for third country cross-border reinsurance transactions,” is ill founded. Even though laws may change, this “argument overlooks a basic fact: if those 24 Member States had favored the use of collateral as a regulatory mechanism, they could already have imposed such requirements,” McGovern wrote. “They have not done so and none has indicated that it proposes to introduce new collateral obligations on third country reinsurers in the future. To do so would be against international regulatory trends and counter to the direction of the thinking of the International Association of Insurance Supervisors. It is the U.S system that looks increasingly isolated and out of step with the international community.”

As further evidence of the EU’s openness in the reinsurance market, he pointed to the community’s “acceptance of the GATS ‘Understanding in Financial Services.’ This Understanding includes a requirement that each signatory has to permit non-resident suppliers of reinsurance and retrocession services to supply such services under national treatment terms and conditions.”

“As with the enforcement of judgments ‘red herring’, this latest debate is rooted not in practical examples of real problems having been encountered by opponents of US collateral reform but more in the language of possible problems that might conceivably arise in the future if laws should be changed.

“The fact of the matter is that discrimination does not apply when US reinsurers trade cross-border into the EU. By contrast, EU and other alien reinsurers face massive financial discrimination under the current US reinsurance collateral rules when trading cross-border into the US. That is the real issue at the heart of this debate.”

Source: Lloyd’s