Regulation of Reinsurance Recoverables: Protection or Protectionism?

1. Regulation of Reinsurance Recoverables: Protection or Protectionism? Presented by: Cassandra Cole, Kathleen McCullough, and Lars Powell American Risk and Insurance Association Meeting, 2006 Washington D.C.

2. Background • Reinsurance recoverables • Paid losses & LAE • Loss reserves • Unearned premium reserves • Authorized/unauthorized reinsurer

3. Background • Credit for Reinsurance Laws • Collateralization • Letter of credit / Trust account • Provision for unauthorized reinsurance • Adjustment to statutory assets

4. Motivation • Scope: • $240b in recoverables (2004) • Almost 60% of industry surplus • Cost of collateralization: • 15 to 60 basis points • Estimate $200m - $500m annually

5. Motivation • Considerable public debate • Lloyd’s of London: not necessary for old and strong reinsurers (such as Lloyd’s) • RAA (and others): • necessary to the financial strength of domestic insurers given differences in accounting methods and enforceability • Collateralization enables smaller insurers to access international reinsurance market

6. Research Question • Valuable solvency protection? • Unfair trade protection? • What does the market think? • How does the PFUR affect the price of insurance?

7. Hypotheses Development • Price of insurance is negatively correlated with insolvency risk • All else equal, if consumers are concerned about collecting uncollateralized recoverables from unauthorized reinsurers, price will be negatively related to PFUR

8. Variables • Price = inverse of economic loss ratio • [Net premium – dividends – UW expenses] / [PV (incurred losses)] • PFUR = provision for unauthorized reinsurance / net premium • Controls: firm size, group membership, organizational form, underwriting leverage, concentration of underwriting exposure, and business mix

9. Data • NAIC Property-Casualty Database 2001-2004 • 25% of insurers report a provision for reinsurance

10. Methodology PFURit =  +  Xit +  % FOREIGNit + it Eq. (1) PRICEit=  +  (PFURit = PFURHATit) +  Xitt + it Eq. (2) where, PFUR = the provision for unauthorized reinsurance scaled by net premiums written for insurer i in year t; X = a vector of exogenous financial and operational factors controlling for the size of the provision for in equation (1) and variation in price equation (2) for insurer i in year t; % FOREIGN = the percentage of premiums ceded to foreign reinsurers by insurer i in year t; PRICE = the inverse of the economic loss ratio for the insurer i during year t; and PFURHAT = the predicted values of the PFUR variable(s) in equation 1 for insurer i in year t used as instrument for these variable(s).

11. Summary Statistics

12. Results

13. Conclusions • There are significant differences in insurers with and without PFUR. • PFUR is negatively related to price. • Initial results suggest Credit for Reinsurance Laws provide protection for U.S. insurers accessing international markets.

14. Further Research • Explore differences for primary insurers and reinsurers • More fully explore the determinates of PFUR • Evaluate proposals by Lloyd’s and other large insurers to reduce collateralization requirements for financially strong alien reinsurers