We live in a world of ever-expanding risks. Just as insurance companies find themselves being asked to cover the expanding risks of their policyholders, which reinsurance companies are then asked to reinsure, so too it appears that efforts to regulate the reinsurance industry keep expanding. Reinsurers today are inundated with unprecedented attempts at regulating how, when, and where reinsurers can do business on a global, national, and state level. This onslaught of regulatory activity comes not only from traditional insurance regulators but also from attorneys general, taxing authorities, sanctioning authorities, and other governmental, quasi-governmental, and industry entities.
Compliance—once thought of as a corporate backwater and a dead-end career—has vaulted into prominence within reinsurance organizations. The ability to navigate through the maze of overlapping and inconsistent regulatory oversight has become a sought-after skill. This commentary will touch on some of these issues. It is not intended to be an in-depth reinsurance regulatory manual, but only an introduction to a very broad topic that is becoming worldwide in its scope.
Insurance Regulation in General
Insurance is a regulated industry. It has been for a very long time. A company cannot just simply incorporate in a state and start writing insurance. State insurance regulators and state insurance laws must be satisfied before one can start an insurance business. While some of these regulations are uniform nationally, many laws and regulations are unique to each particular jurisdiction.
Insurance regulation comes in a wide variety of forms. Most regulations of the insurance industry are state-based regulations. There are state insurance regulations concerning financial requirements and solvency status, policy forms, ownership, investments, claims handling, advertising, lines of business, and myriad other topics. Insurance companies are required to file many different reports with state regulators setting forth details about their business and breaking down their financial status and risks. Regulators examine insurance companies under their jurisdiction periodically to make sure that the state's laws and regulations are being complied with and that the insurance company is not in any financial trouble.
The primary reason for all this regulation is because insurance companies provide financial assurance to policyholders based on a promise to pay if claims come home to roost. Policyholders pay a premium in exchange for an insurance policy that typically promises to cover the policyholder's liabilities or damages to its property. Insurance companies set aside funds as "reserves" for the eventuality that claims will have to be paid on valid claims. Because of these consumer concerns, laws and regulations have developed over the years in an attempt to ensure that insurance companies will remain in business rather than leaving policyholders high and dry.
Regulation of reinsurance companies is not as developed as regulation of direct writing insurance companies. Reinsurance companies typically do not deal directly with the policyholder public, so the consumer-based reasons for insurance regulation typically do not apply to reinsurance companies. Also, because reinsurance is typically an insurance company to insurance company transaction, regulation of policy forms and contract wordings is typically not necessary. Reinsurance also has to be flexible to deal with the ever-changing reinsurance marketplace. Restrictive regulation would preclude the ability of reinsurers to adapt when necessary to provide the capital support essential to their customers.
Nevertheless, reinsurance companies are insurance companies, and in the United States, they must be licensed in a specific state (domicile) and must comply with their home state's laws and regulations. Also, reinsurance companies are required to comply with financial reporting and financial regulation because maintaining the solvency of reinsurance companies is critically important to maintaining the solvency of insurance companies that purchase reinsurance. Moreover, reinsurers, if not directly licensed in multiple states, may be authorized or accredited to reinsure companies licensed to do business in that state.
Reinsurers not located in the United States often reinsure insurance companies writing business in the United States. Non-US reinsurers typically are permitted to do that because they have met certain financial and regulatory requirements (accredited) or because they have posted collateral or security to ensure that any obligations to their reinsureds will be paid.
Global Regulation of Insurance and Reinsurance
Because many insurance organizations are global in nature, and because of the European Union's (EU's) movement toward a uniform regulatory environment for insurance providers within the EU, insurance regulation is becoming more globalized. The recent financial crisis in both Europe and the United States has caused European insurance regulators and others to develop international solvency standards to protect the public against global insurance insolvencies. International insurance regulators, accounting organizations, and actuarial societies have been working for years on solvency standards and uniform reporting and disclosure requirements for insurance companies servicing a global economy.
Part of this push toward global financial regulation of insurance companies is to level the playing field so that all insurance providers are treated fairly in all jurisdictions. For example, for a non-US reinsurer to reinsure a US-based insurer, typically the non-US reinsurer must post collateral to secure its obligation to pay reinsurance claims. More recently, both on a national level through the National Association of Insurance Commissioners and on a state level (New York being one example), the collateral requirements have been lessened or eliminated for non-US reinsurers if they meet certain financial criteria. Having uniform financial standards allows all companies to be treated the same in all jurisdictions without having to worry about special collateral requirements.
Globalization of insurance regulation affects reinsurance companies as well. Many of the capital requirements and financially based regulations apply equally to reinsurance companies. Reinsurance companies have also come under scrutiny from EU regulators and international accounting and actuarial organizations in the context of avoiding a further economic crisis.
Increased Scrutiny and Increased Regulation of Reinsurers
Recent developments have spawned a bevy of initiatives aimed at regulating international reinsurers. These range from capital standards to solvency to sanctions for reinsuring insurance companies doing business with parties on sanctions lists.
A current example of the expansion of regulation over global insurance and reinsurance organizations is the idea that an insurance company can be so systematically important to an economy that it must be designated too big to fail. What that designation means is yet another set of capital and financial requirements imposed upon designees beyond the existing insurance regulations. Efforts to determine whether insurance and reinsurance companies are systemically significant are taking place simultaneously on a global basis with the international Financial Stability Board and within the United States under the Financial Stability Oversight Council of the Treasury Department.
Both of these organizations were created to deal with the failure of large banks and investment firms and the effects of those failures on local and world economies. In looking at whether financial institutions are too big to fail, these organizations have targeted banks and investment firms, but they have also examined and designated nonbanking organizations, including some insurance companies, as too big to fail.
For example, the Financial Stability Board has designated nine systemically important insurers, which include insurance companies that have reinsurance divisions or subsidiaries. The Financial Stability Oversight Council has only designated one insurance company to date, but others may be designated in the future, including companies with reinsurance divisions or subsidiaries. Enforcement of these designations is currently being debated before the G20.
Another example of expanding regulation over reinsurance is sanctions. Violations of economic sanctions instituted by the United States and other countries against persons, groups, or countries that are considered outside proper international behavior are starting to be an issue for reinsurers. For example, the country of Iran and many people, organizations, and businesses connected to Iran are listed on sanctions lists. Reinsurers may find themselves subjected to possible sanctions if they or their affiliates reinsure ceding insurers that happen to write insurance for a person or organization on the ever-changing sanctions lists.
For example, if a company is shipping goods on a freighter owned by an organization on a sanctions list, a reinsurer of the insurance company that provides the insurance for that shipment or that vessel may find itself facing penalties for violating Iranian sanctions. It is much more complicated than this, but what may appear to be tenuous connections may be enough for sanctioning authorities like the US Treasury Department's Office of Foreign Asset Control (OFAC) to have a problem with the relationship.
And even with OFAC examining reinsurance transactions for possible sanctions violations, just recently the New York Department of Financial Services began inquiring among international reinsurers that are either certified or accredited in New York about their assumption of risks that might involve Iran. Thus, state regulators are getting in on the act by using state regulatory inquiry authority to question international reinsurers about whether they might be violating Iranian sanctions.
Taxes are another example of expanding regulation of reinsurance. Offshore reinsurers have been the target of various efforts to rein in what some see as funds going offshore instead of being taxed in the United States. Various tax bills addressing so-called tax reforms have provisions addressed to offshore entities, including offshore reinsurers. This is an area that non-US reinsurers (and insurers) are watching carefully if they do business in the United States or have US subsidiaries.
Another tax area affecting reinsurers is the Foreign Account Tax Compliance Act (FATCA), which has certain reporting and withholding requirements for foreign financial and nonfinancial institutions, including reinsurance intermediaries, depending on how a company is defined. This is a somewhat complicated area of tax law, but the focus is on US taxpayers with foreign accounts or assets or non-US entities in which US taxpayers hold a substantial interest. FATCA deals with withholdings required under certain circumstances for qualified entities under the act.
What this short list above shows is that there is more and more domestic and global scrutiny being applied to reinsurers beyond traditional local insurance regulation. The increased globalization of the insurance industry and the concerns about equal treatment and systemically important institutions, along with sanctions, have fueled these changes. While reinsurers continue to require the flexibility to meet the challenges of nontraditional competitors and to respond to the needs of their customers, the increased regulatory burden just adds to these challenges—challenges the traditional reinsurance industry does not need, considering the competition it now faces from the capital markets.
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