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
• Lloyds of London not necessary for old and
  strong reinsurers (such as Lloyds)
• 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 Lloyds and other large
  insurers to reduce collateralization requirements
  for financially strong alien reinsurers