April 11, 2011 

By: Michael J. Kurtis and Susan T. Stead

This article is an interpretation of current law and is offered for informational purposes only. This material is not legal advice and should not be construed or used as a substitute for the advice of an attorney.

The Reinsurance and Surplus Lines Stimulus and Enhancement Act (Act 2670), recently passed in New Jersey, permits insurance regulators to reduce the reinsurance collateral requirement imposed upon non-U.S. reinsurers. The law does not, in itself, reduce the collateral requirements. It does, however, provide discretion to state regulatory authorities to enact regulations that reduce the current requirement from 100% to significantly lower levels and to allow ceding insurers to claim credit for reinsurance if the assuming reinsurer satisfies specific financial and regulatory benchmarks.

There is a significant benefit in a cedant's ability to claim credit for its reinsurance recoverables. Only cedants with authorized or accredited reinsurance can use this favorable accounting treatment, by which reinsurance recoverables are listed as an asset on the cedant's financial statements, which in turn acts to enhance the cedant's surplus. Conversely, cedants with unauthorized, unsecured reinsurance cannot take advantage of such accounting treatment unless the reinsurer posts security equal to (under most regulatory schemes) 100% of the U.S. liabilities for which the credit is claimed. Because regulators view unauthorized reinsurers as a higher financial risk, excessive unauthorized reinsurance may attract scrutiny or rating agency attention. In addition, cedants using unauthorized, unsecured reinsurance are required to reflect the higher risk by recording a liability on their filed financial statements. This in turn impacts a cedant's underwriting results and surplus, which do not benefit from unauthorized reinsurance to the extent that they would from authorized reinsurance.

Act 2670, and the corresponding regulatory changes, will afford reinsurers greater flexibility in how they deploy their capital, and is touted to support favorable lower reinsurance rates charged to New Jersey domestic insurers. In a May 2010 statement applauding the proposal of the bills that ultimately became Act 2670, Tom Considine, Commissioner of New Jersey's Department of Banking and Insurance, opined that the legislation would result in more jobs and economic growth in New Jersey's insurance industry and provide consumers with more choices. Commissioner Considine went as far as to say that the goal "is to make the western shores of the Hudson River into the Silicon Valley of reinsurance."

This change marks what appears to be an emerging trend among state reinsurance regulatory schemes. Florida was the first state to enact such legislation in 2007, permitting its insurance regulators to establish regulations requiring lower collateral for non-U.S. reinsurers. New York followed suit and passed legislation that gave rise to changes in regulations that took effect on January 1, 2011, permitting non-U.S. reinsurers to put up only 20% of their non-life loss reserves as collateral. Texas legislators have also considered similar changes to their reinsurance regulatory scheme.

Close attention should be paid to the particular regulations that emerge in New Jersey as a result of this recent law. Cedants and reinsurers alike should continue to monitor the status of proposed legislation in other states affecting reductions in reinsurance collateral requirements. In addition, cedants and reinsurers will be sure to keep a close watch for activity from the Federal Insurance Office (established by the Dodd-Frank Act) under its newly-appointed head, Michael McRaith, empowered to identify regulatory issues that threaten the insurance industry or the broader financial health of the United States.

For further insight on issues impacting both the domestic and international reinsurance markets, including claims and transactional matters, please contact Michael Kurtis at 215.358.5139 or via email at mkurtis@nldhlaw.com or Kenneth Levine at 215.358.5170 or via email at klevine@nldhlaw.com.