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

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

4. 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. 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. 6 Research Question Valuable solvency protection? Unfair trade protection? What does the market think? How does the PFUR affect the price of insurance?

7. 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. 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. 9 Data NAIC Property-Casualty Database 2001-2004 25% of insurers report a provision for reinsurance

10. 10 Methodology PFUR it =  +   X it +   % FOREIGN it +  it Eq. (1) PRICE it =  +  (PFUR it = PFURHAT it ) +   X it t +  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. 11 Summary Statistics

12. 12 Results

13. 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. 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