State insurance regulators are thinking about how life insurers should treat collateral in trusts when computing risk-based capital ratios for life reinsurance ceded reserve credits.

The topic was due for discussion at the spring meeting of the National Association of Insurance Commissioners, Kansas City, Mo., which began in Orlando on March 28.

A subgroup of the NAIC’s Capital Adequacy Task Force is reviewing a proposal that discusses the topic of trusteed collateral.

Under the current rules, the computation for net reinsurance ceded risk does not provide a credit charge offset for reinsurance contracts with authorized reinsurers supported by trusteed collateral, according the authors of the proposal.

Authorized reinsurers are reinsurers that are licensed to do business in a state or jurisdiction; non-authorized reinsurers are not licensed to do business in that state or jurisdiction.

When insurers do business with non-authorized reinsurers, the resulting reinsurance treaties must be backed with letters of credit, a trust agreement, funds withheld or other guarantees.

However, reinsurance arrangements secured with “funds held” arrangements do qualify for a credit charge offset.

Funds withheld are monies a ceding company holds to get credit for non-admitted reinsurance, to reduce credit risk or to retain control over investments.

Some reinsurers are arguing that funds in a trust are equivalent to the funds held and ought to qualify for the same offset.

The authors of the CATF subgroup proposal are recommending a change in the rules to incorporate the principle that collateral held in a trust by an authorized reinsurer “may be considered legally and economically equivalent to funds held for purposes of credit risk if there is evidence of periodic draws upon such collateral.”

The term “collateral” already is defined in the Credit for Reinsurance Model Law and Regulations and codified in an appendix to the NAIC Accounting Practices and Procedures Manual, the authors of the proposal note.

In the life RBC ratio computation instructions, the risk associated with the recoverability of money from reinsurers is comparable to highly-rated NAIC bond classes 1 and 2 and is consequently assigned a 0.8% pre-tax factor, the authors of the proposal write.

A 0.8% credit is given to avoid overstatement of RBC for reinsurance with non-authorized companies, affiliated companies, funds withheld, for collateral other than funds withheld supporting non-affiliate reinsurance and for reinsurance involving policy loans, the authors of the proposal write.

Regulators already are discussing the role of reinsurance collateral held in trusts, and a number of issues have come up.

Regulators are asking whether:

–Changing treatment of trusteed collateral can be a short-term project or must be a long-term project.

–Addressing the issue for authorized reinsurers would lead to requests that regulators apply the same changes to unauthorized reinsurers.

–The 0.8% factor is too high.

–Withdrawals from the collateral should be required as part of the reinsurance agreement. Some regulators ask why such a requirement would be necessary; some say it would guarantee that a ceding company has access to the funds in the trust; and some say a ceding company would be better off if it avoided touching the collateral.