The Breadth and Scope of the Global Reinsurance Market and the Critical Role Such Market Plays in Supporting Insurance in the United States FEDERAL INSURANCE OFFICE, U.S. DEPARTMENT OF THE TREASURY Completed pursuant to Title V of the Dodd-Frank Wall Street Reform and Consumer Protection Act DECEMBER 2014 The Breadth And Scope Of The Global Reinsurance Market And The Critical Role Such Market Plays In Supporting Insurance In The United States Table of Contents I. INTRODUCTION .................................................................................................................. 1 II. BRIEF HISTORY OF REINSURANCE ................................................................................ 3 III. DEFINITION AND FORMS OF REINSURANCE............................................................ 7 A. Reinsurance Defined ........................................................................................................ 7 B. Forms of Reinsurance....................................................................................................... 8 1. Treaty Reinsurance ....................................................................................................... 8 2. Facultative Reinsurance .............................................................................................. 10 IV. THE PURPOSE AND IMPORTANCE OF REINSURANCE ......................................... 11 A. Uses of Reinsurance ....................................................................................................... 11 1. Stabilizing Underwriting Results................................................................................ 11 2. Increasing Underwriting Capacity .............................................................................. 11 3. Supporting Entry Into and Exit from Insurance Markets ........................................... 12 4. Promoting Capital Allocation among Affiliates ......................................................... 13 5. Achieving Risk Concentration or Diversification ...................................................... 13 B. The Importance of Reinsurance ..................................................................................... 14 V. REGULATION OF REINSURANCE IN THE UNITED STATES .................................... 18 A. Direct Regulation ........................................................................................................... 19 B. Indirect Regulation ......................................................................................................... 19 C. Federal Involvement in Reinsurance and Industry Oversight ........................................ 20 D. Credit for Reinsurance Collateral Reform ..................................................................... 23 VI. GLOBAL REINSURANCE MARKETS .......................................................................... 26 A. The U.S. Insurance Sector as Purchasers of Reinsurance .............................................. 26 B. Global Suppliers of Reinsurance .................................................................................... 28 1. Reinsurance Industry Data .......................................................................................... 28 2. United States Reinsurance Sector ............................................................................... 34 3. Non-U.S. Reinsurance Sector ..................................................................................... 36 C. Increasing Capital Markets Convergence With Reinsurance ......................................... 38 1. Types of Alternative Reinsurance .............................................................................. 39 2. Development of the Alternative Reinsurance Market ................................................ 40 VII. CONCLUSION .................................................................................................................. 43 FEDERAL INSURANCE OFFICE, U.S. DEPARTMENT OF THE TREASURY i The Breadth And Scope Of The Global Reinsurance Market And The Critical Role Such Market Plays In Supporting Insurance In The United States Glossary A/H ........... Accident & Health Insurance BCR ........... Basic Capital Requirement CEA ........... California Earthquake Authority ComFrame ........... Common Framework for the Supervision of IAIGs Council ........... Financial Stability Oversight Council Dodd-Frank Act ........... Dodd-Frank Wall Street Reform and Consumer Protection Act FAA ........... Federal Aviation Administration FCIC ........... Federal Crop Insurance Corporation FEMA ........... Federal Emergency Management Agency FHCF ........... Florida Hurricane Catastrophe Fund FIO ........... Federal Insurance Office FIO 2014 Annual Report ........... U.S. Department of the Treasury, Federal Insurance Office Annual Report on the Insurance Industry (2014) FRN ........... Federal Register Notice of June 27, 2012 FSB ........... Financial Stability Board G-SII ........... Global Systemically Important Insurer GWP ........... Gross Written Premiums HLA ........... Higher Loss Absorbency IAIG ........... Internationally Active Insurance Group IAIS ........... International Association of Insurance Supervisors ILS ........... Insurance-Linked Securities ILW ........... Industry Loss Warranty LAE ........... Loss Adjustment Expenses L/H ........... Life & Health Insurance Model Law ........... NAIC Credit for Reinsurance Model Law and Regulation Modernization Report ........... Department of the Treasury, How to Modernize and Improve the System of Insurance Regulation in the United States (December 2013) NAIC ........... National Association of Insurance Commissioners NFIP ........... National Flood Insurance Program NRRA ........... Nonadmitted and Reinsurance Reform Act of 2010 NWP ........... Net Written Premiums OPIC ........... Overseas Private Investment Corporation P/C ........... Property & Casualty Insurance PHS ........... Policyholders’ Surplus Project ........... EU-U.S. Insurance Project SPV ........... Special Purpose Vehicle Treasury ........... U.S. Department of the Treasury TRIA ........... Terrorism Risk Insurance Act of 2002, as amended TRIP ........... Terrorism Risk Insurance Program USTR ........... United States Trade Representative FEDERAL INSURANCE OFFICE, U.S. DEPARTMENT OF THE TREASURY ii The Breadth And Scope Of The Global Reinsurance Market And The Critical Role Such Market Plays In Supporting Insurance In The United States I. INTRODUCTION By premium volume, the United States is the largest single-country insurance market in the world. Insurers operating in the United States rely on reinsurers, both foreign and domestic, to support the issuance of new policies, to minimize fluctuations in loss experience, and to limit and diversify individual and portfolio risks, particularly in the case of catastrophes and natural disasters. Reinsurance is a contract of indemnity between commercial parties – an insurer (i.e., the “cedent” or “ceding insurer”) and one or more “assuming insurers” (i.e., reinsurers) – by which, in exchange for a premium, a specified portion of the risks under one or more insurance policies written by the cedent are transferred (“ceded”) to the reinsurers. Reinsurance serves a variety of functions, and can be tailored to the particular needs of a given cedent. Reinsurance is commonly purchased to limit an insurer’s loss experience resulting from insured risk exposures, to increase an insurer’s underwriting capacity, to promote more efficient allocation of an insurer’s capital, or to facilitate an insurer’s entry to or exit from a particular line of business or market segment. Reinsurance serves an important function as protection for cedents against the accumulation of losses from a natural disaster or other catastrophe. “The reinsurance of peak risks originally assumed by primary insurers – i.e., risks with low probabilities of occurrence, but high severities – is the core business of reinsurers.”1 The global reinsurance market includes organizations and companies that have operated for a century or more, as well as relatively new companies and alternative forms of risk transfer. The U.S. reinsurance sector continues to be an important source of capacity for domestic insurers seeking reinsurance. Non-U.S. reinsurers also play a key role, as U.S. insurers purchase a substantial amount of reinsurance protection from companies domiciled outside of the United States, or which are part of groups headquartered outside of the United States, including in Europe, the Asia-Pacific region, Bermuda, and other jurisdictions. Additionally, in recent years, insurers, reinsurers, and various capital market participants have developed a range of insurance- linked securities and special purpose vehicles, which have a growing role in the global risk transfer market. The manner in which reinsurance is regulated in the United States depends upon whether or not the reinsurer is licensed in a U.S. state. Licensed reinsurers are subject to the same state-based regulation as other licensed insurers. Unlicensed reinsurers (typically non-U.S. companies) assuming risks from U.S. ceding insurers are indirectly regulated by state laws, including those that compel licensed insurers to obtain qualifying collateral from unlicensed reinsurers in order for the licensed insurers to take financial statement credit for liabilities ceded to such unlicensed reinsurers. Due to the global diversification of the industry, many non-U.S. reinsurers assuming risk