S&P: Reinsurance May Be An Increasingly Rotten Crutch

Other U.S. insurers and U.S. insurance regulators demand that foreign reinsurers have enough collateral to back 100% of their exposures to U.S. insurers, the S&P analysts write.

In the short run, requirements that reinsurers supply extra collateral may distort the market by helping weak reinsurers, because collateral makes the reinsurance supplied by weak companies look as secure as reinsurance supplied by strong companies, the analysts observe.

In the long run, although the probability of a reinsurer and a bank failing simultaneously is low, "the wisdom of relying on banks to provide collateral remains subject to question," the analysts write. A letter of credit "is only as good as the bank behind it, and many of the institutions providing them are rated lower than the reinsurers they are backing."

Moreover, a bank may include provisions in a letter of credit that give it the right to back out when a reinsurer is suffering from serious financial problems, the analysts write.

The analysts also argue that U.S. reinsurers would have a hard time coming up with enough collateral to back 100% of their exposures if regulators required them to do so.