More than 80 percent of unrated reinsurance transactions are unauthorized reinsurance that includes various types of alternative risk transfers.
insurance regulators applied the Credit for Reinsurance Model Law to unauthorized reinsurance (Cole, McCullough, and Powell, 2010).
A concern regarding collateralization is that insurers that are more likely to be downgraded may choose to use more unauthorized reinsurance with collaterals to lower credit risks.
where Z is a set of factors affecting the usage of unauthorized reinsurance or ratings, which includes investment yield, the ratio of junk bonds to surplus, the percentage of business in catastrophic risk exposed lines, premium to surplus ratio, reserve to surplus ratio, combined ratio, BCAR, log asset, lagged financial rating, industry combined ratio, single unaffiliated firm dummy, and publicly traded firm dummy.
The average ratio of authorized reinsurance recoverable from downgraded unaffiliated reinsurers to policyholders' surplus is 2.75 percent, and the ratio for unauthorized reinsurance recoverable is 0.56 percent.
(8) On November 6,2011, the NAIC Executive Committee and Plenary adopted the revised Credit for Reinsurance Model Law that intends to reduce the collateral requirements for unauthorized reinsurance (McHugh, 2012).
Such reserves include unauthorized reinsurance
, excess of statutory loss reserves over statement reserves, dividends to policy-holders undeclared, and other similar reserves established voluntarily or in compliance with statutory regulations.
If the rent-a-captive is acting as a reinsurer, it will be required to establish some form of security, either a trust fund or a letter of credit, with the fronting carrier, to allow the carrier to take credit for the unauthorized reinsurance
on its statutory statement.