Collateral on a cession follows the reinsurer's rating

When a US insurer passes risk to a reinsurer, it only gets balance sheet credit for that protection if the reinsurer qualifies. If the reinsurer does not qualify, collateral has to fill the gap.

A few terms help here. Passing risk on is called ceding, and the insurer doing it is the cedent. The amount the reinsurer would owe back on ceded claims is the recoverable. The cedent can count it on its statutory balance sheet, the one it files with regulators, only when the reinsurer qualifies. When the reinsurer does not qualify, the cedent needs collateral for the full amount. Collateral is simply assets set aside as security, so there is something to draw on if the reinsurer does not pay.

The schedule is public

Under the NAIC credit for reinsurance model regulation (the NAIC is the National Association of Insurance Commissioners, which brings US state insurance regulators together), a certified reinsurer posts security against ceded liabilities according to its rating. A certified reinsurer is one that a state regulator has assessed and rated. The schedule runs from 0% at Secure-1, 10% at Secure-2, 20% at Secure-3, 50% at Secure-4 and 75% at Secure-5 up to 100% at Vulnerable-6.

A reinsurer in a reciprocal jurisdiction, meaning one the US recognises as supervising insurers to a comparable standard, posts nothing if it holds at least $250m of capital and surplus (roughly its net worth) and passes the solvency tests. An unauthorized reinsurer, one with no recognised standing with the state, posts everything.

So the money locked up behind a cession tracks the reinsurer's certification more closely than the exposure being ceded. It works a bit like a landlord who sets the deposit by the tenant's credit record instead of by the size of the flat.

What the locked-up money costs

Someone pays for that money to sit still. Hamilton Insurance Group's October 2024 filing prices a $230m unsecured letter of credit facility at 162.5 basis points a year. A letter of credit is a bank's written promise to pay the cedent if the reinsurer does not, and a facility is the bank's standing commitment to issue them up to an agreed amount. Unsecured means the bank takes no specific assets as pledge. A basis point is one hundredth of a percentage point.

How long the money stays put depends on the line of business. Property collateral is released as the exposure runs off, that is, as the covered period ends and claims settle. Casualty collateral stays posted while the tail develops, which takes years. Casualty covers liability claims, and the tail is the stretch after a policy year in which those claims are still being reported and settled.

The cost of arranging and administering that security is set per placement rather than by the size of the cession, which is why it lands hardest on the smallest programmes. A placement is one reinsurance deal arranged from start to finish.

At NextBlock RWA, the collateral behind a ceded position sits in a ring-fenced vault, kept apart from other assets, and is valued continuously by Wavenure, our proprietary engine, instead of being confirmed once a year.

In plain words

Regulators let an insurer count reinsurance as real protection only when the reinsurer is trusted or has posted collateral. How much collateral depends mostly on the reinsurer's rating. The cost of arranging it does not shrink with the deal, so small deals feel it most.

Information only. Not an offer or solicitation.