The Office of General Counsel issued the following opinion on May 13, 2004, representing the position of the New York State Insurance Department.
Re: § 1115(a) Use of a Letter of Credit in Place of Reinsurance
May an insurer that assumes a risk that is greater than 10% of its surplus to policyholders be able to substitute, in place of reinsurance, a letter of credit in the sum of that portion of the risk that exceeds the 10% limitation?
No, an insurer that assumes a risk that is greater than 10% of its surplus to policyholders may not substitute a letter of credit in the sum of that portion of the risk that exceeds the 10% limitation in place of reinsurance.
This inquiry was general in nature but provided that the letter of credit used would be obtained from a bank whose letters of credit are approved by the NAIC or the New York Insurance Department for reinsurance purposes.
New York Ins. Law § 1115(a) provides, in pertinent part, as follows:
Except as otherwise provided in this chapter, no insurer doing business in this state shall expose itself to any loss on any one risk in an amount exceeding ten percent of its surplus to policyholders. In determining the amount of risk, any portion reinsured in an assuming insurer authorized to do such business in this state or in an accredited reinsurer, as defined in subsection (a) of section one hundred seven of this chapter, shall be deducted. In determining the limitation of risk under any provision of this chapter, "surplus to policyholders" shall include voluntary reserves, or any part thereof, not required by law, and be determined from the insurer's last sworn statement on file with the superintendent, or the last report on examination filed by the superintendent, whichever is more recent at the time the risk is assumed.
N.Y. Ins. Law § 1115(a) (McKinney 2000).
The rule set forth in the above-quoted section was enacted to prevent an insurer from being exposed to a single potential loss of excessive magnitude relative to its resources. The issue at hand is whether an insurer, which assumes a risk that is greater than 10% of its surplus to policyholders, may be able to substitute, in place of reinsurance, a letter of credit in the sum of that portion of the risk that exceeds the 10% limitation. It is the position of this Office that the language of the statute does not permit such substitution. The express language of the statute only allows for the reinsurance of such large risks and does not allow for any other financial mechanism.
In addition, a letter of credit cannot be regarded as the equivalent of reinsurance in this case. In the situation governed by the statute, an insurer is permitted to take on an excessively large risk only if a portion if that risk is ceded to a reinsurer. When this takes place, the cedents exposure to that risk is limited to the statutorily permissible level, and the balance of the risk is the responsibility of the assuming company. No such mitigation of the excess risk occurs when a letter of credit is obtained. The purchase of the letter of credit by the insurer does nothing to increase its surplus; it is merely a more secure way of ensuring payment. Were a letter of credit purchased by the insurer, the insurer would still be ultimately responsible for the entire loss, a loss that the statute considers too large relative to its surplus. Therefore, a letter of credit may not be substituted for the purchase of reinsurance in an attempt to comply with N.Y. Ins. Law § 1115(a).
For further information you may contact Supervising Attorney Michael Campanelli at the New York City Office.