Having given its blessing to captive reinsurance, the New York State Insurance Department may write a regulation that would make the business less attractive to some lenders.

In captive reinsurance, lenders assume some default risk by reinsuring loans, and receive a portion of the premiums. In a Feb. 1 letter, the department said it deemed such arrangements legal under New York's insurance laws.

But now the department is thinking about requiring captive reinsurance units to use the "quota-share" structure-meaning the lenders would pay claims starting with the first dollar of loss.

More common is the "excess-loss" arrangement, under which the captive reinsurer does not have to pay claims until losses have reached a certain threshold.

New York's Insurance Department has what amounts to extraterritorial authority: If an insurer does something in another state that is illegal under New York's insurance laws, the department can bar it from selling insurance in New York.

Mandating the quota-share structure "would be annoying for the lenders," said Kenneth A. Posner, an analyst at Morgan Stanley Dean Witter. "They have attractive excess-of-loss provisions and are getting premiums for taking very little risk."

The Feb. 1 letter deemed several other mortgage insurance practices illegal, on the grounds that they amount to rebates.

The letter added that the department was "developing guidelines, and, if appropriate, a regulation which will articulate the parameters under which (captive) reinsurance arrangements will be permitted." It said the department wanted to "ensure that the transactions constitute a legitimate transfer of risk."

A department spokeswoman said it was considering making the quota-share arrangement mandatory, because "the transfer of risk is more apparent. Under the excess-loss structure, we may not be able to see the transfer of risk." She added that the department has not made a final decision but hopes to have a draft regulation out by the end of the month.

Vincent Laurenzano, former assistant deputy superintendent at the New York Insurance Department, advocates a mandatory quota-share structure. Such a regulation would ensure that "the captive created by the lender is really in the insurance business and at risk for losses, and is not a means of sending money over without any transfer of risk," said Mr. Laurenzano, who left the department in November 1997. He is now an insurance consultant at Stroock, Stroock & Lavan LLP in New York.

In the excess-loss structure, the premium paid to the reinsurer "may not be commensurate with losses that are likely to be incurred," he said.

Jim Engelhardt, executive vice president of credit risk management at Norwest Mortgage, disagrees. "Companies should be allowed to enter into any reinsurance structure that meets their needs," he said. Though reinsurance is relatively new in mortgage insurance, "these structures have been out there for years."

Mr. Engelhardt disputed the notion that the excess loss structure is a sweet deal for lenders. "It's a good deal for both parties," he said. "It allows us to share risk at a certain mezzanine level, and for the (insurer) to offload that risk."

Norwest entered captive reinsurance last year. Its volume so far has been "minimal," Mr. Engelhardt said, but "we see that increasing over the next six to 12 months."

Norwest has used the excess-loss structure only in its captive arrangements. "Right now excess-loss is a better execution," Mr. Engelhardt said.

The mortgage insurance industry has come under pressure in recent years, as price competition has forced companies to find ways to entice lenders to do business with them.

Requiring the insurers to use the quota-share reinsurance structure would not help, Mr. Posner said. "If the regulator forestalls some avenues for giving good pricing, they'll have to find another way to compete," he said.

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