Financial institutions face increased risk in trading with U.S. insurers due to different state laws, Fitch Ratings cautions.

The firm says that a lack of legal clarity in the treatment of derivative counterparties in insurance company insolvencies increases the risk to firms dealing with U.S. insurers. Fitch is concerned that continued legal uncertainty could hurt insurers’ favorable access to the derivatives market, which in turn could make it harder for them to manage their risks and remain competitive longer term.

“Insurance companies, which contract with banks, broker-dealers and other counterparties to hedge their risks, are generally not covered by the federal laws which provide considerable legal certainty with respect to netting and termination rights when one party defaults,” it explains. “Insurers are governed by state laws that are not consistent from state to state and which give insurance commissioners broad discretionary power over assets in an insolvency.”

“Efforts to align state insurance laws with federal laws in this area have produced limited results,” Fitch adds. “The recent passage of the National Association of Insurance Commissioners’ Insurer Receivership Model Act is a step in the right direction, in Fitch’s view, but individual state legislatures must adopt the law for it to be effective.”