• NAIC Considers Changes to Credit for Reinsurance Model Law and Regulation to Address the US-EU Covered Agreement
  • February 28, 2018 | Authors: Daren L. Moreira; John S. Pruitt
  • Law Firm: Eversheds Sutherland (US) LLP - New York Office
  • The National Association of Insurance Commissioners (NAIC) held a public hearing in New York on February 20, 2018, to receive comments on the steps it should take to address the reinsurance collateral provisions of the Bilateral Agreement Between the United States of America and the European Union on Prudential Measures Regarding Insurance and Reinsurance (Covered Agreement).

    The Context. The Covered Agreement eliminates US reinsurance collateral requirements for qualified reinsurers domiciled in European Union (EU) member countries and gives US states five years to implement new rules. Otherwise, current state credit for reinsurance laws and regulations imposing such requirements will be pre-empted. For additional background on the Covered Agreement and its genesis, see our Legal Alert: US-EU Covered Agreement: An Overview.

    The preemption threat tests the states’ ability to work collectively to preserve the primacy of state regulation of insurance. The Covered Agreement also raises a number of issues for states to resolve as they work on amendments to existing laws and regulations to bring them into conformity with the Covered Agreement. Prior to the hearing, the NAIC solicited comments on these issues—namely, whether the existing credit for reinsurance model law and regulation need to be changed, whether they should accommodate future possible covered agreements, whether similar treatment should be extended to reinsurers in other jurisdictions that qualify as “qualified jurisdictions” under the current rules, whether changes to the criteria for evaluating “qualified jurisdictions” should be changed, and whether additional “guardrails” for US ceding insurers should be established to address increased financial solvency risks caused by the elimination of reinsurance collateral.

    Maria T. Vullo, Superintendent of the New York State Department of Financial Services and NAIC Reinsurance (E) Task Force Chair, touched on these themes in her opening remarks. She expressed the belief that preemption should be avoided and said there are a variety of paths states could follow in order to conform with the Covered Agreement. She noted that new regulatory approaches for US ceding insurers was a topic for consideration on a complementary track, commenting that the Covered Agreement has compelled redefinition of state solvency regulation of reinsurance as insurers face additional solvency risk by not taking into account the solvency risk of EU reinsurers.

    Public Comments. Representatives from 17 different insurance groups and trade associations, from both the US and abroad, testified over several hours (with several more interested parties providing only written testimony). Given the broad range of US and international interests represented, there was a striking number of consistent themes among those testifying. Common themes included:

    • The Credit for Reinsurance Model Law and Regulation should be modified to eliminate reinsurance collateral requirements for EU-based reinsurers, as required under the Covered Agreement, but the amendments should be done in a way that is as simple as possible to allow for state adoption.
    • Reinsurance collateral requirements should also be eliminated for qualified reinsurers (based on the standards set out in the Covered Agreement) domiciled in NAIC Qualified Jurisdictions (which currently include Bermuda, France, Germany, Ireland, Japan, Switzerland and the United Kingdom).
    • The amendments to the Credit for Reinsurance Model Law and Regulation should allow flexibility to accommodate possible future covered agreements between the US and other jurisdictions (although state regulators and some industry representatives have made it clear that they would prefer there be no additional covered agreements).
    • The amendments to the Credit for Reinsurance Model Law and Regulation should provide for automatic reversion to existing collateral requirements should a jurisdiction or a reinsurer fail to satisfy applicable requirements.
    • There is no need for additional “guardrails” for US ceding insurers to address increased solvency risks caused by the elimination of collateral. Some interested parties noted that adequate guardrails already exist under the newly updated Reinsurance Credit Risk factor in the Property and Casualty RBC formula (known as “R3”), which state insurance regulators use to assess the capital adequacy of US property and casualty insurers (one industry representative noted that a comparable risk charge exists for life insurers). Interested parties also noted that, while collateral may no longer be required for US ceding insurers to take financial statement credit for cessions to qualified EU reinsurers, US ceding insurers may still negotiate for collateral under the reinsurance contract.

    Some meeting participants did raise concerns:

    • Some representatives from US insurance groups and trade associations urged regulators to ensure that comparable concessions are made by any jurisdiction outside of the EU before the benefits of the Covered Agreement are extended to reinsurers domiciled in those jurisdictions—specifically, mutual recognition of the US group supervision and group capital regimes.
    • Some regulators questioned the states’ ability to memorialize or enforce criteria for eliminating collateral requirements for non-EU reinsurers that are not subject to a covered agreement. However, industry representatives noted that the NAIC has already established a process for enforcing criteria for reduced collateral for non-US certified reinsurers, and that this process is memorialized through memoranda of understanding (MoUs) between the states and the various NAIC Qualified Jurisdictions.
    • Some interested parties urged regulators to consider using financial strength ratings as a criterion for collateral elimination (rather than a reinsurer’s Solvency Capital Requirement (SCR), as contemplated in the Covered Agreement) on the basis that financial strength ratings are more widely accepted and are updated more frequently.
    • Finally, several representatives from US insurance groups urged the NAIC to memorialize in any amendments to the Credit for Reinsurance Model Law and Regulation some of the key concepts that appear in the joint policy statement on implementation of the Covered Agreement that was issued by the US Treasury and the US Trade Representative—specifically, recognition of the US state-based system of regulation and that elimination of reinsurance collateral requirements only applies prospectively.

    Next Steps. NAIC President, Commissioner Julie Mix McPeak (TN) announced the NAIC’s proposed timeline for adopting any necessary amendments to the Credit for Reinsurance Model Law and Regulation:

    • 2018 Spring National Meeting (March): Financial Condition (E) Committee expected to adopt a formal Request for Model Law Development to amend the Credit for Reinsurance Model Law and Regulation.
    • 2018 Summer National Meeting (August): Draft amendments to the Credit for Reinsurance Model Law and Regulation to be available.
    • 2018 Fall National Meeting (November): NAIC to adopt amendments to the Credit for Reinsurance Model Law and Regulation.
    While this timeline may seem aggressive, it may be necessary to avoid federal preemption of state credit for reinsurance rules that are inconsistent with the Covered Agreement. The reinsurance collateral reduction elements of the Covered Agreement are to be fully implemented within five years, but the US is required to encourage states to adopt phase-in provisions for the gradual elimination of collateral requirements (a 20% annual reduction from current levels). The Director of the Federal Insurance Office (FIO) is also to begin evaluating US state insurance laws and regulations for preemption within three and one-half years. With the US having signed the Covered Agreement in September and the EU Parliament scheduled to vote on adoption of the Covered Agreement on March 1, the clock may soon begin ticking for state insurance regulators.