United States: U.S., EU Enter Into Covered Agreement On Insurance; Congress Reacts

On Jan. 13 – in the waning days of the Obama administration – the U.S. Department of the Treasury and the Office of the U.S. Trade Representative (USTR) released the terms of the long-awaited covered agreement between the U.S. and the European Union (the "Covered Agreement") on prudential insurance matters. A congressional hearing held on February 16 exposed concerns in connection with the Covered Agreement around process, federalism and the direction of U.S. insurance regulation.

Once effective, the Covered Agreement will have a significant impact on international insurance groups doing business between the two regions. For instance, it has been estimated that $40 billion of collateral, currently posted by European reinsurers in the U.S. pursuant to state laws, could be released once the Covered Agreement is fully implemented.

Generally, the Covered Agreement imposes reciprocity, as between a U.S. state on the one hand and any EU jurisdiction on the other, in three areas of insurance regulation: reinsurance, group supervision and exchange of information between regulators' jurisdictions.

Reinsurance

Under the Covered Agreement, both U.S. and EU jurisdictions would rescind regulations requiring reinsurers to post collateral as a condition to allowing such a reinsurer that has its head office or is domiciled in the territory of the other party (a "Home Party Assuming Reinsurer") to enter into, or take balance sheet credit for, a reinsurance agreement with a ceding insurer that has its head office or is domiciled in the foreign territory (a "Host Party Ceding Insurer"), where such requirement would treat the Home Party Assuming Reinsurer less favorably than counterparts that have their head office or are domiciled in the same jurisdiction as a Host Party Ceding Insurer.

Additionally, the Covered Agreement prevents a party from imposing a condition that the Home Party Assuming Reinsurer have a local presence in the host jurisdiction, where such requirement would result in such less favorable treatment.

In order to qualify for this treatment under the Covered Agreement, the assuming reinsurer must meet several criteria, including maintaining, on an ongoing basis, at least €226 million (for EU reinsurers) or $250 million (for U.S. reinsurers) of own funds or capital and surplus; maintaining a solvency ratio of 100% SCR under Solvency II or an RBC of 300% Authorized Control Level, as applicable in the territory in which the assuming reinsurer has its head office or is domiciled; and agreeing to provide prompt, written notice and explanation to the regulator in the territory of the ceding insurer if any regulatory action is taken against it for serious noncompliance with applicable law, or if it falls below such minimum own funds or capital and surplus, as applicable, or the solvency or capital ratio, as applicable. Various other requirements set forth in the Covered Agreement are outlined in greater detail here.

Prudential Group Supervision

The Covered Agreement stipulates that a "home party" (the jurisdiction of a group's worldwide parent entity) insurance or reinsurance group is subject only to worldwide prudential insurance group supervision by its "home" supervisory authorities, and is not subject to group supervision at the parent level by any other "host" jurisdiction where it operates. However, the host supervisor may exercise group supervision at the level of the "parent undertaking in its territory."

The Covered Agreement outlines specified exceptions in which a host supervisor may exercise some level of group supervision. A notable exception relates to Own Risk and Solvency Assessments (ORSA) required in the various jurisdictions of both the U.S. and the EU. The exception applies:

• Where a worldwide risk management system, as evidenced by the submission of a worldwide group ORSA, is applicable to a home party insurance or reinsurance group, and the home regulator that requires the ORSA provides a summary of the worldwide group ORSA to the host supervisory authorities, if they are members of the group's supervisory college, as well as to the supervisory authorities of significant subsidiaries or branches of that group in the host party, at the request of those supervisory authorities.
• Where no such worldwide group ORSA is applicable to a home party group, and the relevant U.S. state or EU member state regulator provides equivalent documentation.

This summary must include a description of the insurance or reinsurance group's risk management framework, an assessment of the group's risk exposure, and a group assessment of risk capital and a prospective solvency assessment. If the summary of the worldwide group ORSA exposes any serious threat to policyholder protection or financial stability in the host jurisdiction, the host regulator may impose "preventive, corrective or otherwise responsive measures" after consulting with the relevant home regulator.

The Covered Agreement also clarifies that the group supervision limitations and restrictions are not intended to limit or restrict the ability of EU or U.S. regulators to exercise authority over entities that own or control credit or depository institutions, or have banking operations, in either jurisdiction.

Exchange of Information

Finally, the Covered Agreement includes a nonbinding model memorandum of understanding (MOU) for supervisory authorities in the U.S. and EU, pursuant to which such parties should exchange information. The MOU includes best practices for time, manner and content of information requests and responses, including standards for the confidential treatment of the information. The Covered Agreement explicitly disclaims that the MOU does not address requirements that may apply to the exchange of personal data by supervisory authorities.

Effectiveness

The Covered Agreement "enters into force" seven days after the parties notify each other that they have completed their internal requirements. In the U.S., under Dodd-Frank, these internal requirements consist mainly of the submission of the Covered Agreement to specified congressional committees (which occurred on January 13, 2017) and the expiration of a 90-day period thereafter. The Covered Agreement begins to "apply" on the later of such date of "entry into force" and the date that is 60 months from the date the Covered Agreement was signed. However, the Covered Agreement also contemplates that the parties will "provisionally apply" certain terms of the Agreement even prior to entry into force or formal application.

The Housing and Insurance Subcommittee of the House Financial Services Committee held a hearing on February 16 addressing the Covered Agreement. Witnesses included representatives from both the insurance industry and the regulatory community. Testimony concerning the merits of the Covered Agreement was split, even within the groups of industry representatives and regulatory witnesses, and much of the questioning from the subcommittee members was skeptical, particularly concerning the timing of the Covered Agreement's release (a week prior to the new incoming administration), the impact of the Covered Agreement on the pre-eminence of the state-based regulatory system and the role of congressional involvement. This suggests a potentially uncertain road to effectiveness in the U.S., although, barring any superseding action, Congress is subject to the 90-day time limit imposed by Dodd-Frank, which expires April 13.