United States: THE NAIC Moves To Facilitate The Implementation Of Portions Of The Covered Agreement

Last Updated: June 8 2018
Article by Roland Goss

The National Association of Insurance Commissioners ("NAIC") has started to take steps to facilitate the implementation the reinsurance collateral provisions of the Covered Agreement entered into by the United States and European Union.

On February 20, 2018, the NAIC's Reinsurance (E) Task Force ("the Task Force") held a public hearing ("the hearing") to address issues relating to the implementation of the reinsurance collateral reform provisions, which is one aspect of the Covered Agreement. The hearing was followed by a series of quick action steps at the NAIC's Spring National Meeting in late March, which included the publishing of the NAIC's anticipated schedule for addressing these issues.

The necessary legislation to implement the reinsurance collateral provisions of the Covered Agreement must occur at the state level. The Covered Agreement provides for the federal preemption of state laws that are not in compliance with the requirements of the Covered Agreement.

To facilitate this compliance effort, the NAIC is seeking to move relatively quickly to adopt amendments to the Credit for Reinsurance Model Law (#785) and the Credit for Reinsurance Model Regulation (#786). If the amended Models comply with the requirements of the Covered Agreement, and if a state adopts amendments to its own credit for reinsurance laws and regulations that are consistent with the provisions of the revised Models, that state may avoid the preemption of its credit for reinsurance laws.

It is the NAIC's stated goal to propose the amendments to the Models to its membership for a vote at the Fall National Meeting in mid-November of this year.

I. The NAIC's February Hearing

The hearing was announced by a Notice of Public Hearing and Request for Comments ("Notice"), which stated that the purpose of the hearing was to "begin discussions on how to proceed with reinsurance collateral reform."[i] The Notice solicited formal written comments, in advance of the hearing, on the following issues and approaches to reinsurance collateral reform:

  • Amending the Credit for Reinsurance Model Law (#785) and the Credit for Reinsurance Model Regulation (#786) to eliminate reinsurance collateral requirements for E.U.-based reinsurers meeting the conditions of the Covered Agreement;
  • Extending similar treatment to reinsurers from other jurisdictions covered by potential future covered agreement(s) that might be negotiated pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act;
  • Providing reinsurers domiciled in NAIC Qualified Jurisdictions with similar reinsurance collateral requirements;
  • Considering changes to the criteria for evaluating whether a jurisdiction should be a Qualified Jurisdiction;
  • Considering additional "guardrails" relative to U.S. ceding companies, such as changes to the risk-based capital (RBC) formula or new regulatory approaches to help address the increased financial solvency risks caused by the elimination of reinsurance collateral; and

·         Any other considerations to weigh as part of the states' implementation of the Covered Agreement.

Prior to the hearing, the NAIC received written comments from 20 entities:

  • ABIR (Association of Bermuda Insurers and Reinsurers);
  • ACLI;
  • Allstate;
  • American Academy of Actuaries;
  • American Insurance Association;
  • Aon;
  • California Department of Insurance;
  • Chubb;
  • Cincinnati Insurance Companies;
  • CNA Insurance;
  • GDV (German Insurance Association);
  • General Insurance Association of Japan;
  • International Underwriting Association;
  • Liberty Mutual Insurance;
  • Lloyd's America;
  • NAMIC (National Association of Mutual insurance Companies);
  • RAA (Reinsurance Association of America);
  • Swiss Re Americas and Zurich North America;
  • Switzerland Federal Department of Finance; and
  • XL Catlin.[ii]

The NAIC has not made a recording or a transcript of the February 20 hearing available.[iii] According to the published agenda for the meeting, after initial comments, oral presentations were received from many of the entities that had submitted written comments, followed by a discussion of how the implementation process might unfold.[iv]

Probably the most complicated part of the implementation of the Covered Agreement will be the amendment of the credit for reinsurance laws and regulations of all U.S. states and territories so that they are in compliance with the requirements of the Covered Agreement. Laws and regulations that are not in compliance with the requirements of the Covered Agreement will eventually be preempted by operation of federal law.

It has been anticipated that the most likely way to implement the reinsurance collateral provisions of the Covered Agreement would be through a revised Model Credit for Reinsurance Law and Regulation, which would be revised to be in compliance with the provisions of the Covered Agreement and then be adopted by the states.

However, as has been the case with virtually all Model Acts and Regulations, the Model Credit for Reinsurance Law and Model Regulation have not to date been adopted uniformly by all states. A small number of states have not adopted any version of the Model, other states have adopted a version of the Model that is not current, other states have made unique modifications to the Model, and other states are in the process, this legislative season, of considering amendments to their adopted statutes and regulations to be consistent with the current version of the Model.[v]

The mere revision of the Model to comply with the requirements of the Covered Agreement will not avoid the preemption of particular provisions of the laws of particular states with respect to reinsurance collateral issues. Revisions to the Model would be only the first step in this route to compliance with the Covered Agreement. Ultimately, whether the laws of any state comply with the requirements of the Covered Agreement or face possible preemption will depend upon whatever action is taken with respect to this topic by each state's legislature.

The key question will be whether the provisions of the law of the state with respect to reinsurance collateral, whatever its source and ancestry, complies with the requirements of the Covered Agreement. Adopting a revised Model that complies with the requirements of the Covered Agreement of course is not the only route a state may rake to achieve compliance with the requirements of the Covered Agreement and the avoidance of preemption. Yet, perhaps the prospect of preemption may be the incentive that will prompt substantial uniformity among the states in the aspects of credit for reinsurance and collateral requirements that are the subject of the Covered Agreement.

The main issues treated in many of the written comments, and noted in reports on the hearing, are not surprising, and include: (1) the extent to which compliance with the Covered Agreement can be achieved through revisions to the Model as opposed to a more basic revision of regulatory requirements; (2) the extent to which reinsurers not subject to the Covered Agreement will be extended the same concessions now available to E.U. domiciled reinsurers, and if so whether and how their domiciliary jurisdictions will agree to the same conditions for collateral reduction agreed to by the E.U. in the Covered Agreement; and (3) whether the elimination of collateral requirements exposes U.S.-domiciled ceding insurers to additional credit or collection risks that merit regulatory attention through what have been referred to as "guardrails."

Some of the written comments, particularly those received from non-U.S. reinsurers or trade associations, advocate for equal treatment for reinsurers domiciled in the E.U. and those domiciled elsewhere, such as London or Bermuda.

While that may be in the best interests of reinsurers not domiciled in the E.U., it may or may not be in the best interests of U.S. ceding insurers. Such treatment might be achieved by applying the reinsurance collateral provisions of the Covered Agreement to non-U.S. reinsurers domiciled in what the NAIC has found to be Qualified Jurisdictions. Others have advocated for expanding the applicability of the reduced collateral provisions through the establishment of a new category in the Model for certain non-U.S. reinsurers.

Concern has been voiced that if the reduced collateral benefits of the Covered Agreement are extended to non-E.U. reinsurers, that such an accommodation should be conditioned upon the domiciles of such reinsurers agreeing to the other provisions of the Covered Agreement, to which E.U. reinsurers and the E.U. are subject, such as the provisions concerning group supervision, capital regimes, and local presence.

With respect to the NAIC's question concerning "guardrails," the comments were fairly uniform that the elimination of collateral requirements would not, in and of itself, indicate the need for guardrails or other financial regulation beyond that al-ready in place. If additional financial-related regulations were put in place, some voiced the position that such provisions should he applied equally to all companies, regardless of their domicile.

II Action at the NAIC Spring National Meeting

Approximately one month after the hearing, the NAIC convened its Spring National Meeting. At that meeting, the Reinsurance Task Force approved and forwarded to the Financial Condition (E) Committee a Memorandum report on the February 20, 2018 public hearing, which also contained a number of recommendations for action and the first action step to seek the amendment of the Models to comply with the Covered Agreement.[vi] The next day the Financial Condition (E) Committee adopted those recommendations and included them in its report to the Executive (EX) Committee, which "received" the report of the (E) Committee the following day.[vii]

The basic approach of the Task Force is to revise the Model Credit for Reinsurance Model Law and Model Regulation so that they comply with the requirements of the Covered Agreement, and to extend the reduced collateral benefit of the Covered Agreement to reinsurers domiciled in the non-E.U. NAIC-approved Qualified Jurisdictions, on condition that those jurisdictions agree to the group supervision, group capital, and information-sharing provisions in the Covered Agreement.

Qualified Jurisdictions outside the E.U. that would benefit from this approach include Bermuda, Japan, Switzerland, and, after Brexit, the United Kingdom. The stated goal is to provide the proposed Model amendments for discussion and approval at the committee level at the NAIC summer national meeting in August, with consideration of the proposed Model amendments by the NAICS full membership at the NAIC's fall national meeting in November of this year.

The issue raised in connection with the public hearing of whether there would be a need for "guardrails" due to the increased credit and collection risks to which ceding insurers would be exposed as a result of reduced collateral resulted in a recommendation by the Reinsurance Task Force for the review and monitoring of such risks, followed by consideration of any indicated modifications to the Models, risk-based capital rules, and financial statement presentation requirements. This portion of the process is expected to take up to two and one-half years.

The Task force made a number of specific recommendations to the Financial Condition (E) Committee, which took the following action:

Adopted the Reinsurance Task Force's request for the development of revisions to the Model Credit for Reinsurance Model Law and Model Regulation to bring the Models into compliance with the terms of the Covered Agreement, in accordance with the NAIC's process for amending model laws and regulations.

Adopted charges to the Reinsurance Task Force, the Qualified Jurisdiction (E) Working Group, and the Reinsurance Financial Analysis (E) Working Group, which would have to develop processes to implement the anticipated revisions to the Models.

Adopted charges to the Capital Adequacy (E) Task Force and the Statutory Accounting Principles (E) Working Group to address related reduced reinsurance collateral issues.

Details of the actions of the Financial Condition (E) Committee are found in the Reinsurance Task Force's Memorandum report. This process anticipates a very aggressive schedule, with the proposed revisions to the Models (and possibly other changes) being ready for consideration by the Reinsurance Task Force at the NAIC's 2018 Summer National Meeting in August, and by the NAIC's membership at the NAIC's 2018 Fall National Meeting in November.

One possible complication to this anticipated schedule is that any agreement of non-E.U. Qualified Jurisdictions to the group supervision, group capital, and information-sharing provisions in the Covered Agreement might have to be implemented through a Memorandum of Understanding with each such jurisdiction, which might not be accomplished by November of this year.  While such a timing complication should not affect the implementation of the reinsurance collateral provisions of the Covered Agreement, it might result in somewhat of a competitive advantage for E.U.-domiciled reinsurers in the market until such Memoranda of Understanding are negotiated and adopted.

It was the clear sense of the participants in the hearing, and of the Reinsurance Task Force's subsequent Memorandum report to the Financial Condition (E) Committee, that reinsurers domiciled outside the E.U. should not have the benefit of reduced collateral for reinsurance without there being an agreement with their domiciliary jurisdictions with respect to group supervision, group capital, and information-sharing issues. Absent such an agreement, reinsurers domiciled in non-E.U. jurisdictions would, from the standpoint of the United States and U.S. domiciled ceding insurers, have a more favorable agreement than those domiciled in Covered Agreement jurisdictions. There is likely to be great resistance to such a potential scenario.

Conclusion

There is no doubt that the implementation of the Covered Agreement will be a complicated and drawn out affair. The NAIC has expressed a commitment to moving quickly to revise the Models as one route for states to comply with the requirements of the Covered Agreement concerning reinsurance collateral. However, speed has not been the hallmark of the history of the NAIC's consideration of reinsurance collateral issues over many years, and how best to work Qualified Jurisdictions into this process is largely an unknown. Only time will tell how these issues develop within the framework for the implementation of the Covered Agreement.

Republished with permission of Harris Martin, Reinsurance & Arbitration Publication (May, 2018).

Endnotes

[i] The Notice is available in the Related Documents section of the Task Force's internet site at http://www.naic.org/cmte_e_reinsurance.htm.
[ii] The individual written comment submissions are available in the Related Documents area of the Task Force's internet site at http://www.naic.org/cmte_e_reinsurance.htm.
[iii] The NAIC did issue a press release after the hearing, which did not contain significant substantive discussion of the hearing. See http://www.naic.org/Releases/2018_docs/ naic_holds_public_hearing_on_covered_agreement.htm.
[iv] The agenda is available at http://www.naic.org/documents/cmte_e_r einsurance_180220_hearing_agenda.pdf.
[v] See e.g., Michigan Senate Bill 638 (text and legislative analysis available at https://www.legislature.mi.gov/(S(y0eeyjmqbmi525rebvj3psg4))/mileg.aspx?page=ge tObject&objectName=2017-SB-0638) and a Notice of Proposed Rulemaking from the New Mexico Office of Superintendent of Insurance (Docket Number 18-00009-RULE-PC at https://wvvw.osi.state.nm.us/MiscPages/osilegal.aspx).
[vi] See the Materials for the meeting of the Task Force at http://www.naic.org/meetings1803/sortable_agenda.htm.
[vii] The Materials for these meetings are available at http://www.naic.org/meetings1803/sortable_agenda. htm.

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