United States: California Overhauls Reinsurance Regulations

After months of discussion, the State of California recently adopted a comprehensive set of regulations governing reinsurance transactions. These new regulations, referred to as the Reinsurance Oversight Regulations, cover three principal areas: (1) accounting for reinsurance on a ceding insurer’s financial statements, (2) requirements applicable to the form and content of reinsurance agreements, and (3) oversight of reinsurance transactions and related sanctions. According to introductory comments contained in the regulations, these provisions "are intended to elicit from insurers a true exhibit of their financial condition and to safeguard the solvency of licensees."

The new regulations apply to all insurers licensed or accredited in California. They also apply to all approved U.S. trusts of otherwise unauthorized reinsurers and licensed reinsurance intermediaries. Reinsurers that are not licensed in California but assume risks from California domestic and foreign insurers may also be affected by certain changes contained in the regulations addressing acceptable forms of security used to secure reinsurance obligations.

The new regulations are scheduled take effect on January 1, 2007. After that date, insurers licensed in California may not claim reserve credit for any new or renewal reinsurance agreement executed after January 1, 2007 unless the agreement and any related collateral conform to the new rules. Reinsurance agreements (and any security provided to secure them) entered into prior to the effective date will remain subject to the requirements outlined in Bulletin 97-5, previously issued by the California Department of Insurance.

The regulations span 46 pages and constitute a substantial rewrite of California’s existing credit for reinsurance laws. Among the issues covered in the regulations are detailed requirements that licensed insurers must follow in order to receive credit for reinsurance on their financial statements. The regulations also address risk transfer requirements and set forth specific provisions for acceptable reinsurance arrangements. While a detailed discussion of specific provisions of the regulation goes beyond the scope of this article, the following is a list of the general topics covered in the regulations:

• Credit for reinsurance ceded to admitted insurers and accredited reinsurers

• Credit for reinsurance secured by an approved U.S. trust

• Credit for reinsurance required by law

• Credit for reinsurance secured by a single beneficiary trust, a letter of credit, or funds withheld

• Credit for reinsurance of foreign insurers

• Transfer of risk for both life and disability and property and casualty business

• Contract requirements necessary to receive statement credit

• Requirements regarding the form of reinsurance agreements

• Oversight of reinsurance transactions

• Examination of reinsurance intermediaries

• Denial of statement credit and non-admission of assets

Insurers domiciled outside of California that trigger the new definition of a volume insurer will be subject to many of the same reinsurance requirements applicable to California domestic insurers. A volume insurer means any foreign insurer whose three-year average gross direct premiums written in California exceeds the average gross direct premiums written in its state of domicile for the same period and constitutes 33 percent or more of its total gross direct premiums written in the United States for such period. This definition may be familiar to many insurers as it is very similar to the test applied to commercially domiciled insurers under California law.

Each year, the California Department of Insurance is required to prepare a list of foreign insurers that have attained the status of a volume insurer. Insurers deemed to be volume insurers will be subject to many of the same requirements applicable to California domestic insurers, including specific provisions governing the form and content of reinsurance agreements.

The final regulations reflect months of intense negotiations between California regulators and the insurance industry. Industry groups vigorously opposed an earlier version of the reinsurance regulations, claiming they were unnecessary and onerous and would cause California’s regulatory system to be out of line with other jurisdictions. Regulators argued that the new rules were necessary to update California’s reinsurance provisions in light of changing developments in the reinsurance arena. They also believed revisions were necessary to further protect ceding companies in their reinsurance recovery efforts.

Ultimately, substantial revisions were made to reflect various compromises reached between the California Department of Insurance and industry members. The final regulations appear to be less objectionable for many industry members as several of the more controversial provisions have been softened or removed entirely from the final regulations.

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