For many years, the primary reinsurance regulatory mechanism in the United States has been the regulation of credit given to ceding companies for reinsurance. The regulation of credit provided to ceding companies on their financial statements indirectly regulated foreign and domestic reinsurers, as ceding companies would only choose reinsurance that would provide them with financial statement credit. A significant part of this regulatory practice was the requirement that non-U.S. licensed reinsurers had to post collateral for 100 percent of the reinsurance obligations for ceding companies to receive credit. This requirement was imposed regardless of the financial strength of the non-U.S. reinsurer or the regulatory environment where the reinsurer was licensed.
In response to a growing recognition by insurance regulators of the possible inequities of this blanket collateral rule, on March 5, 2006, the Executive Committee of the National Association of Insurance Commissioners (NAIC) asked the Reinsurance Task Force to "develop alternatives to the current reinsurance regulatory framework, including the U.S. and abroad. Consider approaches that account for a reinsurer's financial strength regardless of domicile, i.e., state or country." In accordance with this directive, on December 10, 2006, the Reinsurance Task Force presented a proposal entitled "NAIC Reinsurance Evaluation Office – Proposal to Grant Credit for Ceded Reinsurance" ("REO Proposal").
The REO Proposal sought to establish an NAIC Reinsurance Evaluation Office (the "REO"). Under the proposal, the REO would evaluate the financial condition of domestic and foreign reinsurers and assign them a rating from "REO-1" to "REO-6". Those ratings would be primarily based upon ratings from national rating organizations, such as Standard & Poors, Fitch, Moody's and A.M. Best, but also included some unspecified evaluation of "the strength of financial solvency regulation" in the reinsurer's country of domicile, the reinsurer's "reputation" for payment of claims, and the length of time that a reinsurer has assumed risks. A rating of REO-1 (which equated with the highest financial rating of the rating organizations) would require no collateral from a foreign or domestic reinsurer for a ceding company to take full credit for the reinsurance assumed by companies with that rating. Each successively lower rating band resulted in a 20 percent incremental increase in the collateral requirement, so that a rating of REO-2 required collateral of 20 percent and a Rating of REO-6, the lowest rating possible, required 100 percent collateral. The collateral requirements under this proposal applied both to foreign and domestic reinsurers.
As a result of concerns expressed by regulators that the REO Proposal provided no incentive for domestic reinsurers to keep their U.S. licenses, and that the proposal gave too much authority to the REO, the Reinsurance Task Force submitted an amended proposal on September 7, 2007 (the "RSRD Proposal"). The RSRD proposal would create a different entity called the "NAIC Reinsurance Supervision Review Department" (the "RSRD") with more limited authority, and would permit a non-U.S. licensed reinsurer to be "certified" by a "point of entry state" that would allow the reinsurer to post lesser amounts of collateral. Of greatest significance, the amended RSRD Proposal would continue to require the posting of significant collateral from non-U.S. licensed companies. In contrast to the REO Proposal, under the amended RSRD Proposal even the strongest rated foreign reinsurers from countries with regulatory schemes that most closely approximate those in the U.S. would still have to post collateral in the amount of 60 percent of the reinsured obligation. Moreover, the amended proposal would not apply the same collateral requirements to domestic reinsurers. Only those domestic insurers with poor financial ratings, or who have not maintained adequate capital or a minimum financial strength would have to post collateral.
Under the RSRD Proposal, a non-U.S. reinsurer could not be certified unless the company was domiciled and licensed under a "functionally equivalent jurisdiction" recognized by the RSRD. The RSRD would make recommendations, to be approved by the insurance regulators, as to which foreign jurisdictions were "functionally equivalent" for the purposes of reinsurer regulation. The proposal lays out nine fundamental principles to be considered to find that a foreign regulatory scheme is "functionally equivalent." Of greatest significance, the RSRD would evaluate not only the regulatory framework, but also assess whether the outcomes of the framework achieve equivalent results, and whether it is adequately enforced. Further, the U.S. regulators "must have" effective cooperation arrangements with the foreign regulators. The U.S. regulators must also have the ability to enforce U.S. laws, including requirements that the foreign reinsurers would consent to "exclusive" jurisdiction of the U.S. courts and would appoint agents for service of process. Finally, the RSRD would assess whether the same rights and remedies of "insurers/policyholders" are "practically available" against the foreign reinsurer.
Once the recommendation of the RSRD that a foreign jurisdiction is "functionally equivalent" is accepted by U.S. regulators, an "accredited" point of entry state may consider the application of a foreign reinsurer for certification. The RSRD would establish minimum guidelines for a port of entry state to be accredited. The port of entry state would evaluate whether to certify a foreign reinsurer based on procedures established by state insurance regulators "through port of entry criteria." Those criteria would result in a rating by the port of entry state regulator of Class 1 through 5, with respective collateral amounts of 60 percent (Class 1), 70 percent (Class 2); 80 percent (Class 3) or 100 percent (Classes 4 and 5.) Like the REO Proposal, the RSRD Proposal allows the port of entry state to rely on national rating organizations in determining the rating. As noted above, even reinsurers with the highest rating (Class 1) will be required to post 60 percent collateral for the reinsured obligation. However, the RSRD Proposal further permits the regulator of a ceding company's domicile state to amend the collateral requirements of a certified reinsurer. The proposal makes reference to rights of appeal, but those are not detailed.
Numerous comments have been received regarding this proposal. Some have objected to the proposal as not being consistent with the original charge to "consider approaches that account for a reinsurer's financial strength regardless of domicile." Others object that it continues to discriminate against foreign insurers, since all foreign reinsurers would still have to post at least 60 percent collateral, but only domestic reinsurers falling into the lowest rated financial strata would have to post any collateral. On the other hand, organizations supporting cedents argue that the proposal fails to consider the effectiveness of the legal systems of the foreign reinsurers' domicile and does not take sufficient steps to ensure adequate collectability of judgments in foreign jurisdictions. Others question the authority of state regulators to enter into cooperation agreements with foreign regulators and argue that key concepts in the proposal are too vague, such as "functionally equivalent" jurisdictions, "accredited" port of entry states, or "port of entry criteria."
The Reinsurance Task Force met earlier this month to discuss the proposal and comments. The goal is to present a proposal to the NAIC at the winter meeting in Houston, Texas in December. If that proposal is adopted in December, the Reinsurance Task Force will seek input from other parts of the NAIC, including the Receivership and Insolvency Task Force; the Capital Adequacy; the Accounting and Procedures Task Force; the Examination Oversight Task Force; and the Financial Analysis Working Group. The Reinsurance Task Force will also consider whether any changes need to be made to existing Model Laws, such as the Credit for Reinsurance Model Law or State of Entry Model Law.
Saul Ewing's Insurance Practice Group will be tracking the developments of this proposal through the NAIC and will report periodically on its progress.
reprinted with permission of Saul Ewing LLP
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