NAIC model law update offers relief for offshore reinsurers

Reinsurers domiciled in the European Union, Bermuda, Japan and Switzerland should soon benefit from collateral relief under an updated model law and regulation adopted by the National Association of Insurance Commissioners — assuming all U.S. states move quickly to adopt it and do so without major changes rather than risk federal preemption, experts say.

The NAIC last week approved revisions to its Credit for Reinsurance Model Law and Regulation to make the models consistent with provisions of covered agreements with the European Union and United Kingdom.

In September 2017, the United States and the European Union signed a covered agreement to address the U.S. lack of equivalency related to the bloc’s Solvency II directive for the insurance industry, including requirements on group capital, group supervision and reinsurance collateral. The agreement eliminates reinsurance collateral requirements for EU reinsurers maintaining a specified minimum of funds and meeting a Solvency II capital requirement, while U.S. reinsurers meeting capital and surplus thresholds would not be required to maintain a local presence to do business in the EU or post collateral in the EU.

In December 2018, U.S. representatives signed an agreement with the United Kingdom in anticipation of that country’s Brexit from the European Union featuring similar provisions.

In May, the NAIC’s reinsurance task force adopted revisions to the model law and regulation consistent with these changes, which were approved later that month by the financial condition committee, to eliminate reinsurance collateral requirements for reciprocal reinsurers.

Previously, certified reinsurers domiciled in qualified jurisdictions generally posted only 10% or 20% in collateral, said John Rehagen, division director of the insurance company regulation division for the Missouri Department of Insurance in Columbia, who led the task force’s recent efforts on the model law and regulation. “Now, if you are a reinsurer in a reciprocal jurisdiction and you meet the requirements, you (post) zero collateral,” he said.

The reinsurance collateral reductions will not just apply to the EU, but will also provide reinsurers domiciled in NAIC-qualified jurisdictions other than within the EU — currently Bermuda, Japan and Switzerland — with the same collateral relief, according to the NAIC.

“It didn’t make a whole lot of sense to create an unlevel playing field by giving zero collateral to EU countries and not give zero collateral” to Bermuda, Switzerland and Japan, said Robert Woody, vice president of policy for the American Property Casualty Insurance Association in Washington.

A potential failure to sign the covered agreements prompted concerns about U.S.-based insurers being put at a competitive disadvantage and potential retaliation against EU-based entities. The covered agreement resolved most of those issues and the EU has already eliminated its requirement for U.S. reinsurers to have a local presence in their jurisdictions, but the agreement does require the United States to adopt the collateral reduction requirements for EU entities doing U.S. business, said John Finston, San Francisco-based partner with Drinker Biddle & Reath LLP and former general counsel and deputy insurance commissioner for California.

“The concern is that if the states don’t adopt those changes, then the possibility is that the EU could terminate the covered agreement and take away some of those advantages,” he said.

States must comply with the provisions in the covered agreement within five years of its signing or face potential preemption by the Federal Insurance Office.

“When NAIC models go to the states, there’s always a temptation on the part of the states to tweak things here and there,” Mr. Woody said. “If states try to do that, that could create issues, particularly if tweaks are of such a nature that it could be argued that they would bring the state out of compliance with the covered agreement. I’m not anticipating any particular issues, but knowing the whole history of states implementing NAIC models, there always seem to be those kind of glitches that pop up somewhere. The difference here is you do have the hammer hanging over the states’ heads of ‘if you don’t implement the covered agreement, then you’re at risk of getting preempted.’ I think that might make some states think twice before they veer too far from the NAIC model.”

A state legislature could try to reduce the collateral requirement rather than eliminating the need for collateral, which could create an inconsistency with the covered agreement and potentially allow the federal government to exercise its preemption authority, Mr. Finston said.

“That is a very powerful hammer that I think the state regulators are very concerned about,” he said. “It’s a pretty powerful incentive to get the laws enacted in the various states.”

Such concerns are in part rooted in the experience with a previous NAIC modernization of its credit for reinsurance model, experts say. State insurance regulators have historically required foreign reinsurers to hold 100% collateral within the United States for the risks they assume from U.S. insurers, but the NAIC adopted amendments to the model law in 2011 to allow foreign reinsurers to post less than 100% collateral for U.S. claims, provided the reinsurer is in solid financial health and is overseen by an effective regulator.

“I think this has become the most needlessly overcomplicated thing that I’ve ever seen in the insurance industry in terms of statutes and regulations,” said Charlene McHugh, counsel for the New York office of Bryan Cave Leighton Paisner LLP and a member of the firm’s transactional and regulatory insurance group. “It was a huge battle at the NAIC level, and at the state level, everyone tried to take another bite at the apple."

In fact, not all states adopted that version of the model law — 42 as of March 2018 — so federal officials negotiated language into the covered agreement that requires states to eliminate collateral requirements entirely or face preemption.

“I do think there will be attempts," Ms. McHugh said. "I don’t think they will be successful because of the preemption.”

Even if state legislators resist any urges to change the model law and regulation, timing of state adoption could become an issue because many state legislatures have adjourned for the year and will not be able to begin considering this until 2020, experts say.

“It’s hard to get 50 states to do something in a two-year time period, but there’s pressure on them to do it,” Mr. Woody said.