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    Covered Agreement Implementation Discussions Move Forward

    Locke Lord Publications

    The National Association of Insurance Commissioners (NAIC) held a public hearing on February 20, 2018 to discuss the reinsurance provisions of the Bilateral Agreement between the U.S. and the EU on Prudential Measures Regarding Insurance and Reinsurance (the Covered Agreement), signed this past September. In signing the Covered Agreement, the U.S. and the EU took a significant move forward on cross-border insurance regulatory cooperation. The Covered Agreement sets forth a framework which eliminates reinsurance collateral for EU reinsurers that meet certain requirements, and in return U.S. insurers will continue to be supervised by the states according to U.S. standards. U.S. insurers will not be subject to Solvency II type requirements and will have equal access to the EU market. However, though signing the agreement is a strong endorsement of U.S. insurance regulation, the implementation steps are critical.

    The NAIC requested comments in advance and received a number of responses on the following topics:

    • Amending the Credit for Reinsurance Model Law (#785) and the Credit for Reinsurance Model Regulation (#786) (the Models) to align with the Covered Agreement eliminating reinsurance collateral requirements for EU reinsurers.
    • Extending similar collateral treatment to other jurisdictions that negotiate a Covered Agreement.
    • Non-EU reinsurers domiciled in NAIC Qualified Jurisdictions eligibility for zero collateral.
    • Revising the criteria for Qualified Jurisdictions.
    • Additional “guardrails” for U.S. ceding companies due to less solvency protection from a loss of collateral.

    Considering the questions presented by the NAIC and implementation issues, several common objectives were evident at the hearing:

           Amending the Models to align with the Covered Agreement. This preferred option adds a category for the elimination of collateral for EU reinsurers (essentially adding the Covered Agreement to the Models); and,

      Certified reinsurers from Qualified Jurisdictions should be permitted to use the Covered Agreement category for reduced collateral. This is the simplest approach leaving the current certified reinsurer framework in place and keeping the revisions to the Models less complex and easier for states to adopt through their legislatures.  

    Negotiating separate Covered Agreements remains an option, though an unlikely solution, as most interested parties and regulators prefer to avoid similar agreements and address the issues and implementation through the Models. 

    There is value in retaining the certified reinsurer framework. The Covered Agreement is prospective, therefore requiring that the Qualified Jurisdiction and certified reinsurer framework remains intact.

    State regulators considered “guardrails” on the ceding company and indirect regulation of the reinsurance transaction to account for increased solvency risk from collateral reduction. Industry participants do not support guardrails on ceding insurers as the industry has not exhibited significant negative market performance in recent years. Participants commented that ceding companies are already sufficiently protected through previous adoption of the reinsurance Models. Also the 2018 P&C RBC formula assigns a charge to a ceding company’s reinsurance recoverables based on the financial strength of the reinsurer. The NAIC plans to review the Life and Health RBC formula for a similar charge.

    There are observations to be cognizant of during the implementation discussions. The status of reinsurers from NAIC-designated Qualified Jurisdictions of Bermuda, Japan, Switzerland and the post-Brexit UK, not a party to the Covered Agreement, will be clarified as to their eligibility for similar collateral reductions. Also, the NAIC will need to reconcile the Covered Agreement reinsurer requirements with the Uniform Application Checklist for Certified Reinsurers that are part of the current Model. Requirements in the Checklist are not subject to preemption if the state regulator treats domestic insurers and EU reinsurers the same. If not reconciled these differences may cause reciprocity issues between the U.S. and EU and create an uneven playing field. As discussed above, a solution would be for certified reinsurers to be eligible for Covered Agreement requirements.

    For now, insurers and reinsurers should be aware that similar requirements under the Models will exist under Covered Agreement conditions. Compliance requirements to take advantage of collateral reductions will continue. Insurers should have contingency plans in place in the event those requirements are not met. Both the Models and the Covered Agreement are prospective and only apply to new or renewal reinsurance agreements.

    The NAIC stated an ambitious schedule of next steps. The Financial Condition (E) Committee adopted formal charges to the respective NAIC groups to have a working draft of the Model revisions for the 2018 NAIC Summer National Meeting. If all goes as planned, NAIC membership will consider adoption at the 2018 NAIC Fall National Meeting. States must adopt the Models within five years of the signing of the Covered Agreement to avoid federal preemption of state law.

    The great opportunity for the U.S. is gained from amending the Models with the condition that only jurisdictions agreeable to recognizing the U.S. supervisory framework of solvency, capital requirements and group supervision, including assuring open access to the EU market, benefit from collateral reduction.

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