Regulation of Reinsurance – New Appleman on Insurance Law Library Edition, Chapter 78

Regulation of Reinsurance – New Appleman on Insurance Law Library Edition, Chapter 78

By Kimberly M Welsh, Vice President and Assistant General Counsel, RGA

The following chapter discusses important principles of reinsurance regulation today.  It begins in Section 78.01 with an overview of the regulatory framework for reinsurers and reinsurance transactions in the United States.  Reinsurance is regulated principally by the states and not at the federal level, pursuant to the McCarran-Ferguson Act, which applies to reinsurance as well as insurance.[1]

Section 78.02 discusses state regulation of reinsurers.  State reinsurance regulation is focused principally on the financial solvency and strength of the reinsurer to ensure the reinsurer is able to pay its reinsurance claims, which helps protect the ceding insurer's solvency and ultimately its ability to meet its obligations to policyholders.  The bulk of the laws and regulations applicable to U.S. reinsurers are based on models developed and promulgated by the National Association of Insurance Commissioners.

How, and to what extent, reinsurers are regulated depends on whether they are licensed, accredited or unauthorized in a particular state.  As with respect to insurers, states regulate domestic and foreign licensed reinsurers directly through licensing requirements as well as other financial regulations, including those focused on capital and surplus, financial reporting and examinations, and investment restrictions.  The extent to which a state is permitted to regulate a licensed reinsurer not domiciled in its state has been restricted by the federal Nonadmitted and Reinsurance Reform Act ("NRRA").[2] The NRRA is discussed in detail in Section 78.05[1].

States regulate reinsurers indirectly through their credit for reinsurance laws and regulations, which are discussed in Section 78.03.  One of the principal reasons insurers obtain reinsurance is the benefit it provides on their financial statements.  An insurer is required to maintain a minimum amount of reserves for liabilities as required by its domiciliary state's laws and regulations.  Pursuant to the state's credit for reinsurance rules, an insurer is permitted to record on its financial statement, as either an increase in its assets or a reduction of its unearned premium or loss reserves, the amount of its reinsurance recoverables if certain requirements are met.  This financial statement credit, called credit for reinsurance, also gives the insurer increased capacity to write new insurance business.  The requirements vary depending on whether the reinsurer is licensed, accredited or unauthorized in the ceding insurer's state of domicile.  Unauthorized reinsurers must post security in the state in order for the ceding insurer to receive financial statement credit for reinsurance.  Pursuant to significant amendments to the NAIC Credit for Reinsurance Model Law and Regulation adopted in 2011, unauthorized reinsurers can become "certified" in the ceding insurer's domiciliary state and may be able to post less than 100 percent collateral based on a sliding rating scale assigned by the state.  States would need to adopt these amendments to the Models in order for reinsurers to have this option.  At this time, the NAIC does not intend to make these amendments accreditation requirements, meaning states will not have to adopt them in order to maintain their NAIC accreditation.

The reinsurance transaction also must meet certain requirements, such as risk transfer, in order to be eligible for credit for reinsurance.  In addition, the contract must contain certain contract clauses, such as an insolvency clause.

As discussed in Section 78.04, states regulate reinsurance transactions differently than they regulate insurance agreements.  The primary objectives of insurance regulation are to ensure the continuing solvency of the insurer, so that it is able to pay its claims, and to protect the interests of policyholders and the public generally.  States regulate reinsurance agreements differently because the primary purpose of such regulation is to ensure the continuing solvency of the parties, rather than to protect policyholders.  As such, reinsurance agreements are not subject to rate and form regulation.  Reinsurance agreement premiums also are not subject to state premium taxes, because the taxes have already been levied on the underlying direct insurance policy.  Reinsurers also do not pay state Insurance Guaranty Association assessments because the Associations do not guarantee reinsurance agreements.  Although reinsurers are not assessed by the Association, reinsurance agreements sometimes include a provision for the reinsurer to contribute to the ceding insurer's assessment.

Although states do not subject reinsurance agreements to the same degree of regulation as insurance agreements, states to varying degrees do regulate reinsurance agreements.  For instance, some states require domestic insurers to file or obtain prior approval for certain reinsurance agreements.  Notably, reinsurance agreements between affiliates in which the reinsurance premiums or a change in the ceding insurer's liabilities are above a certain size must be filed with, and not disapproved by, the commissioner.  States also sometimes institute special laws and regulations for certain types of reinsurance, such as captive reinsurance.

Section 78.05 discusses relevant sections of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010.  Within the Dodd-Frank Act, certain provisions entitled the Nonadmitted and Reinsurance Reform Act ("NRRA") provide for federal preemption of certain state reinsurance measures.  These provisions are intended to stop state's extraterritorial application of their laws with respect to the regulation of the financial solvency of reinsurers and the regulation of the reinsurance agreement and credit for reinsurance.  Such states take the position that a foreign insurer licensed in the state must comply with all of that state's laws and regulations that are applicable to its own domestic insurers.  The NRRA provides that a state is solely responsible for regulating the financial solvency of its domestic reinsurers.  It also provides that if a state regulator recognizes credit for reinsurance for its domestic ceding insurer's ceded risk, then no other state may deny such credit.  In addition, a state may regulate its domestic ceding insurer's reinsurance agreements, and other states generally may not interfere with those agreements.[3]

This section also discusses the Federal Insurance Office ("FIO"), which was created by the Dodd-Frank Act.  FIO is not a regulator and does not have any direct regulatory authority or responsibilities.  Regulation of insurers and reinsurers will remain in the states' domain, although FIO will have the ability to influence state regulation applicable to insurers and reinsurers through the negotiation of covered agreements that preempt state insurance measures.[4]

Section 78.06 discusses implementation of provision of the Dodd-Frank Act that could impact reinsurers.  It also addresses important current issues in U.S. reinsurance regulatory reform.  A significant issue is the NAIC's on-going Solvency Modernization Initiative, intended to be a critical self-examination of state's insurance solvency regulation framework and includes developing new or improving existing regulation as necessary.  Finally, this section provides an overview of the attempts to establish an optional federal charter or license for reinsurers.

The final section of this chapter addresses important issues with respect to international reinsurance regulatory developments.  As reinsurance is truly a global industry, both with respect to the location of risks and the domiciles of reinsurers and companies within insurance and reinsurance groups, multiple jurisdictions regulate reinsurers and reinsurance transactions, but the nature and extent of that regulation varies.  Section 78.07 summarizes several important efforts to improve and coordinate reinsurance regulation.  The International Association of Insurance Supervisors ("IAIS"), a nongovernmental standard setting body representing insurance regulators and supervisors from 190 jurisdictions, is engaged in several projects, including developing a framework for internationally active insurance (and reinsurance) groups and the use of the IAIS's insurance core principles for regulation as part of the International Monetary Fund's evaluation of different countries' financial sectors and the effectiveness of their financial market supervision.  Similar to the ongoing development of regulations concerning systemic risk and systemically significant companies in the U.S. pursuant to the Dodd-Frank Act, another international standard setting body, the Financial Stability Board ("FSB"), is engaged in the study of systemic risk of financial institutions.

Finally, the European Union ("EU") has been active on streamlining and strengthening the regulation of insurance and reinsurance by the EU member companies through the development of Solvency II.  As part of Solvency II, non-EU, or "third-party", countries' regulatory regimes will be evaluated for "equivalence", i.e., whether their regulatory regimes provide a similar level of solvency regulation and policyholder and beneficiary protection as Solvency II.  This evaluation will consider the third-country's reinsurance regulation.  This effort has had an impact on the NAIC's work with respect to its Solvency Modernization Initiative and if the U.S. is evaluated for equivalence, its performance on that evaluation will have an impact on U.S. insurance and reinsurance companies and markets.

[1]  US-15 U.S.C. § 1012(b);
Stephens v. Am. Int'l Ins. Co., 66 F.3d 41, 44 (2d Cir. 1995).

[2]  US-15 U.S.C. §§ 8221-8223.

[3]  US-15 U.S.C. §§ 8221-8223.

[4]  US-31 U.S.C. §§ 313(a) - 313(d).

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Kimberly M Welsh is Vice President and Assistant General Counsel in RGA's Washington, D.C. office.  Ms. Welsh directs RGA's analysis of federal insurance and reinsurance laws and regulations, as well as non-U.S. laws and regulations, which impact RGA's global operations.  Kim also serves as the liaison to RGA's D.C.-based consultants and trade associations for all regulatory matters.  Prior to joining RGA, Kim spent five years as Assistant General Counsel with the Reinsurance Association of America (RAA), first as Assistant Vice President and then as Vice President.  At the RAA, Kim advocated for reinsurance interests before state and federal regulators and legislators, worked with member companies, served on the RAA's Law Committee, and coordinated development and implementation of reinsurance policy at state, federal and international levels.  She also served as senior staff attorney and antitrust counsel to the RAA's Life Reinsurance, Underwriting, and Broker Committees.   Before working for the RAA, Kim was Assistant Vice President - Litigation for Renaissance Re Holdings Ltd., and was an associate in the reinsurance and insurance practice group of the global law firm of Chadbourne & Parke LLP.

The author expresses her gratitude for the research assistance of Katherine S. Paulson of the law firm of Katten Muchin Rosenman LLP.

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