On December 7, 2008, the plenary session of the National Association of Insurance Commissioners (NAIC) adopted its Reinsurance Regulatory Modernization Framework Proposal (the Proposal). Adoption of the Proposal marks a substantial step toward reforming U.S. statebased regulation of reinsurance collateral requirements.

Under the current reinsurance regulatory model, all non-U.S. licensed reinsurers must post collateral (in the form of cash, securities, or unconditional letters of credit) for 100 percent of the reinsurance obligations for domestic ceding companies to receive financial statement credit. In comparison, a licensed or accredited U.S.-domiciled reinsurer need not post collateral for a cedent to receive credit, regardless of the financial strength of the domestic reinsurer. The recently adopted Proposal was borne from two previously rejected Reinsurance Task Force (RTF) proposals. The prior RTF proposals were the subject of a November 2007 Bulletin provided by Saul Ewing's Insurance Practice Group at http://www.saul.com/common/publications/pdf_1482.pdf.

The Proposal creates two new classes of reinsurers in the United States – "national" reinsurers and "port of entry" (POE) reinsurers. A national reinsurer is defined as "a reinsurer that is licensed and domiciled in a [U.S.] home state and approved by such state to transact assumed reinsurance business across the United States while submitting solely to the regulatory authority of the home state supervisor for purposes of its reinsurance business." A POE reinsurer is defined as "a non-U.S. assuming reinsurer that is certified in a port of entry state and approved by such state to provide creditable reinsurance to the U.S. market."

Unlike the cumbersome fifty state regulatory status quo, the Proposal would establish a regime in which a single qualifying state would be the sole U.S. regulator of a national or POE reinsurer writing assumed business across the United States. A domestic or foreign reinsurer not interested in seeking certification as a national or POE reinsurer could continue operating under the current regulatory framework.

In order to establish uniform standards, the Proposal also provides for the establishment of the NAIC Reinsurance Supervision Review Department (RSRD). The RSRD is envisioned as a transparent and publicly accountable entity within the NAIC. A supervisory board of the RSRD (consisting of state insurance regulators) would, among other tasks, establish uniform standards for determining POE state and/or home state supervisor certification eligibility. During the home state supervisor or POE supervisor qualification process, the following benchmark standards, among other criteria, would be considered by the RSRD: state experience in regulating sophisticated market participants, depth and quality of department staff, accreditation through the NAIC's Financial Regulation Standards and Accreditation Program and experience in regulating reinsurance transactions. A second key function of the RSRD would be to evaluate the regulatory regimes of non-U.S. jurisdictions and generate a list of foreign jurisdictions eligible to be recognized by POE states. The Proposal envisions that mutual cooperation agreements will be entered into between POE/home state supervisors and such eligible jurisdictions. A non-U.S. reinsurer located within such an eligible jurisdiction could then apply to qualified POE states to become a certified POE reinsurer.

In order to be licensed as a national reinsurer or certified as a POE reinsurer, the reinsurer must "have a minimum capital and surplus requirement of $250 million." The $250 million requirement could also be satisfied by a recognized underwriter (such as Lloyd's) "having minimum capital and surplus equivalents (net of liabilities) of at least $250 million and a Central Fund containing a balance of at least $250 million."

As a means of eradicating the indiscriminate universal 100 percent collateral requirement presently imposed on foreign reinsurers, the Proposal establishes a sliding scale rating system for assessing collateral obligations. The home state supervisor or POE supervisor would be responsible for assigning the appropriate rating for collateral purposes to its national and POE reinsurers respectively – based on the ratings of at least two recognized ratings agencies and other factors deemed significant by the POE/home state supervisor. The stepped-up ratings and corresponding collateral calculations are as follows: Secure-1 (collateral required 0%); Secure-2 (collateral required 10%); Secure-3 (collateral required 20%); Secure-4 (collateral required 75%); and Vulnerable-5 (collateral required 100%). Although this sliding scale makes strides toward equalizing regulatory treatment of foreign and domestic reinsurers, pursuant to the Proposal, national reinsurers rated Secure-3 or above would not have to post any collateral. In contrast, POE reinsurers rated Secure-3 or above are subject to the scaled percentage collateral obligations referenced above. For those national reinsurers that are rated Secure-4 or Vulnerable-5, the 75 and 100 percent collateral requirements would be respectively imposed. The more lenient collateral requirements for national reinsurers rated Secure-3 and above are possible due to the "prudential U.S. reinsurance regulatory requirements designed to protect policyholders and ensure the integrity and stability of the U.S. financial system."

The Proposal recommends implementation through federal enabling legislation to permit greater uniformity of application and to alleviate some concerns regarding possible constitutional issues. During previous comment periods, commentators and regulators questioned the constitutionality of a proposal that encouraged state (or RSRD) negotiation and information-sharing with foreign jurisdictions. The Proposal offers only an initial framework which must be developed into concrete statutory proposals and ultimately legislatively adopted by the states. Saul Ewing's Insurance Group will be tracking developments of this Proposal and will report as significant events occur.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.