United States: NAIC Updates – October 2017

Status of Covered Agreement Between EU and U.S.

The NAIC Reinsurance (E) Task Force ("RTF") held its most recent open meeting on Monday, August 7, 2017 during the NAIC 2017 Summer National Meeting in Philadelphia, Pennsylvania. During the meeting, the RTF heard a status report on the proposed Bilateral Agreement Between the European Union and the United States of America on Prudential Measures Regarding Insurance and Reinsurance ("Covered Agreement"), which was subsequently executed by the United States and the European Union on September 22, 2017. The Covered Agreement will "eliminate reinsurance requirements for EU reinsurers that maintain a minimum amount of own funds equivalent to $250 million and a solvency capital ratio (SCR) of 100% under Solvency II," and allow U.S. reinsurers to do business in the EU without local presence so long as they "maintain capital and surplus equivalent to €226 million with an RBC of 300% of Authorized Control Level."

As discussed below, the NAIC had initially voiced opposition to the Covered Agreement during the negotiation process between the U.S. and the EU. However, the September 22, 2017 policy statement released by the U.S. in tandem with its execution of the Covered Agreement seems to have assuaged many of the NAIC's concerns.

Background

Prior to the execution of the Covered Agreement, the NAIC participated in a hearing on the Covered Agreement before the House Financial Services Committee's Subcommittee on Housing and Insurance on February 16, 2017, and also submitted a letter to Treasury Secretary Steven Mnuchin on March 15, 2017. During the negotiation process, the NAIC consistently voiced numerous concerns with the form of the Covered Agreement. Over the last several years, the NAIC prioritized the reduction of reinsurance consumer protection collateral requirements, and the majority of states have passed legislation to implement the NAIC Credit for Reinsurance Models. Accordingly, if Models #785 (Credit for Reinsurance Model Law) and #786 (Credit for Reinsurance Model Regulation) were adopted as accreditation standards, the NAIC believed the states would already have accomplished the goals of the Covered Agreement.

In its March 15 letter, the NAIC urged caution in considering the terms of the Covered Agreement, noting the following concerns:

1. Elimination of Collateral Requirements: The NAIC letter noted that states had taken measures to reduce, but not eliminate collateral requirements, relying on a risk-based approach with collateral requirements ranging from "0% to 100% based on an assessment of the financial strength of the reinsurer and quality of its supervision." Noting that the conditions required of EU insurers under the Covered Agreement "differ materially from current state credit for reinsurance laws," the NAIC expressed concern that "states may have to take alternative measures to ensure that ceding U.S. insurers, and, by extension, U.S. policyholders are protected from any risks posed by reinsurance counterparties."

2. Group Capital Assessment: The Covered Agreement "suggests the states should impose a capital requirement . . . at the group level of a U.S. insurer, rather than at the legal entity level." As the NAIC does not currently require additional capital at either level, the NAIC is concerned that this requirement could result in increased costs for U.S. insurers.

3. Group Supervisory Framework: The Covered Agreement could disrupt "existing group supervisory authorities," as it "appears to place conditions upon the use of longstanding regulatory authorities to protect U.S. consumers." Essentially, the Covered Agreement would limit supervision of EU reinsurers, even those operating in the U.S., to EU supervisory authorities.

Progress of the Covered Agreement

As required by Title V of the Dodd-Frank Wall Street Reform and Consumer Protection Act ("Dodd-Frank"), the Covered Agreement was submitted to Congress on January 13, 2017 by the U.S. Department of Treasury ("Treasury Department") and the Office of the U.S. Trade Representative ("USTR"). In an open meeting on April 9, 2017, the RTF explained that if Congress took no action against the Covered Agreement within the 90-day congressional review period required by Dodd-Frank, the Treasury Secretary would be authorized to execute the agreement. On April 13, 2017, the 90 days elapsed, and Congress had thus far not taken any action.

Against the NAIC's advice, plans to execute the Covered Agreement continued to move forward under the Trump administration. On July 14, 2017, the Treasury Department and the USTR issued a joint statement of intent to sign the Covered Agreement in the near future, and on September 22, 2017 both the United States and the European Union executed the Covered Agreement. That same day, the U.S. released a policy statement to offer clarity on some of the Covered Agreement's more contentious provisions:

With regard to the elimination of collateral requirements, the U.S. policy statement clarified that the Covered Agreement "does not prevent a state insurance regulator from imposing non-collateral requirements that do not have substantially the same regulatory impact as collateral requirements as conditions for ceding companies to enter into reinsurance agreements with EU reinsurers or to allow credit for such reinsurance, if the state insurance regulator applies the same requirements in the case of reinsurance agreements with U.S. reinsurers domiciled in that state."

As to group capital requirements, the "United States expects that the NAIC's group capital calculation will satisfy the 'group capital assessment' condition" of the Covered Agreement, and the Covered Agreement "does not require a group capital assessment with respect to U.S. insurance groups that do not have operations in the EU."

With regard to supervisory requirements, the policy statement also clarified that "U.S. insurance supervisors are able to obtain information about the EU parent of insurers that are active in the United States, if necessary, to protect against serious harm to U.S. policyholders, or a serious threat to financial stability, or a serious impact on the ability of an insurer to pay its claims in the United States."

In addition, the Covered Agreement provides for a "Joint Committee" which "will serve as a forum for consultation and to exchange information on the administration and proper implementation of the [Covered] Agreement." The policy statement recognized the important role of U.S. state insurance regulators, noting that because they "will be largely responsible for implementing the Agreement, the United States is committed to the direct involvement of state insurance regulators, including their staff, in the work of the Joint Committee. To this end, the United States will consult with state insurance regulators, and will establish a robust consultative process to ensure that discussions in the Joint Committee will be well-informed of the views and interests of state insurance regulators."

This policy statement was well-received by the NAIC, and seems to have addressed several of the NAIC's concerns. Shortly after the policy statement was issued, NAIC President and Wisconsin Insurance Commissioner Ted Nickel released a statement on the NAIC website noting that the NAIC is "pleased to see the Treasury and USTR clarify their interpretation of the covered agreement," and that the NAIC has "worked closely with Treasury and USTR on these clarifications and appreciate[s] their affirmation of the primacy of state regulation." However, the NAIC generally disfavors the use of covered agreements as a mechanism to set U.S. insurance policy and, in his own statement in response to the U.S. policy statement, NAIC CEO Mike Consedine thanked the Treasury and USTR for "working constructively" to "resolve [NAIC] concerns with the [C]overed [A]greement," but "caution[ed] against using this mechanism in the future."

Looking Forward

Now that the agreement has officially gone into effect, U.S. states have "five years to implement its reinsurance provisions or face potential preemption by the Federal Insurance Office." The RTF noted, and the U.S. policy statement confirmed, that the Covered Agreement will not apply retroactively to contracts that are already in force, and will only be available to new or renewal business or newly amended contracts involving only prospective reinsurance. While it reduces the reinsurance collateral to 0% for many EU reinsurers, the Covered Agreement retains "several important elements from the NAIC's credit for reinsurance models, including requirements with respect to enforcement of final U.S. judgments, service of process, financial reporting requirements, prompt payment of claims and solvent schemes of arrangement." Finally, now that the Covered Agreement has been executed, the NAIC plans to form a specific structure to oversee its implementation along with the RTF, which will also play a crucial role in the process.

Qualified Jurisdictions

At its Summer Meeting on August 7, 2017, the RTF heard the report of the Qualified Jurisdiction (E) Working Group. At the 2016 Summer National Meeting, the Working Group had been charged with the task of studying and reporting on the implementation of Solvency II by the European member-states, and to assess the potential impact on the Qualified Jurisdiction Status of France, Germany, Ireland, and the UK. The Working Group was advised by NAIC leadership to hold off on any public recommendations given the uncertainty surrounding the Covered Agreement, which, if executed, would render the Qualified Jurisdiction status of EU member states moot.

Given the public statement of intent to sign the Covered Agreement issued by the Treasury Department and USTR on July 14, 2017, the RTF determined that the Working Group should discontinue work on the report unless and until it becomes relevant again. As the Covered Agreement was officially executed by both the U.S. and EU on September 22, 2017, it is unlikely that work on the report will be reinitiated.

Despite the execution of the Covered Agreement, the Working Group's charge is still relevant in at least one respect. As the Working Group noted at the RTF's August 7, 2017 meeting, the CoveredAgreement includes a five-year grace period for U.S. states to come into compliance. Accordingly, the states now have 60 months to adopt reinsurance reforms removing collateral requirements for EU reinsurers that meet the prescribed consumer protection conditions, and until the states have done so, the Qualified Jurisdiction status of the EU member states will remain relevant.

The designation as a Qualified Jurisdiction is valid for five years, and all seven current Qualified Jurisdictions (Bermuda, Japan, Switzerland, France, Germany, Ireland, and the UK) were approved as of January 1, 2015. As such, each must be re-evaluated no later than December 31, 2019. Because the five-year compliance period of the Covered Agreement will still be in effect at that time, the RTF charged the Working Group with performing a re-evaluation of all seven Qualified Jurisdictions, including those in the EU, before the current designations expire on December 31, 2019.

Finally, the Working Group reported that it has received an application from another EU member state requesting designation as a Qualified Jurisdiction. It was noted that the "evaluation process is very time-consuming and can take up to a year to complete," but because the Covered Agreement has essentially validated Solvency II as an effective supervisory system, the Working Group may be able to make a recommendation as early as the Fall National Meeting in December of 2017, with a proposed effective date of January 1, 2018. Taking into account the five-year compliance period of the Covered Agreement, the RTF agreed that evaluation of the EU applicant as a potential Qualified Jurisdiction remained worthwhile, and directed the Working Group to proceed in preparing a recommendation.

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