Spring 2016 Global Insurance & Regulatory Bulletin US/Americas UNITED STATES 1 Federal Reserve Board Previews Capital Rules for Insurers Subject to Federal Supervision 1 Final Fiduciary Rule Issued by Department of Labor 3 NAIC Spring 2016 Meeting Summary 5 BERMUDA 11 Bermuda Contracts (Rights of Third Parties) Act 2016 11 BRAZIL 12 SUSEP Clarifies Requirements for Reinsurance Contract Formation 12 UK/Europe UNITED KINGDOM 13 Brexit Referendum Draws Near 13 Amendments to Insurance Act 2015 Address Late Payment of Claims 13 UK IPT to Rise (Again) 14 EUROPEAN UNION 14 EU Insurance Distribution Directive 2016/97 14 Have You Seen Our Global Insurance Industry Year in Review? 17 Recent Lateral Partner Additions 17 Contact Info 17 MAYER BROWN | 1 US/Americas UNITED STATES Federal Reserve Board Previews Capital Rules for Insurers Subject to Federal Supervision On Friday, May 20, 2016, Daniel Tarullo, a member of the Board of Governors of the US Federal Reserve System (the “Board”) previewed a conceptual proposal for capital standards that will be applied to insurers subject to the Board’s supervision. In a speech at the International Insurance Forum in Washington DC sponsored by the National Association of Insurance Commissioners (“NAIC”), Governor Tarullo announced that the Board would issue an advance notice of proposed rulemaking (“ANPR”) in the coming weeks to solicit feedback from regulators, the US insurance industry and other interested parties on a two-pronged approach that would impose separate capital standards on systemically important insurers (“SIIs”) and on insurers subject to the Board’s supervision as a result of their ownership of a federally insured bank or thrift (“Non-SIIs”).1 He also indicated that the Board would soon propose enhanced prudential standards for SIIs in the areas of corporate governance, risk management and liquidity management and planning. Background Section 312 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”) abolished the Office of Thrift Supervision (“OTS”) and distributed its responsibilities among several federal agencies, including the Board. Supervisory oversight of savings and loan holding companies, a category that includes several dozen insurers with bank or thrift subsidiaries, was transferred from the OTS to the Board. As a result of Dodd-Frank, the Board is also vested with oversight of insurers designated by the Financial Stability Oversight Council (“FSOC”) as systemically important— currently Prudential and AIG. According to Governor Tarullo, this means that 25 percent of US insurance industry assets are now within the jurisdiction of the Board. In his speech, Governor Tarullo briefly surveyed a number of existing or developing frameworks for insurance capital regulation, including the Solvency II regime adopted by the European Union and the insurance capital standard being developed by the International Association of Insurance Supervisors for internationally active insurance groups and global systemically important insurers. Governor Tarullo stated, however, that the Board does not intend to follow any of those approaches. Among other criticisms, he indicated that several of the approaches rely too extensively on internal models, and others have conceptual appeal or promise but are “impractical for the foreseeable future” given the Board’s need to develop and implement its insurance capital standard in the relatively near term. Capital Standards for Non-SIIs Governor Tarullo devoted a significant portion of his speech to addressing capital rules for Non-SIIs. He suggested that the Board is likely to propose what he called a “building block approach” (“BBA”) for Non-SIIs. Under the BBA, capital requirements at each regulated subsidiary (e.g., insurer, bank or thrift) would “generally” be determined using the regulatory capital rules already applied to such subsidiary by the relevant regulator, which could be a state or non-US insurance regulator in the case of an insurer. (Unregulated subsidiaries would be analyzed using the existing standardized risk-based capital rules applicable to affiliates of bank holding 2 | Global Insurance & Regulatory Bulletin companies.) The group’s aggregate capital requirement would in turn “generally” be the sum of these individual capital requirements. Governor Tarullo expressed the view that most of the complexity in such a regime would involve developing a translation matrix to put different regulatory regimes on an equivalent footing and then applying that matrix to address intercompany transactions and other exposures (such as permitted accounting practices for insurers). The goal would be to impose some type of enterprise-wide capital requirement without forcing insurers to incur the burdens and costs associated with moving to fully consolidated GAAP-type financial reporting. Capital Standards for SIIs Governor Tarullo also commented on the Board’s likely approach to capital requirements for SIIs. In contrast to the BBA to be used for Non-SIIs, Governor Tarullo indicated that a modified consolidated capital framework would be appropriate for SIIs because of the risks they pose to financial stability. Accordingly, this “consolidated approach” would use consolidated financial information based on GAAP, with “appropriate adjustments for regulatory purposes.” The consolidated insurance group’s assets and liabilities would be segmented with each segment receiving a risk weighting that takes into account the longerterm nature of most insurance liabilities. The consolidated capital requirements would then be compared to the corresponding resources and measured against a minimum ratio of required capital. The number of risk categories could be increased over time to achieve greater risk sensitivity as the Board gains experience with the consolidated approach. The regulatory capital framework for SIIs as outlined by Governor Tarullo therefore would be similar in scope and structure to the basic regulatory capital framework for bank holding companies, though with perhaps some more favorable risk-weightings and other potential adjustments tailored to the insurance business. Implications Assuming the building-block and consolidated approaches to insurer capital regulation are ultimately implemented in a manner consistent with Governor Tarullo’s speech, multinational insurance groups subject to the Board’s jurisdiction will soon face additional challenges in navigating an even larger patchwork of capital standards (one of two Board standards: the insurance capital standards of the International Association of Insurance Supervisors or the NAIC and other country-specific standards, including Solvency II). Governor Tarullo acknowledged as much in his speech, though he expressed the view that the incremental regulatory burden under the Board’s forthcoming proposals would be less than under alternative proposals it has considered. In making this observation, he may have been mindful of the recent decision by the United States District Court for the District of Columbia in MetLife, Inc. v. Financial Stability Oversight Council, No. 15-0045 (D.D.C. Mar. 30, 2016), which rested in part on the failure of the FSOC to consider the costs attendant to MetLife complying with its SII designation. It is also not immediately apparent what additional insight the Board will gain from the BBA, which generally tracks existing regulations. Because most Non-SIIs do not, and under the Collins Amendment to Section 171 of Dodd-Frank cannot be required to, produce consolidated financial statements on a GAAP basis, the Board will have to rely heavily on the translation matrix in order for the BBA to produce meaningful results. It is therefore possible that the translation matrix, when proposed, will be quite intricate and complex, which could have the unintended consequence of placing a comparatively larger compliance burden on Non-SIIs than on SIIs. Next Steps As noted above, Governor Tarullo stated that the Board intends to issue an ANPR in the coming weeks to solicit feedback from interested parties. ANPRs MAYER BROWN | 3 are used by federal agencies to gather feedback on a conceptual proposal from interested parties before formally proposing new regulations. In choosing to telegraph the scope and content of the ANPR with Governor Tarullo’s speech, the Board has, in effect, acknowledged that its forthcoming proposals may create substantial controversy in the US insurance industry. Based on the reception to Governor Tarullo’s speech at the International Insurance Forum, such controversy may not be limited to the domestic market. Endnote 1 The Non-SIIs addressed by Governor Tarullo consist of those insurers that own a bank or thrift and that are significantly engaged in commercial or insurance underwriting activities. Those insurers were specifically excluded from the Board’s US Basel III capital rules adopted in 2013 pending the development of a tailored capital rule along the lines outlined by Governor Tarullo. See 78 Fed. Reg. 62018 (Oct. 11, 2013). The Board’s US Basel III capital rules (with some special insurance-specific provisions) apply to banks and savings and loan holding companies that are not themselves significantly engaged in commercial or insurance underwriting but that own insurers. UNITED STATES Final Fiduciary Rule Issued by Department of Labor On April 6, 2016, the U.S. Department of Labor (“DOL”) released in final form its massive package of rules, exemptions and amendments to existing exemptions that comprise its Fiduciary Rule (“Fiduciary Rule”). The overall objective of the Fiduciary Rule is to significantly broaden the scope of persons who are considered fiduciary advisers to plans, plan participants and IRA owners, and impose on fiduciary advisers heightened disclosure, reporting, procedural and other requirements under the Employee Retirement Income Security Act of 1974 (“ERISA”) and comparable provisions of the Internal Revenue Code of 1986 (“Code”). In promulgating the final version of the Fiduciary Rule, the DOL addressed many of the technical issues raised by commentators during the rulemaking process, but essentially retained intact the framework of its April 2015 drafts. It will take some time for the industry to sort out the full implications of the Fiduciary Rule for each situation; however, certain of the provisions of the Fiduciary Rule of greatest interest to insurance companies are briefly summarized below. While the Fiduciary Rule is effective on June 7, 2016, many of its provisions will not apply until April 10, 2017, either by its terms or through the new “best interest contract exemption,” discussed below, which contains a broad exemption grandfathering investments made before that date. The Fiduciary Rule significantly expands the scope of the fiduciary relationship to include persons who make recommendations for a fee or other compensation (direct or indirect) to a plan fiduciary or participant or IRA owner with respect to (i) the acquisition, sale or holding of securities or other property; (ii) distributions from a plan or IRA or decisions to rollover a plan account to an IRA; (iii) general investment management decisions; or (iv) the selection of investment managers or advisers for the plan or IRA. Fiduciary obligations attach upon a person representing or acknowledging fiduciary status, entering into an agreement or understanding that recommendations provided are based on the particular investment needs of the recipient, or directing recommendations to a particular recipient. 4 | Global Insurance & Regulatory Bulletin Carveouts from fiduciary status exist for (i) dealings with sophisticated plan fiduciaries, (ii) swap transactions, and (iii) plan sponsor employees. The DOL broadened the carveouts in the final version of the Fiduciary Rule, making them significantly more useful, in response to industry comments. However, substantial exclusions from the carveouts still remain. The DOL did acknowledge that a mere communication would not trigger fiduciary status unless it constitutes a “recommendation,” which is now determined according to an objective standard. It is therefore expected that industry participants will develop new wordings for direct communications regarding investment matters that are carefully crafted to avoid fiduciary status. A non-exhaustive list of permissible communications was set forth in the final Fiduciary Rule and includes investment education, general investment information and asset allocation models. Most referrals by banks and their employees will also not constitute a “recommendation” within the meaning of the Fiduciary Rule. ERISA and the Code generally prohibit fiduciaries from receiving payments from third parties and from acting in circumstances that present a conflict of interest. Many types of compensation common in the retail retirement investment market would, in the absence of an available exemption, violate these prohibitions. The Fiduciary Rule substantially narrows one such exemption commonly relied on by insurance groups who provide products and services to retail customers planning for retirement and conducting estate planning, Prohibited Transaction Class Exemption (“PTE”) 84-24, and introduces a new exemption, the Best Interest Contract Exemption (“BICE”), restoring the ability to provide certain products and services previously covered under PTE 84-24 subject to a new, higher standard of care. Prior to the effectiveness of the Fiduciary Rule, the insurance industry often relied on PTE 84-24 to receive commissions or engage in transactions involving the sale of insurance contracts, annuities and investment company securities and mutual fund shares. The Fiduciary Rule narrows PTE 84-24’s scope. Going forward, PTE 84-24 will only apply to recommendations with respect to insurance contracts and “Fixed Rate Annuity Contracts” (e.g., products currently referred to as immediate annuities, traditional annuities, declared rate annuities, fixed rate annuities or deferred income annuities). Variable annuities, indexed annuities and other insurance products based on an investment return (actual or modeled) of an index or separate account are now excluded from PTE 84-24 and will be covered by BICE. In the DOL’s view, these products are substantially more complex, involve enhanced conflicts and often require the investor to bear the investment risk, in contrast to Fixed Rate Annuity Contracts. The DOL therefore concluded that the higher threshold for exemption contained in BICE would be more appropriate for these latter products. PTE 84-24 continues to cover an agent’s receipt of commissions in connection with a plan’s investments into mutual funds; but will now exclude IRAs from the scope of coverage. In the case of the sale of either insurance contracts or mutual funds, the commissions that may be received by the agent-adviser have been narrowed to exclude anything other than the sales commission or load. PTE 84-24 no longer permits receipt of revenue sharing payments, administrative fees or marketing payments. BICE requires that any adviser or financial institution seeking to rely on it: • Acknowledge fiduciary status with respect to the advice provided to the customer and (except where the customer has substantially the same recourse under applicable law such as ERISA section 502(a)(2) and (3)) have a contract with the customer that may not disclaim liability MAYER BROWN | 5 for compensatory damages (but may disclaim liability for punitive damages and rescission) or require the customer to waive its right to pursue a class action or other representative action in court; • Establish (and adhere to) policies and procedures “reasonably designed” to prevent violating “impartial conduct standards,” which include (i) giving advice in the customer’s best interest (i.e., prudent advice based solely on the customer’s investment objectives, risk tolerance and financial circumstances), (ii) charging no more than reasonable compensation, and (iii) making no misleading statements about any customer transaction, any compensation it receives in connection with the customer relationship or the presence of any conflict of interest in the customer relationship and those standards; • Provide advance notice to the DOL of its intent to rely on BICE, and maintain records evidencing its compliance with BICE; • Refrain from giving or using incentives that are intended or would reasonably be expected to cause individual advisers to act contrary to the customer’s best interest, such as quotas, bonuses, special awards or sales contests; and • Fairly disclose (including electronically) fees, compensation and incentive arrangements for employees, sources of third-party payments, conflict policies and procedures and a description of the mandatory contract terms. As stated above, most investments made before April 10, 2017 will be grandfathered. Compliance with the various conditions of the BICE will phase in between that date and January 1, 2018. Given continuing industry concerns with BICE, including the lack of a clear definition of “best interest,” we expect that many insurance groups providing financial advice will opt to limit their communications with plans, plan participants and IRA owners to avoid fiduciary status, or look to avail themselves of other statutory or administrative exemptions. The final Fiduciary Rule also includes amendments to other class exemptions commonly relied upon in the financial industry to address fiduciary conflicts involving plan investments and transactions, including PTE 77-4 for investments in affiliated mutual funds, PTE 86-128 for securities and affiliated brokerage arrangements, and PTE 75-1 for securities transactions effected through a broker. In general, the amendments aim to add new conditions that mirror BICE and better align them with the objectives of the Fiduciary Rule. Firms that rely on these exemptions will need to conform their compliance procedures by April 10, 2017. UNITED STATES NAIC Spring 2016 Meeting Summary The NAIC held its Spring National Meeting (the “Spring Meeting”) in New Orleans from April 2-6. Set forth below are developments of interest as well as a recap of recurring themes. Big Data and Price Optimization The Spring Meeting kicked off with a public hearing sponsored by the newly formed Big Data (D) Working Group. Representatives from the industry (including vendors), academics, consumer representatives and regulators were asked to provide input on the definition, sources and uses of big data, consumer benefits and concerns relating to the use of big data, and how regulators might leverage big data to regulate more 6 | Global Insurance & Regulatory Bulletin efficiently and effectively. Most if not all presenters agreed on the following: No common definition. “Big data” means different things to different people at different times. A state insurance commissioner might use “big data” to refer to information obtained from an industry data call. Auto insurers might talk about it in connection with usage-based insurance initiatives, while writers of crop insurance might think about correlating meteorological data with commodity prices. Property insurers might look at the terabytes of data potentially generated by smart appliances or environmental sensors as an aid to risk mitigation efforts. Data is neutral. How it is used is not. The availability and ubiquity of big data has contributed to the growth in usage of price optimization techniques, primarily in personal lines. Two of the price optimization practices identified by the Price Optimization White Paper first tabled at the Fall 2015 NAIC National Meeting as being inconsistent with statutory requirements that rates not be “unfairly discriminatory” rely on the use of big data: insurers setting prices based on price elasticity of demand or the propensity to shop for insurance (i.e., the willingness of a policyholder to switch carriers). Some consumers distrust that insurers’ collection and use of big data (for example, through the use of telematics in connection with auto insurance) would be mutually beneficial. On the other hand, the industry may be uniquely positioned to partner with consumers to improve risk management and risk mitigation in both personal and commercial property lines. Similarly, big data is being used to proactively plan disaster response and resource deployment following natural catastrophe events. Respondents were less uniform in their recommendations for areas of further study and potential regulation. Industry representatives observed that insurers are already subject to existing state and federal laws and regulations, such as those addressing non-discrimination, unfair trade practices and anti-competitive conduct, that would or could apply to their use of big data and, accordingly, tended to suggest that a lighter regulatory touch from the NAIC might be appropriate. Academics and consumer representatives were generally more in favor of increased transparency and disclosure, but some recommended that new regulations might be desirable to protect the privacy of consumer data, especially where protecting one’s information or vindicating a data privacy right might be impossible or impractical. The Working Group subsequently held a follow-up call on May 9 and an in-person meeting on May 19 during the NAIC/NIPR Insurance Summit to discuss what data insurers and data vendors have and how that data is used in rating, underwriting and claims. Subsequent meetings will focus on the use of big data in claims settlement, including in connection with loss prevention and fraud detection, and regulators’ use of big data, including gaps in or mismatches between available data and data needs. Discussion of insurers’ use of big data for marketing has been deferred for the time being. Cybersecurity/Insurance Data Security Model Law As previously reported, in early March the Cybersecurity (EX) Task Force exposed an initial draft of the Insurance Data Security Model Law aimed at establishing “the exclusive standards for data security and investigation and notification of a breach of data security” for insurers, producers and other persons subject to regulation by a state’s insurance department. A comparatively brief comment period was set in order to have feedback from regulators and interested parties in time for the Spring Meeting. Written comments were submitted by a wide range of trade groups representing both insurance and reinsurance companies and producers as well as consumer interest groups and cybersecurity vendors. Many of these interested parties also gave prepared MAYER BROWN | 7 remarks at the Task Force’s session at the Spring Meeting, which was very well attended. All agreed that the subject matter of the model law is of vital importance to the industry, but the exposed draft drew significant criticisms. Several commenters suggested that a series of drafting sessions would be needed in which the trade groups and regulators could work through the voluminous comments provision-by-provision. Some questioned whether the accelerated development timeline proposed by the NAIC would result in a model law that would not be well received by state legislatures. Concerns were also expressed about the manner in which the model law would expressly or impliedly conflict with existing data security laws and regulations; the American Council of Life Insurers (“ACLI”) noted that the exposed draft raises substantial “questions about the anticipated interplay between the model law and other state and federal laws that impose security and breach notification requirements and the possibility that ultimately the model law may result in duplicative, rather than exclusive, requirements within a state.” Others noted that the preemption issues would invite litigation if the model law were passed in its current form. Producer representatives in particular were worried that a one-size-fits-all approach would unreasonably burden smaller insurance companies and producers, including individual agents. The Task Force has not provided an indication as to when a subsequent draft of the model law will be exposed. Principle-Based Reserving Barring any last-minute roadblocks, it appears that life and health insurers will begin using principlebased reserving (“PBR”) over a three-year phase-in period commencing January 1, 2017. The PBR framework is set forth in the NAIC’s Standard Valuation Model Law (#820), which provides that in order for it to become operative, the model law (or legislation including substantially similar terms and provisions) must be enacted by at least 42 states representing at least 75 percent of direct written life and health premiums in the United States. If these requirements are met on or before July 1 of a given calendar year, PBR will become operative (and a three-year phase-in period will commence) on January 1 of the succeeding calendar year. During the meeting of the PBR Review (EX) Working Group at the Spring Meeting, NAIC staff confirmed that the numerical thresholds had been met. As of the end of April, 43 states representing 76.17 percent of premium had adopted the model law, and 4 more states (Alabama, Massachusetts, Pennsylvania and Washington) were considering adoption. In an April 26 memo to the Principle-Based Reserving Implementation (EX) Task Force, NAIC legal staff expressed the view that the “substantially similar” requirement has been satisfied, subject to Louisiana’s timely passage of certain conforming amendments. The memo recommended that the Task Force provide the NAIC Plenary with its endorsement, and suggested that the Plenary should act on such endorsement by early June, since some states require separate action to ratify the effectiveness of PBR before the July 1 deadline. (The memo encourages all states to take some affirmative action with respect to their PBR determinations—whether or not required to do so—to provide “clear guidance to both the insurance industry and to other states.”) While each state ultimately needs to make its own determination as to whether the requirements for effectiveness have been met, it is expected that the NAIC’s recommendation will carry great weight. Related task forces and working groups within the NAIC have been proceeding for some time on the assumption that PBR will become effective on January 1, 2017. PBR pilot projects continue to 8 | Global Insurance & Regulatory Bulletin identify possible friction points as companies and regulators transition to new procedures, financial systems, reporting blanks and regulator dialogues. A follow-on industry survey will be conducted by the NAIC during the summer to understand how quickly and for what products insurers plan to transition to PBR, and to help the NAIC gauge resource needs as effectiveness approaches. XXX/AXXX Credit for Reinsurance Model Regulation Regulators and interested parties provided feedback to the Reinsurance (E) Task Force on the February 26 exposure draft of the Model Regulation on Credit for Reinsurance of Life Insurance Policies Containing Non-level Gross Premiums, Non-level Gross Benefits and Universal Life With Secondary Guarantees (“XXX/AXXX Credit Regulation”). The XXX/AXXX Credit Regulation complements the Credit for Reinsurance Model Act (#785) and the Credit for Reinsurance Model Regulation (#786) and focuses on the use of affiliated captive reinsurance companies in reserve financing transactions. Like Actuarial Guideline 48, the XXX/AXXX Credit Regulation provides for two layers of security. The “Required Level of Primary Security” may only be supported by high-quality assets (cash, SVO-listed securities and, for funds withheld and modified coinsurance arrangements, certain commercial mortgage loans), while the “Other Security” layer may be supported by any security acceptable to the applicable insurance commissioner. Previously, the Task Force had agreed, through a majority vote, to deny all credit for reinsurance to a ceding insurer that fails to maintain the Required Level of Primary Security, and the exposure draft reflected this. The ACLI reiterated its concern with this “all-ornothing” approach, and Vermont withdrew its earlier support for this option; both expressed support for a more measured consequence of failing to meet the Required Level of Primary Security. Florida, while remaining supportive of denying all credit to a noncompliant ceding insurer, proposed softening the consequence by providing for a brief remediation period during which credit would be allowed on a proportional basis. ACLI also argued that the large professional reinsurer exemption contained in the exposure draft should be expanded to include smaller professional reinsurers to avoid unintended consequences in circumstances where they might inadvertently be brought within the scope of the XXX/AXXX Credit Regulation. ACLI’s proposal was received sympathetically by some states and skeptically by others. The Task Force directed the NAIC to draft a revised Model Regulation reflecting the discussion at the Spring Meeting and requested an extension until the NAIC Summer National Meeting in August from its parent committee, the Financial Condition (E) Committee, in light of such direction. Certified Reinsurer Provisions Become Mandatory Accreditation Standards Further to the discussion in our Global Insurance Industry Year in Review 2015, the Financial Regulation Standards and Accreditation (F) Committee approved upgrading the certified reinsurer provisions of the Credit for Reinsurance Model Law and the Credit for Reinsurance Model Regulation from “optional” to “mandatory” accreditation standards, effective January 1, 2019. (Previously, the Committee had recommended a January 1, 2018 effective date.) The Committee also reported that no additional countries have formally initiated the qualification process, although the NAIC is in dialogue with one jurisdiction that is considering making an application. Currently Bermuda, France, Germany, Ireland, Japan, Switzerland and the United Kingdom have status as Qualified Jurisdictions. The adoption of the new accreditation standards is MAYER BROWN | 9 subject to ratification by the Plenary at the Summer National Meeting. Flood Insurance Developments The Property and Casualty Insurance (C) Committee and its subsidiary working groups and task forces are working on several projects relating to private flood insurance in preparation for next year’s reauthorization of the National Flood Insurance Program (“NFIP”), which currently expires on September 30, 2017. The Committee’s charges for 2016 include developing a legislative proposal for enhancements to the NFIP to improve the efficiency and penetration of flood insurance coverage through increased reliance on market mechanisms, including direct provision of flood insurance overseen by state insurance regulators. The Committee adopted a blanks proposal to collect data on flood insurance to provide state regulators and the NAIC with data to help evaluate proposals for changes to the NFIP. Primary market coverage (primary and excess) for flood insurance not offered through the NFIP, including creditorplaced flood insurance, will now need to be separately reported (previously it was aggregated with allied lines). The Committee rejected proposals to further distinguish creditor-placed flood insurance. The Committee also heard presentations from interested parties on the NFIP reauthorization process. Industry associations observed that the forthcoming reauthorization process presents an opportunity to reorient the NFIP toward the private market and noted that their members have expressed interest in taking on risk within the NFIP. Better modeling techniques, increased access to experience data and more powerful technology continue to improve flood underwriting. Rates are trending toward actuarial soundness, though political realities continue to serve as a counterweight to this trend; opinions differ on the optimal time frame for the transition to risk-based pricing. An abundance of catastrophe reinsurance capacity exists in both the traditional and alternative markets, and the financial resources available to government at every level continue to be stressed. Increased participation of the private market may also accelerate hazardmitigation programs and reduced development in areas susceptible to flooding, as well as provide an incentive to simplify and modernize the product itself. Regulators and interested parties were in agreement that greater legislative certainty with respect to the sufficiency of private flood insurance for lending requirements was a necessary condition to greater participation by the private market. The NAIC had testified before the House Financial Services Committee in favor of the H.R. 2901, the Flood Insurance Market Parity and Modernization Act (the “Flood Modernization Act”), which was unanimously approved by the House of Representatives on April 28. The Flood Modernization Act provides this clarity, putting flood insurance written by both admitted and surplus lines carriers on the same footing as flood insurance written through the NFIP. The Senate has not yet taken action on S. 1679, the identical companion bill to the Flood Modernization Act. Formation of New Joint Longevity Risk (A/E) Subgroup The Life Risk-Based Capital (E) Working Group, together with the Life Actuarial (A) Task Force (“LATF”), has created a new joint subgroup to provide evaluations and make recommendations concerning formal recognition of longevity risk in statutory reserves and/or risk-based capital calculations. The American Academy of Actuaries has its own task force devoted to studying this question, and the Subgroup will liase with the Academy’s task force as it develops its recommendations to the NAIC. 10 | Global Insurance & Regulatory Bulletin Several factors have contributed to the Subgroup’s formation: improved mortality experience, the marked growth of annuities and other products with material longevity risk, and an extended low interest rate environment. The Subgroup will begin its work by focusing on a general conceptual framework for a longevity risk charge or reserve, taking into account the nature and scale of longevity risk in various insurance products, international approaches to longevity risk and their underlying rationales, current risk management approaches to longevity risk, the degree to which longevity risk is implicity accounted for in existing reserving practices, diversification benefits associated with longevity risk, and the severity, volatility and speed of onset of the financial impact of longevity risk. The Subgroup expects to present its initial findings to LATF at the Summer 2016 National Meeting in August. Contingency Plans for Covered Agreement At the Spring Meeting the Financial Condition (E) Committee adopted, and the Executive Committee and Plenary subsequently approved, an additional charge for the Financial Condition (E) Committee to consider and develop contingency plans in the event that a “covered agreement” with the European Union is concluded on terms deemed to be less than favorable to the US insurance industry. Title V of the Dodd-Frank Act (which created the Federal Insurance Office) authorized the Secretary of the Treasury and the United States Trade Representative to jointly negotiate “covered agreements” with foreign governments, authorities or regulators regarding prudential measures with respect to insurance and reinsurance. In part at the urging of the US insurance trade associations throughout 2015, the Secretary and Trade Representative announced in late November that they would pursue a “covered agreement” with the European Union to obtain (i) permanent Solvency II equivalence for insurers and reinsurers based in the United States, (ii) recognition of the US approach to supervising insurance groups and (iii) uniform treatment regarding credit for reinsurance and related collateral requirements, as well as to facilitate exchange of confidential supervisory information between jurisdictions. While the Secretary and Trade Representative stated in their announcement that state regulators would have a “meaningful role during the covered agreement negotiating process,” concerns were expressed at the Spring Meeting that the negotiations will not be fully open and transparent and that the outcome of negotiations could have a meaningful effect on state insurance laws and/or regulations, especially those relating to credit for reinsurance and related collateral requirements. In particular, the EU has called for the elimination of collateral requirements for cessions to EU-based reinsurers, presumably beyond what is already available to specific jurisdictions and reinsurers through the certified reinsurer process. With the additional charge approved, it is expected that the Financial Condition (E) Committee will begin deliberations over the direction of such contingency plans as soon as its next meeting. MAYER BROWN | 11 BERMUDA Bermuda Contracts (Rights of Third Parties) Act 2016 Bermuda has enshrined the concept of a thirdparty beneficiary in law. Traditionally, common law jurisdictions required privity of contract for enforcement; US courts were peculiar in retaining and further developing the concept beginning in the later nineteenth century. The Contracts (Rights of Third Parties) Act 2016 (“Bermuda Act”) became effective at the end of March. While it is modeled closely on the eponymous UK statute, there are a few notable differences: • Under UK law, a person not a party to the contract may nevertheless have rights under that contract if the relevant contractual term “purports to confer a benefit on him.” Conversely, the Bermuda Act requires that the third party be expressly identified in the contract (by name, as a member of a class, or meeting a particular description, though the third party need not be in existence at the time the contract is entered into) and that the contract “expressly provide in writing that the third party may enforce” the relevant contractual term(s). • In the ordinary course, once the right of enforcement vests in the third party (generally upon notice, knowledge or reliance), the third party’s entitlement may not be varied or rescinded without his consent. Bermuda permits a court or arbitral panel to dispense with the consent requirement if it is “satisfied that it is just and equitable to do so having regard to all the circumstances.” The circumstances under which a UK court or arbitral panel may do the same are limited to two: mental incapacity or inability to locate the third party. • The Bermuda Act expressly reserves all defenses, rights of set-off and rights of counterclaim against the third party as though the third party were a party to the contract. • Both the Bermuda and the UK laws delineate certain types of contracts for which no third party may be granted rights (for example, promissory notes, negotiable instruments, formative documents of a body corporate, employment contracts and contracts for carriage of goods). However, Bermuda also prohibits third-party rights in letters of credit. The Bermuda Act should further strengthen Bermuda’s appeal as a governing law for commercial and financial transactions involving reinsurance. For example, the use of “cut-through” provisions, while fairly commonplace in a subset of reinsurance contracts, has traditionally been clouded by legal uncertainty; the Bermuda Act should help to resolve these doubts. Any preexisting contract may be amended to grant rights to third parties to the extent permitted by the Bermuda Act. However, a third party may only enforce a right which accrues on or after the later of the amendment date or the effective date of the Bermuda Act (March 28, 2016). 12 | Global Insurance & Regulatory Bulletin BRAZIL SUSEP Clarifies Requirements for Reinsurance Contract Formation SUSEP, the Brazilian insurance regulator, published its Regulation No. 524 in late January. The regulation augments and clarifies provisions of Article 37 of the Resolution No. 168 of the National Council of Private Insurance (“CNSP”), relating to the formation of reinsurance (and retrocession) contracts in Brazil and containing a requirement to reduce them to writing within 270 days of the start of coverage. The regulation confirms SUSEP’s interpretation that either electronic or physical documents will satisfy the statutory requirement, and that the formal requirement of the cedent’s signature to the contract generally may be waived. Notwithstanding the foregoing, acceptance of the terms and conditions of the reinsurance contract by the reinsurance broker does not replace the need for express agreement by the cedent, nor will a coverage note issued by the reinsurance broker override the reinsurance contract. The new rules are now in effect and will provide greater flexibility in completing new reinsurance business in Brazil. MAYER BROWN | 13 UK/Europe UNITED KINGDOM Brexit Referendum Draws Near The UK’s referendum on continued membership in the European Union will take place on June 23, 2016. A vote to leave the EU (“Brexit”) would trigger the provisions of Article 50 of the Treaty of the European Union. If the UK votes to leave, formal notice would then be made to the EU of the UK’s intention to withdraw, which would trigger a two-year period in which to arrive at a negotiated withdrawal. Any agreement specifying the arrangements for withdrawal (which should take into account the framework for the UK’s future relationship with the EU) is subject to approval, in the case of the EU, by not less than 15 of the remaining member states representing 65 percent of the remaining population, as well as ratification by the UK. If no withdrawal agreement is approved and put into effect within two years from the date the UK gives notice of its intention to withdraw, the UK will, on that second anniversary, cease to be part of the European Union, unless all of the remaining member states vote to extend the negotiation period. The insurance industry has been almost unanimous in its opposition to a Brexit, which would create unprecedented levels of uncertainty for the industry in the short to medium term. Presumably the UK would need to be separately certified as Solvency II equivalent. Withdrawal from the EU would also jeopardize access to the single market through the EU passporting regime. The International Monetary Fund has observed that the UK’s separation from the EU would risk “severe regional and global damage by disrupting established trading relationships,” and President Obama warned that the UK’s smaller size as an independent trading partner could put it at a disadvantage in bilateral trade negotations with the United States. In the event the UK does vote to leave, the best negotiated outcome for the insurance sector would likely be a continued close trading relationship with Europe as part of the European Economic Area (consisting of all EU member states plus Iceland, Norway and Liechtenstein), which would preserve the vast majority of the benefits of the single market for the industry. It is far from certain, however, that this would be the ultimate result. UNITED KINGDOM Amendments to Insurance Act 2015 Address Late Payment of Claims Amendments to the Insurance Act 2015 (“Insurance Act”) providing policyholder remedies for unreasonable delays in claim payments have received Royal Assent. Part 5 of the Enterprise Act 2016 introduces an implied term in every contract of insurance that the insurer must pay any sums due in respect of a claim within a reasonable time, where what is “reasonable” depends on all of the relevant circumstances (including any dispute resolution process with respect to a claim). Parties are not generally allowed to contract around this implied term, though non-consumer insurance contracts may be varied if the transparency requirements of 14 | Global Insurance & Regulatory Bulletin the Insurance Act are satisfied in connection with such variation. The legislation was originally introduced in September 2015 after similar provisions in an earlier draft of the Insurance Act were removed from the final enrolled version. The Insurance Act will come into force on August 12, 2016 and will have far-reaching effects on primarily non-consumer insurance contracts. The changes wrought by the Insurance Act have received extensive coverage, including by Mayer Brown. (See Mayer Brown’s March 25, 2016 Client Alert.) In preparation for the Insurance Act’s effectiveness, the Lloyd’s Market Association and the International Underwriting Association published both a comprehensive guide and a quick reference guide to the Insurance Act in June and July of last year, respectively; both are available at http://www.lmalloyds.com/act2015. UNITED KINGDOM UK IPT to Rise (Again) Following a more than 50 percent increase (from 6 percent to 9.5 percent) which took effect in November 2015, the UK Parliament voted a (much smaller) further increase in the Insurance Premium Tax (“IPT”) as part of Budget 2016. Subject to certain exceptions, IPT of 10 percent will now apply to insurance premiums received on or after October 1, 2016 with respect to most contracts of insurance affecting risks located within the UK. (Reinsurance is exempt from IPT, as are certain primary lines of business including life and long-term care and certain aircraft, marine and rail lines.) The October 1, 2016 effective date does not apply to insurers who use a special accounting scheme; the new IPT rate will apply to premiums received by those insurers on or after February 1, 2017 on risks covered by the terms of a contract entered into before October 1, 2016. The increased rate is intended to help the government fund flood defenses and resilience, and is in addition to the surcharge being assessed on homeowners’ policies to fund the recently launched Flood Re program. EUROPEAN UNION EU Insurance Distribution Directive 2016/97 Directive (EU) 2016/97 of the European Parliament and of the Council of 20 January 2016 on insurance distribution (recast) (“Directive”) entered into force on February 23. In passing the Directive, the European Union expressly acknowledged both the inadequacy of prior rules intended to accelerate the implementation of the single market in the insurance sector and the need to address continued opportunities for regulatory arbitrage by firms offering insurance-based investment products. Accordingly, the Directive updates and will eventually replace the older Insurance Mediation Directive (Directive 2002/92/EC) (“IMD”). Member states have until February 23, 2018 to transpose the Directive’s provisions into national law. As usual, member states will be free to provide greater protections than what are set out in the Directive. MAYER BROWN | 15 Scope of Regulation The Directive expands the scope of covered activities, which now includes most forms of insurance and reinsurance intermediation and distribution. Distribution activities undertaken by insurance firms themselves and comparisonshopping websites will now be within the scope of regulation. However, ancillary distribution activities (e.g., travel agents selling baggage protection alongside airline tickets) are excluded from coverage. The Insurance Single Market The Directive clarifies and augments procedures for freedom of service (“FOS”) rules as they apply to the insurance sector. Member states will be required to publish “general good” rules to facilitate transparency and increase cross-border business. The Directive also provides guidance for interactions between home country and host country regulators, and provides for information exchange between regulators (along with a professional secrecy rule). It also sets forth rules for the supervision and sanctioning of insurance distributors. Conduct of Business The Directive notably introduces a requirement for intermediaries and distributors to act “honestly, fairly and professionally in accordance with the best interests of customers.” The Directive also seeks to increase transparency in connection with the distribution of insurance products and services. Information provided to a customer must be clear and not misleading. Basic informational and conflict of interest disclosures (other than with respect to large risks) must be delivered to the customer in good time before the conclusion of an insurance contract, including with respect to intermediaries affiliated with insurance firms (and vice versa) and the nature of the remuneration received by the intermediary and its employees. Member states must establish ombudsman-style procedures for the resolution of disputes and customer complaints. The Directive also aims to increase oversight within the distribution chain to ensure fair dealing. Individuals who perform intermediation or distribution activities (whether alone or as an employee of a firm) must have a level of professional knowledge commensurate with the complexity of the products they service and the activities they undertake, and will be subject to continuing education requirements. Even in the case of ancillary distribution, sufficient knowledge of the product, including with respect to the handling of claims and complaints, is required. Additionally, “relevant persons” within the management structure must also possess an appropriate level of knowledge and competence in relation to the activities undertaken by their firm. Insurance-based Investment Products The Directive’s provisions in respect of the distribution of insurance-based investment products by insurers and intermediaries are intended to be consistent with and complement existing regulation contained in MiFID II (Directive 2014/65/EU) and the PRIIPs Regulation (Regulation 1286/2014). Rules governing the prevention and disclosure of conflicts of interest are set out in the Directive, as well as disclosure requirements concerning suitability and compensation. Unlike most of the remainder of the Directive, the provisions in respect of insurancebased investment products immediately supplant the IMD’s provisions in this area (Chapter IIIA of the IMD). EIOPA’s Role The European Insurance and Occupational Pensions Authority (“EIOPA”) has been asked to provide technical advice to the European Commission by February 1, 2017 in the areas of product oversight and governance, conflicts of interest, inducements, and assessments of product suitability and appropriateness as well as reporting. On the basis of the advice received, the Commission will then consider the need for any delegated acts relating to the Directive. 16 | Global Insurance & Regulatory Bulletin EIOPA will also act as a central clearinghouse for the aggregation of information about intermediaries and distributors. The Directive directs it to create and maintain a single electronic register containing information about intermediaries that have notified member states of their intention to carry on crossborder business in accordance with EU freedom of service requirements, and to maintain on its website links to the “general good” rules of the various member states. EIOPA will help develop a standardized presentation of non-life insurance product information (other than for large risks) in consultation with the national authorities and following consumer testing. Finally, EIOPA has been asked to monitor whether the Directive succeeds in its goals of furthering an insurance single market and reducing regulatory arbitrage through a series of reports to the Commission in 2018, 2019 and 2020. MAYER BROWN | 17 Have You Seen Our Global Insurance Industry Year in Review? In our Global Insurance Industry 2015 Year in Review, we discuss developments and trends in insurance industry transactions in the past year in the United States, Europe, Asia and Latin America, with particular focus on mergers and acquisitions, corporate finance, the insurance-linked securities and convergence markets, and certain tax and regulatory developments in the industry. For Mayer Brown and our global insurance transactional practice, 2015 was a banner year thanks to the continued support of our clients. We were privileged to work on many of the most interesting and innovative transactions in the industry, including insurance M&A deals, underwritten offerings of equity, hybrid and debt securities, pension de-risking transactions and numerous other corporate financings. In addition, in 2015 we acted on more than 15 completed offerings of insurance-linked securities and sidecar transactions raising more than $4 billion of risk capital. Our reputation in the marketplace across North America, Europe and Asia continues to grow, and this year our insurance industry practice was again recognized by Chambers Global, US, UK and Latin America; Legal 500 US, UK and Asia Pacific; and US News Insurance Law Nationwide. Request your copy. Recent Lateral Partner Additions Earlier this year, a 26-lawyer team joined our Consumer Financial Services group. This industry-leading team, which brings a wide range of regulatory counseling, enforcement defense and transactional experience, strengthened the firm’s consumer financial services presence in Washington DC, Northern California and Texas. In April, the Consumer Financial Services group launched the blog, “Consumer Financial Services Review,” which may be found at cfsreview.com. In addition, Frank Monaco joined as a partner our Insurance Industry Group in New York. Frank represents insurance and reinsurance companies, investment banks, financial buyers and rating agencies on a broad range of transactions. Contact Info If you have any questions in connection with anything in this Bulletin, please do not hesitate to get in touch with your usual Mayer Brown contact or one of the contacts referred to below. 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