On January 13, 2017, the US Department of the Treasury (Treasury), the Office of the US Trade Representative (USTR) and the European Commission announced that they had reached a covered agreement (Agreement) regarding international insurance groups doing business in the United States and the European Union (EU), concluding negotiations that officially began in November 2015. The Agreement strikes a grand bargain with respect to three areas of prudential regulation that have historically been sources of controversy: reinsurance collateral, group supervision and information exchange between regulators. According to the joint statement accompanying the release of the Agreement’s final text, the Agreement will provide “enhanced regulatory certainty for insurers and reinsurers operating in both the U.S. and the EU.” The actual implementation of the various aspects of the Agreement will take place over a period of up to five years, though certain provisions of the Agreement will likely be effectively operative at an earlier date. This Legal Update provides a preliminary summary of the Agreement. The Agreement eliminates the requirement that EU reinsurers post collateral as a condition for a US ceding insurer to take statutory financial statement credit for reinsurance, provided that the reinsurer satisfies certain minimum financial tests and other requirements. It also prohibits national regulators in the EU from imposing local presence requirements on US reinsurers as a condition of doing business in EU member states. Finally, it confirms the mutual agreement of the United States and EU that insurers operating in each other’s markets will only be subject to worldwide prudential insurance group oversight by the supervisors in their home jurisdiction, although individual regulators will still be able to regulate operations within their jurisdictions. The removal of collateral requirements has been particularly sought after by EU insurance bodies, which have long argued that US reinsurance collateral requirements imposed on foreign insurers were unfairly discriminatory. For US insurers and reinsurers doing business in the EU, the Agreement eliminates local presence requirements as a precondition to reinsuring EU insurers, which should address some initial concerns about some EU member states’ national implementations of Solvency II. The Agreement will enter into force seven days after the date the United States and EU exchange written notifications certifying that they have completed their respective internal requirements and procedures. As contemplated by the DoddFrank Act, this completion date is April 13, 2017, with respect to the United States (90 days after the January 13, 2017, transmittal of the Agreement to Congress). The European Parliament and Council must ratify the Agreement before it can enter into force in the EU. Full implementation of the Agreement will take 2 Mayer Brown | United States and European Union Reach a Covered Agreement on Cross-Border Insurance and Reinsurance place over a period of five years, though further clarity will be needed with respect to some provisions of the Agreement and their implementation. Background Title V of the Dodd-Frank Act, which established the Federal Insurance Office (FIO) within Treasury, granted the FIO the authority to coordinate federal efforts and develop federal policy on prudential aspects of international insurance matters. The FIO was empowered to negotiate arrangements (called covered agreements) with one or more foreign authorities that achieve a level of protection for US insurance or reinsurance consumers substantially equivalent to the level of protection achieved under the US state insurance regulatory system. The FIO was also given the authority to determine whether such covered agreements will preempt state insurance laws and regulations. In its initial report on the state of the US insurance system mandated by DoddFrank and released in December 2013, the FIO recommended pursuing a covered agreement for reinsurance collateral requirements based on the most current version of the National Association of Insurance Commissioners’ (NAIC) Credit for Reinsurance Model Law and Credit for Reinsurance Model Regulation. The USTR and FIO initially notified Congress of their intent to negotiate a covered agreement with the EU in November 2015. State insurance laws have already somewhat eased collateral posting requirements for certain highly rated reinsurers that are domiciled in certain non-US jurisdictions. Specifically, in 2011, the NAIC amended its Credit for Reinsurance Model Law and Credit for Reinsurance Model Regulation to reduce the collateral requirements for unauthorized reinsurers that complete a special certification process. Prior to the amendments, reinsurers that were not authorized or accredited in the ceding insurer’s domiciliary jurisdiction were generally required to post 100 percent collateral for the liability being assumed. The amendments (which have been adopted in a majority of US states, but not all states) allow unauthorized reinsurers that have been certified by the ceding insurer’s domiciliary regulator to post a reduced amount of collateral (determined on a sliding scale) based on their financial strength (including minimum capitalization of $250 million and ratings issued by two nationally recognized rating agencies) and business practices. As explained below, the collateral reduction provisions in the Agreement, which will apply only to EU-based reinsurers, are broader than the certified reinsurer provisions because they would completely eliminate the collateral requirement (as opposed to reducing it on a sliding scale) and because the financial strength requirements are less stringent. Covered Agreement Provisions on Reinsurance Under the Agreement’s terms, a “host jurisdiction” (e.g., any state in the United States) may not condition a local ceding insurer’s entry into, or prohibit such an insurer from taking credit for liabilities ceded under, a reinsurance agreement with an assuming reinsurer domiciled in the “home jurisdiction” (e.g., a member state within the EU) or impose collateral requirements or local presence requirements with respect to the assuming reinsurer which result in less favorable treatment than reinsurers domiciled in the host jurisdiction would receive. The Agreement makes clear that ceding insurers and assuming reinsurers may negotiate more stringent collateral or other requirements on a bilateral basis as part of their reinsurance negotiations. GENERAL REQUIREMENTS The provisions relating to reinsurance in the Agreement apply to insurers domiciled in the 3 Mayer Brown | United States and European Union Reach a Covered Agreement on Cross-Border Insurance and Reinsurance United States or the EU, respectively, that satisfy the following requirements: • Financial requirements. − In the case of US insurers, maintain minimum capital and surplus of $250 million and a minimum authorized control level risk-based capital of 300 percent (which translates to 150 percent of company action level risk-based capital). − In the case of EU insurers, maintain minimum capital and surplus of €226 million and a minimum Solvency II solvency capital ratio (SCR) of 100 percent. In contrast to the requirements for certified reinsurer status in the United States, there is no minimum credit rating requirement. The Agreement does not clarify whether permitted (as opposed to prescribed) accounting practices can be taken into account for purposes of the foregoing calculations. • Notification requirements. Maintain good communications with the host jurisdiction’s supervisory authority, including (i) giving notice of certain material events, (ii) delivering financial statements, actuarial opinions and related materials and (iii) submitting semi-annual lists of disputed and overdue (by 90 days or more) reinsurance claims from ceding insurers domiciled in the host jurisdiction. • Submission to jurisdiction. Submit to the jurisdiction of, and agree to respect the judgments of, the host jurisdiction’s court system, including with respect to the enforcement of arbitration awards. Additionally, an assuming reinsurer must appoint the host supervisory authority as its agent for service of process. Each reinsurance agreement must also provide that the assuming reinsurer will post collateral for 100 percent of its liabilities thereunder if it resists enforcement of a final judgment awarded to the ceding insurer. • Prompt claims settlement. Demonstrate that it settles reinsurance claims promptly. Information regarding its assumed and ceded business and claims experience must be provided to the supervisory authority of the host jurisdiction in support of the assuming reinsurer’s claims practices. Any of the following will cause the assuming reinsurer to fail this test: − more than 15 percent overdue or disputed reinsurance claims; − more than 15 percent overdue (by at least 90 days) undisputed claims in excess of $100,000 or €90,400 per ceding insurer; or − overdue (by at least 90 days) undisputed claims in excess of $50 million or €45.2 million in the aggregate. • No solvent scheme of arrangement. Confirm that it is not participating in any solvent scheme of arrangement involving ceding insurers in the host jurisdiction at the time of entry into a reinsurance agreement, and agree to post 100 percent collateral if the assuming reinsurer enters into such an arrangement. Additionally, a ceding insurer subject to resolution, receivership or liquidation proceedings may seek an order from the court administering such proceedings, requiring the assuming reinsurer to post collateral for all outstanding ceded liabilities. Furthermore, a supervisory authority in a host jurisdiction must notify the assuming reinsurer and its supervisory authority if it makes a determination that the reinsurer no longer satisfies the above conditions, and must generally provide the assuming reinsurer with 30 days to submit, and 90 days to execute, a compliance plan to remedy the defect or deficiency before imposing collateral requirements or local presence requirements. A final decision to impose collateral requirements or local presence requirements as a consequence of a failure to remedy must be explained to the assuming reinsurer in writing. 4 Mayer Brown | United States and European Union Reach a Covered Agreement on Cross-Border Insurance and Reinsurance APPLICATION OF COLLATERAL PROVISIONS Under the current pre-Agreement regime, if a US ceding insurer enters into a reinsurance agreement with an EU reinsurer that is not licensed or accredited in the US ceding insurer’s domiciliary state, the EU reinsurer is generally required to post 100 percent collateral for the reinsured liabilities (unless the EU reinsurer is a certified reinsurer in that state, in which case a lesser amount of collateral is required). Upon the effectiveness of the Agreement and its actual applicability to the relevant US ceding insurer’s domiciliary state, if the EU reinsurer meets the conditions under Article 3, paragraph 4 of the Agreement (described in “General Requirements,” above), zero collateral will be required. The elimination of collateral requirements will only apply prospectively.1 Until the date on which the Agreement becomes fully effective (see “Effectiveness and Transition Period,” below), the collateral elimination provisions of the Agreement will go into effect upon their adoption by individual US states. It remains to be seen whether the NAIC, which has been somewhat skeptical of the federally-led negotiation process that produced the Agreement, will take the initiative in encouraging early adoption of those provisions. However, US states that delay implementing the Agreement’s provisions will run the risk that the FIO will declare that the state’s applicable law is preempted by the Agreement. In this regard, the Agreement mandates the United States to conduct a federal preemption analysis of the Agreement’s provisions, to commence not later than July 2020, prioritizing the states with the highest volume of gross ceded reinsurance. Upon such a determination with respect to a state, the collateral provisions of the Agreement will go into effect in such state. APPLICATION OF LOCAL PRESENCE PROVISIONS As part of the transposition2 of Solvency II at the member state level, some EU jurisdictions implemented measures in 2016 that non-EU insurers and reinsurers have asserted are unfairly discriminatory against non-EU insurers and reinsurers.3 It is not immediately clear when these member state practices will cease as a result of the Agreement. However, the Agreement provides that the EU must cease imposing group capital requirements on US insurance groups immediately and must eliminate local presence requirements by January 2019. We anticipate that the EU will promulgate legislation to accomplish these objectives; this may well be done by way of a regulation, which would have a direct effect and not require transposition at the member state level. Covered Agreement Provisions Affecting Prudential Supervision GENERAL REQUIREMENTS The Agreement also contains provisions clarifying the prudential supervision of worldwide insurance and reinsurance groups. This will be welcome news to US-based insurance groups that have been informed by the supervisory authorities of several EU member states that they could be subject to Solvency II on a worldwide basis as a result of their reinsurance activities within the EU. • The supervisory authority of the jurisdiction in which the worldwide group parent is domiciled or has its head office (the home supervisory authority) will generally have sole responsibility for worldwide prudential insurance group supervision, including worldwide group governance, solvency and capital requirements and reporting. Supervisory authorities in other jurisdictions where the group has operations (host jurisdictions) will not have supervisory authority at the group level. • Home supervisory authorities that receive worldwide group Own Risk and Solvency Assessments (ORSAs) or equivalent documentation must provide summaries of 5 Mayer Brown | United States and European Union Reach a Covered Agreement on Cross-Border Insurance and Reinsurance such information to supervisory authorities in host jurisdictions. • Host jurisdictions retain the ability to exercise group supervision over and, where a group’s local financial stability is threatened or local policyholders are at risk, obtain information from and impose preventative or corrective measures with respect to, a worldwide group’s local activities in that jurisdiction, in some cases in consultation with the home supervisory authority or through the group’s supervisory college. The Agreement is not intended to limit or restrict the ability of US or EU supervisory authorities to exercise regulatory authority over groups that control banking or credit institutions in their respective geographic areas or which are large or complex enough to pose a threat to the financial stability of the United States or EU, as the case may be. APPLICATION OF PRUDENTIAL SUPERVISION PROVISIONS The prudential supervision provisions of the Agreement are operative on a provisional basis immediately and are fully operative upon the entry into force of the Agreement. The EU must ensure that member state regulators follow the practices set forth in Article 4 of the Agreement regarding prudential supervision, and the United States is charged with using best efforts and encouraging state regulators to do the same. (The federal preemption analysis required by the Agreement also applies to the prudential supervision provisions.) The Agreement also provides a termination right to each party following an accelerated mandatory consultation process in the event that the other party applies prudential supervision measures to an insurance or reinsurance group on an extraterritorial basis following a determination that such group could pose a threat to the financial stability of such other party. Covered Agreement Provisions Concerning Information Exchange Recognizing the inherently bilateral nature of information exchange, annexed to the Agreement is a model memorandum of understanding (MOU) for supervisory authorities in US states and EU member states to use as a basis for their negotiations. The MOU contains best practices for the time, manner and content of information requests and responses. It also provides for confidential treatment of information provided under its framework and urges a recipient regulator to obtain the prior consent of the disclosing regulator before onward sharing to a third party that is expected to maintain the information’s confidentiality on an equivalent basis. However, the MOU expressly does not address requirements that may apply to the exchange of personal data by supervisory authorities. Effectiveness and Transition Period The Agreement will not be fully effective until January 2022, the fifth anniversary of its execution (or, if later, the date that the European Parliament and Council ratify the Agreement). Until such time, the United States and EU are only required to “encourage relevant authorities to refrain from taking any measures” inconsistent with the Agreement’s conditions or provisions, notably the collateral and local presence requirements. The United States must also encourage state regulators to phase out credit-forreinsurance collateral requirements during the transitional period by reducing them 20 percent each year for EU reinsurers that would satisfy the eligibility requirements described above. Additionally, certain provisions of the Agreement may be effectively operative sooner, as discussed above. After the Agreement becomes effective, each party’s obligations under the Agreement are contingent upon continued compliance by the 6 Mayer Brown | United States and European Union Reach a Covered Agreement on Cross-Border Insurance and Reinsurance other party; this will help ensure that the United States and EU each get the benefit of the bargain (eliminated collateral requirements for EU reinsurers operating in the United States and equitable treatment under Solvency II for US reinsurers operating in the EU). For more information about the topics raised in this Legal Update, please contact any of the following lawyers or your regular Mayer Brown contact. David W. Alberts +1 212 506 2611 firstname.lastname@example.org Mark Compton +44 20 3130 3388 email@example.com Lawrence R. Hamilton +1 312 701 7055 firstname.lastname@example.org Francis R. Monaco +1 212 506 2227 email@example.com Colin Scagell +44 20 3130 3315 firstname.lastname@example.org Matthew G. Gabin +1 212 506 2321 email@example.com Endnotes 1 Article 3, paragraph 8 of the Agreement provides that the collateral reduction provisions apply “only to reinsurance agreements entered into, amended, or renewed on or after the date on which a measure that reduces collateral pursuant to this Article takes effect, and only with respect to losses incurred and reserves reported from and after the later of (i) the date of the measure, or (ii) the effective date of such new reinsurance agreement, amendment, or renewal.” 2 “Transposition” is the term the EU uses to describe the process by which individual EU member states implement an EU directive by making changes to their local statutes and regulations. 3 In one case, the UK’s Prudential Regulatory Authority (PRA) has required US insurance groups to obtain a revocable waiver from the PRA in order to continue doing business without subjecting their entire group to Solvency II. In another, Germany’s BaFin required that a branch be separately capitalized to write insurance in Germany, and restricted a US reinsurer from writing reinsurance on anything other than a correspondent basis (which requires the reinsurer to deal directly with ceding insurers rather than placing reinsurance through brokers). Mayer Brown is a global legal services organization advising many of the world’s largest companies, including a significant proportion of the Fortune 100, FTSE 100, CAC 40, DAX, Hang Seng and Nikkei index companies and more than half of the world’s largest banks. Our legal services include banking and finance; corporate and securities; litigation and dispute resolution; antitrust and competition; US Supreme Court and appellate matters; employment and benefits; environmental; financial services regulatory & enforcement; government and global trade; intellectual property; real estate; tax; restructuring, bankruptcy and insolvency; and wealth management. 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