In July 2010 the U.S. Congress enacted the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Act”). As part of the overall federal financial regulatory reform package contained in the Act, Congress has finally legislated limited reforms in the reinsurance and surplus lines sectors1. It has also at least opened the door to greater federal oversight of U.S. insurance markets (although the mid-term election results have now made even that proposition uncertain).
The new Act makes a number of significant adjustments to U.S. insurance regulation:
Federal Insurance Office Established
The Act creates2, for the first time, a Federal Insurance Office (“FIO”) in the Treasury Department, with a Director appointed by the Treasury Secretary. The FIO has the authority to gather information, to advise the Treasury Secretary on key issues such as terrorism risk coverage and insurance accounting rules, and to send reports to Congress.
The FIO Director will also serve as a non-voting member of the Financial Stability Oversight Council (“FSOC”)3. Even more importantly, the FIO can also recommend to the FSOC the designation of an insurer as “systemically significant” and therefore subject to regulation by the Federal Reserve as a bank holding company.
In addition, under very limited circumstances, the FIO can declare a state insurance law or regulation “pre-empted”; but this can be done only after extensive consultation with state insurance regulators, the Federal Office of Trade Representative, and key insurance industry players (in trade associations representing insurers and intermediaries).
In this context, pre-emption denotes the declaration by the FIO that a state law is inoperative because it conflicts with federal law. The federal government does not intervene and directly supervise in such circumstances; instead, the state is still charged with supervision but cannot enforce the relevant state law.
The test for such pre-emption is whether the state law or regulation‘‘(A) results in less favorable treatment of a non- United States insurer domiciled in a foreign jurisdiction that is subject to a covered agreement than a United States insurer domiciled, licensed, or otherwise admitted in that State; and (B) is inconsistent with a covered agreement.”
Under the Act, a “covered agreement” is defined as a bilateral or multilateral agreement between the U.S. and one or more other countries that “relates to the recognition of prudential measures with respect to the business of insurance or reinsurance that achieves a level of protection for insurance or reinsurance consumers that is substantially equivalent to the level of protection achieved under State insurance or reinsurance regulation.”
In short, a U.S. state can be obliged not to discriminate against (re)insurers from outside the U.S. if the law of the country of the foreign (re)insurer provides equivalent protection to the law of the U.S. state.
Nonetheless, it is important to keep in mind that, except for this limited pre-emption authority, the FIO has no supervisory authority over insurers generally; and whilst it does have subpoena powers, these must be exercised in coordination with state insurance regulators. Further, the FIO has no authority over (i) health insurance (although the determination as to whether an activity constitutes “health insurance” will be made by federal, not state, officials), (ii) long-term care insurance that is not otherwise part of a life insurance policy or annuity contract, and (iii) crop insurance.
Surplus Lines Reforms
Effective 12 months after enactment of the Act4, only the “home state” of an insured may regulate the placement of non-admitted insurance or collect premium tax on property-casualty insurance sold in the “surplus lines” (non-admitted) market in the U.S. This Federal pre-emption does not apply, however, to risk retention groups (e.g., captives) or to workers compensation insurance.
The “home state” means the U.S. state where the insured has its principal place of business or, if the insured is an individual, his or her principal residence.
Most significantly for major commercial insureds5, as a result of the Act, a surplus lines broker need not follow state rules on first obtaining declinations from admitted insurers, if (a) the broker discloses to the insured that its insurance cover might be obtained from admitted insurers with greater protection and regulatory oversight and (b) the insured requests in writing that the broker instead proceed to obtain insurance from a non-admitted insurer.
Again, effective 12 months after enactment, if a ceding insurer’s state of domicile follows NAIC standards, no other state may deny financial statement credit for its reinsurance, regulate the reinsurer’s solvency or regulate the terms of the reinsurance agreement.
The most immediate effect of these provisions will be to end the extra-territorial reach of regulators in states like New York, which historically have imposed their own rules for obtaining credit for reinsurance on ceding companies licensed, but not domiciled there. No longer will a reinsurer headquartered in an E.U. country, but not licensed in the U.S., have to follow the rules of multiple states on each reinsurance transaction. The only rules that it must follow, in terms of providing security for its liabilities, are those of the ceding insurer’s domicile.
European and Asian (re)insurers, particularly Lloyd’s syndicates and LIRMA companies, will welcome the lifting of multiple, cumbersome state-by-state requirements in the U.S. surplus lines and reinsurance markets.
What remains to be seen is the degree to which the Obama Administration will be more willing than its predecessors to challenge the autonomy of state insurance regulators by adopting in practice the new FIO pre-emption authority conferred by the Act. To date, state insurance officials have been able, throughout the GATT and WTO rounds, to continue regulating non-U.S. insurers and reinsurers without regard to the removal of trade barriers which other industries have enjoyed.
Although there is no immediate sign that the Federal government’s traditional deference to these state regulators will lessen, the fact that the U.S. Congress has given the FIO the power to preempt, however limited, at least lays the groundwork for future, more significant changes in U.S. insurance regulation