On Jan. 13, 2017, the U.S. Department of the Treasury and the Office of the U.S. Trade Representative ("USTR") released the terms of the long-awaited covered agreement between the United States and the European Union (the "Covered Agreement") on prudential insurance matters. Once effective, the Covered Agreement will have a significant impact on international insurance groups doing business in the United States and the European Union.

Pursuant to Title V of the Dodd-Frank Wall Street Reform and Consumer Protection Act ("Dodd-Frank"), the Secretary of the Treasury and the USTR are authorized to jointly negotiate a covered agreement with one or more foreign governments, authorities or regulatory entities with respect to the regulation of insurance markets.

Generally, the Covered Agreement imposes reciprocity, as between a U.S. state on the one hand and any EU jurisdiction on the other, in three areas of insurance regulation – reinsurance, group supervision and exchange of information between regulators’ jurisdictions.

The Three Substantive Areas

Reinsurance. Subject to certain conditions, the Covered Agreement:

  • prevents the U.S. and EU (each referred to as a “party”) from requiring the posting of collateral as a condition to allowing an assuming reinsurer that has its head office or is domiciled in the territory of the other party (a “Home Party Assuming Reinsurer”) to enter into, or take balance sheet credit for, a reinsurance agreement with a ceding insurer that has its head office or is domiciled in its territory (a “Host Party Ceding Insurer”), where such requirement would result in less favorable treatment of Home Party Assuming Reinsurers than assuming reinsurers that have their head office or are domiciled in the same jurisdiction as a Host Party Ceding Insurer; and
  • prevents a party from requiring, as a condition of entering into a reinsurance agreement with a Host Party Ceding Insurer or as a condition to allow the Host Party Ceding Insurer to recognize credit for such reinsurance, the Home Party Assuming Reinsurer to have a local presence in the host jurisdiction, where such requirement would result in such less favorable treatment.

These requirements are subject to the assuming reinsurer’s:

  • maintaining, on an ongoing basis, at least €226 million (for EU reinsurers) or $250 million (for U.S. reinsurers) of own funds or capital and surplus;
  • maintaining a solvency ratio of 100% SCR under Solvency II or an RBC of 300% Authorized Control Level, as applicable in the territory in which the assuming reinsurer has its head office or is domiciled;
  • agreeing to provide prompt written notice and explanation to the regulator in the territory of the ceding insurer if
    • it fails below such minimum own funds or capital and surplus, as applicable, or the solvency or capital ratio, as applicable; and
    • any regulatory action is taken against it for serious noncompliance with applicable law;
  • consenting to the jurisdiction of the courts of the ceding insurer’s territory;
  • consenting to the appointment of the ceding insurer’s domiciliary regulator as its agent for “service of process” where applicable;
  • consenting to pay all final judgments obtained by a ceding insurer that have been declared enforceable in the territory where the judgment was obtained;
  • agreeing in each reinsurance agreement that it will provide collateral for 100% of the assuming reinsurer’s liabilities attributable to the reinsurance ceded pursuant to that agreement if the assuming reinsurer resists enforcement of a final and enforceable judgment;
  • agreeing to provide certain documentation (e.g., audited financials, actuarial opinions, schedule of reinsurance recoverables) to the host regulator, if requested;
  • maintaining a practice of prompt payment of claims under reinsurance agreements; and
  • confirming that it is not presently participating in any solvent scheme of arrangement and agreeing to provide 100% collateral consistent with the terms of the scheme should the assuming reinsurer enter into such an arrangement.

In addition, the assuming reinsurer’s home regulator must confirm to the ceding company’s jurisdiction on an annual basis that the assuming reinsurer complies with the solvency ratio/RBC requirement listed in the second bullet above, and, if subject to resolution, receivership or winding-up proceedings, the ceding insurer may seek, and, if determined appropriate by the court, obtain, an order requiring that the assuming reinsurer post collateral for all outstanding ceded liabilities.

Each party is required to observe a specified notification procedure, which includes an opportunity for a cure period, where a reinsurer in its jurisdiction no longer satisfies any of the above conditions.

The Covered Agreement applies only to reinsurance agreements entered into, amended or renewed on or after the date on which a measure that reduces collateral requirements 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.

Prudential Group Supervision. The Covered Agreement stipulates that, subject to participation in supervisory colleges as well as other exceptions described in the Agreement, a “home party” (meaning the jurisdiction of a group’s worldwide parent entity) insurance or reinsurance group is subject only to worldwide prudential insurance group supervision by its “home” supervisory authorities, and is not subject to group supervision at the parent level by any “host” (jurisdiction where the group conducts operations but not including the home jurisdiction).

However, the Covered Agreement makes clear that the host supervisor may exercise group supervision at the level of the “parent undertaking in its territory.”

The Covered Agreement provides certain specified exceptions where a host supervisor may exercise some level of group supervision. Some of the exceptions appear intended to be linked to others, while others appear disjunctive from any other, although the exact interplay among these exceptions seems imprecisely laid out. The exceptions include the following:

  • where a worldwide risk management system, as evidenced by the submission of a worldwide group Own Risk and Solvency Assessment (“ORSA”), is applicable to a home party insurance or reinsurance group, and the home regulator that requires the ORSA provides a summary of the worldwide group ORSA
    • to the host supervisory authorities, if they are members of the group’s supervisory college, without delay, and
    • to the supervisory authorities of significant subsidiaries or branches of that group in the host party, at the request of those supervisory authorities;
  • where no such worldwide group ORSA is applicable to a home party group, and the relevant U.S. state or EU member state regulator provides equivalent documentation which is prepared consistent with the two sub-bullets immediately above;
  • the summary of the worldwide group ORSA (or equivalent documentation) includes the following elements:
    • a description of the insurance or reinsurance group’s risk management framework;
    • an assessment of the group’s risk exposure; and
    • a group assessment of risk capital and a prospective solvency assessment;
  • if the summary of the worldwide group ORSA (or equivalent documentation) exposes any serious threat to policyholder protection or financial stability in the host jurisdiction, that host regulator may impose “preventive, corrective or otherwise responsive measures” after consulting with the relevant home regulator;
  • prudential insurance group supervision reporting requirements in the territory of the host party do not apply at the level of the worldwide parent entity of the insurance or reinsurance group unless they “directly relate to the risk of a serious impact on the ability of undertakings within the insurance or reinsurance group to pay claims in the territory of the host party”;
  • a host regulator retains the ability to request and obtain information from an insurer or reinsurer pursuing activities in its territory, whose worldwide parent entity has its head office in the territory of the home party, “where such information is deemed necessary by the host supervisory authority to protect against serious harm to policyholders or serious threat to financial stability or a serious impact on the ability of an insurer or reinsurer to pay its claims” in the host jurisdiction. The host regulator “avoids burdensome and duplicative requests”; and
  • with respect to group capital assessments:
    • with regard to a home party insurance or reinsurance group with operations in the host party and that is subject to a group capital assessment in the home party that fulfills the following conditions:
      • the group capital assessment includes a worldwide group capital calculation capturing risk at the level of the entire group, including the worldwide parent, which may affect the insurance or reinsurance operations and activities occurring in the territory of the other party; and
      • the regulator applying the group capital assessment has the authority to impose preventive, corrective or otherwise responsive measures on the basis of the assessment, including “capital measures,” the host regulator does not impose a group capital assessment or requirement at the level of the worldwide parent; and
    • where a home party insurer or reinsurer is subject to a group capital requirement in the territory of the home party, the host regulator does not impose a group capital requirement or assessment at the level of the worldwide parent.

The Covered Agreement clarifies that notwithstanding the group supervision limitations and restrictions discussed above, such restrictions are not intended to limit or restrict the ability of EU or U.S. regulators to exercise authority over entities or groups that own or control credit or depository institutions, or have banking operations, in the EU or U.S., as applicable, or whose material financial distress or the nature, scope, size, scale, concentration, interconnectedness or mix of activities have been determined could pose a threat to the financial stability of the U.S. (i.e., insurers that have been designated “SIFIs” under Dodd-Frank).

Exchange of Information. The Covered Agreement includes as an annex a nonbinding model memorandum of understanding ("MOU") for supervisory authorities in the U.S. and EU, pursuant to which such parties should exchange information. The MOU includes best practices for time, manner and content of information requests and responses, including standards for the confidential treatment of the information. The Covered Agreement explicitly disclaims that the MOU does not address requirements that may apply to the exchange of personal data by supervisory authorities.

Implementation of the Covered Agreement

From the date of “entry into force” or “provisional application” of the Agreement (explained below), whichever is earlier:

  • the parties are required to encourage relevant authorities to refrain from taking any measures that are inconsistent with any of its conditions or obligations. This may include, as appropriate, “exchanges of letters between relevant authorities” on such matters;
  • the parties must take all measures, as appropriate, to implement and apply the Agreement as soon as possible in accordance with the “application” provisions described below; and
  • the U.S. must encourage each state to promptly adopt the following measures:
    • the reduction, in each year following the date of entry into force or provisional application of this Agreement, of the amount of collateral required by each state to allow full credit for reinsurance by 20% of the collateral that the state required as of the Jan. 1 before signature of the Agreement; and
    • the implementation of relevant state credit for reinsurance laws and regulations consistent with the reinsurance provisions, as the method for adopting measures in conformity with the collateral prohibitions.

Provided that the Agreement has entered into force, on a date no later than the first day of the month that is:

  • 42 months after the date of signature of this Agreement, the United States must begin evaluating a potential pre-emption determination under its laws and regulations with respect to any state insurance measure that the U.S. determines is inconsistent with the Agreement and results in less favorable treatment of an EU insurer or reinsurer than a U.S. insurer or reinsurer licensed in that state; and
  • 60 months after the date of signature, the United States must complete any necessary pre-emption determination.

For these purposes, the U.S. is required to prioritize those states with the highest volume of gross ceded reinsurance for purposes of potential pre-emption determinations.

“Entry Into Force” and “Application”

The Covered Agreement:

  • “enters into force” seven days after the parties notify each other that they have completed their internal requirements. In the U.S., under Dodd-Frank, these internal requirements consist mainly of the submission of the Covered Agreement to specified congressional committees (which occurred on Jan. 13, 2017) and the expiration of a 90-day period thereafter; and
  • “applies” on the later of
    • the date of “entry into force” as described above and
    • the date that is 60 months from the date the Covered Agreement was signed.

However, the Covered Agreement also contemplates that:

  • the parties will “provisionally apply” certain terms of the Agreement even prior to entry into force or formal application and
  • certain provisions will apply upon the date of entry into force even if earlier than the 60-month deadline.

Specifically, each party must (i) provisionally apply the group supervision provisions until the date of entry into force, and then, (ii) from and after entry into force, ensure (in the case of the EU) or use best efforts and encourage (in the case of the U.S.) that its respective regulatory authorities will follow such provisions beginning on the seventh day following the completion of internal requirements for their jurisdictions.

In addition, the Covered Agreement provides that certain requirements, in order to be applicable to a party, are dependent on the other party’s observing certain other specified requirements (the “Cross Conditions”). Specifically, on the later of the date of “entry into force” and the date that is 60 months from the date the Covered Agreement was signed,

  • a party’s obligation not to impose collateral requirements for a cedent in its territory and the obligations described under “Implementation of the Covered Agreement” above are applicable only for so long as the other party is observing the group supervision requirement and the local-presence requirement described above;
  • the group supervision requirement and local presence requirement are applicable only for so long as the other party is observing the mandate not to impose collateral requirements; and
  • the local presence requirement is applicable only for so long as the other party is observing the group supervision requirement and the obligation not to impose collateral requirements.

Either party may terminate where a party applies measures outside its territory in the event of a systemically important insurer. The Covered Agreement also makes certain of its provisions dependent on compliance by U.S. states or determinations of pre-emption of state measures (the "State Compliance Conditions"). Specifically, until the later of the date of entry into force and the date that is 60 months from the date the Covered Agreement was signed, the obligation not to impose collateral requirements on reinsurance will apply with respect to an EU reinsurer in a U.S. state on the earlier of:

  • adoption by such U.S. state of a measure consistent with such requirement; or
  • the effective date of any determination by the U.S. that such U.S. state measure is pre-empted because it is inconsistent with the Agreement and results in less favorable treatment of an EU insurer or reinsurer than a U.S. insurer or reinsurer licensed in that state.

From the date of provisional application and for 60 months thereafter, supervisory authorities in the EU may not impose a group capital requirement at the level of the worldwide parent with regard to a U.S. insurance or reinsurance group with operations in the EU.

From the date of signature, during the 60-month period thereafter, if a party does not meet the local presence requirements, the supervisory authorities of the other party may, after mandatory consultation, impose a group capital assessment or group capital requirement at the level of the worldwide parent on an insurance or reinsurance group which has its head office or is domiciled in the other party.

The local presence requirement must be implemented and applicable in the territory of the EU no later than 24 months from the date of signature of the Agreement, provided that the Agreement has been provisionally applied or has entered into force.

Subject to the Cross Conditions and the State Compliance Conditions, the collateral requirements must be implemented and fully applicable in all of the territory of both parties no later than 60 months from the date of signature of the Agreement by both parties, provided that the Agreement has entered into force.

As from the date of entry into force or provisional application of this Agreement, whichever is earlier, the provisions (i) establishing a joint committee of the parties, (ii) relating to termination and mandatory consultation, and (iii) relating to amendment become applicable.

As to the above requirements, where a party does not comply in a timely fashion, the other party may seek mandatory consultation through the joint committee.