The U.S. Department of the Treasury and the Office of the U.S. Trade Representative (the "USTR") announced the successful completion of a four-year negotiation with the European Commission for a Covered Agreement on January 13, 2017. This bilateral Agreement addresses prudential measures with respect to insurance or reinsurance by focusing on three specific areas: (1) group supervision, (2) reinsurance and (3) exchanges of information among insurance regulatory authorities.
The Covered Agreement process was implemented by The Federal Insurance Office Act of 2010, which is a component of Title V of the Dodd-Frank Act, 31 U.S. Code § 314, in order to deal with international aspects of the regulation of the insurance and reinsurance business and Article 218 of the Treaty on the Functioning of the European Union. Covered agreements were discussed in the previous Duane Morris Alert, "NAIC Summer 2105 Meeting: Certified Reinsurers."
It has long been recognized that state-based regulation of the insurance industry is effective domestically; however, it has limitations in the international context. In particular, reinsurers domiciled outside of the U.S. object to requirements regarding the posting of collateral in transactions with ceding insurers in the U.S.—particularly when the reinsurer is financially strong, and despite the fact that the foreign jurisdictions largely do not impose collateral requirements on U.S.-based reinsurers.
At the same time, U.S.-based insurers and reinsurers, as well as state regulators, remain concerned with the possible imposition of onerous international group supervision standards and capital requirements. Specifically, the concern is that the EU's Solvency II Directive would apply to U.S.-based insurance groups with operations in the EU unless the U.S. groups are subject to domestic regulatory regimes that meet certain standards deemed equivalent by the EU.
Resolving these issues is not impossible, but the state-based system does not lend itself to quick responses. For example, despite the fact that the NAIC adopted the Credit for Reinsurance Model Law to ease the collateral requirements for foreign insurers, it has only been adopted by 32 states and, therefore, is not currently an accreditation standard that must eventually be adopted by the remaining states. In addition, state regulators are not necessarily willing to accede to regulatory standards developed by the EU or other international organizations, such as the International Association of Insurance Supervisors. The Covered Agreement is a means of bypassing state regulation, utilizing the preemption powers provided under Dodd-Frank.
The Covered Agreement
The Treasury Department Fact Sheet states that the Covered Agreement will:
- limit the worldwide application of EU prudential measures (such as those contained in the Solvency II Directive) to U.S. insurers operating in the EU, specifically group capital requirements, governance and reporting;
- limit EU prudential supervision of U.S. insurers to their EU operations and activities; and
- affirm the integrated U.S. system of state and federal insurance regulation, including the role of state insurance regulators as the primary supervisors of the business of insurance, and is expected to reduce reinsurance costs for primary insurers and improve the affordability and availability of insurance products to personal and commercial insurance consumers.
With regard to reinsurance, the Covered Agreement makes clear that the U.S. will, if and when needed, use its preemption powers to ensure that a state may not impose collateral requirements on a non-U.S. reinsurer that it does not similarly impose on a U.S. reinsurer that is domiciled in that state. These requirements are intended to provide a substantially equivalent level of protection for ceding insurers and consumers to that which is currently provided under state insurance laws. In order to maintain that level of protection, the Covered Agreement provides that an EU-based reinsurer will not be eligible for collateral elimination in the U.S. unless that reinsurer meets robust capital and solvency standards, and maintains a record of prompt payments to ceding insurers (discussed below). The Covered Agreement also relieves U.S.-based reinsurers from the obligation to establish a local presence, through a branch or subsidiary, in order to do business in the EU.
The elimination of the collateral and presence requirements only apply if reinsurers domiciled in a jurisdiction that is a component of one party to the Covered Agreement (such as a state of the U.S. or a member of the EU) are treated less favorably when they conduct operations in the other party’s jurisdiction than reinsurers domiciled in that jurisdiction. It is noteworthy that nothing in the Covered Agreement will limit or in any way alter the right of the actual parties to a reinsurance agreement to require collateral or to renegotiate agreements.
Thus, if New York does not impose collateral requirements on reinsurers domiciled in New York when they provide reinsurance to ceding companies domiciled in New York, it may not impose those (or similar) requirements on reinsurers domiciled in the EU when they reinsure New York ceding insurers. At the same time, the member states of the EU will be prohibited from imposing any local presence or office requirements on a New York-based reinsurer operating in the EU, unless a presence requirement also applies to an EU-domiciled reinsurer.
The Covered Agreement benefits, discussed above, apply only if the assuming reinsurer:
- maintains capital and surplus of either €226 or $250 million, as appropriate;
- maintains a solvency ratio of 100 percent SCR under Solvency II or an RBC of 300 percent of Authorized Control Level;
- provides written confirmation that it will consent to the jurisdiction of the courts of the territory in which the ceding insurer has its head office or is domiciled (although the parties to the reinsurance agreement are free to use alternative dispute mechanisms);
- will maintain a practice of paying claims promptly, consent to the appointment of the supervisory authority as agent for service of process, and consent in writing to pay all final judgements obtained by the ceding insurer (and to post collateral in the event that it disputes such judgements); and
- agrees to provide financial information when requested by a relevant supervisory authority.
The Covered Agreement provides that when an insurance or reinsurance group domiciled in one party to the Covered Agreement (referred to in the Covered Agreement as a "Home Party") is subject to worldwide group prudential supervision, including matters relating to group governance, solvency and capital, and reporting by its Home Party supervisory authorities, it will not be subject to group supervision at the level of the worldwide parent of the group by any supervisory authority in which it does business (referred to in the Covered Agreement as a "Host Party"). Despite this, Host Party supervisory authorities (such as state regulators in the U.S. or supervisory authorities in EU member countries) may exercise group supervision with regard to Home Party insurance or reinsurance groups "at the level of the parent undertaking in the territory of the Host Party." This means, for example, that an insurance or reinsurance group based in the U.S., that is subject to group supervision by U.S.-based (Home Party) regulators, will not be subject to group supervision by EU (Host Party) regulators, but with the proviso that an EU regulator has supervisory authority over groupings of companies that are managed from the EU, even when the top-tier company is based in the U.S.
When there is a worldwide risk management system, as evidenced by an Own Risk and Solvency Assessment ("ORSA"), applicable to a Home Party insurance or reinsurance group, the Home Party supervisor that requires the ORSA will provide a summary to the Host Party supervisory authorities that are members of the group’s supervisory college, and to supervisory authorities of significant subsidiaries or branches of the group that operate in the Host Party, at the request of supervisory authorities. If there is no worldwide group ORSA for a Home Party insurance or reinsurance group, the relevant U.S. or EU supervisory authority will provide equivalent documentation.
Prudential group supervision reporting requirements of a supervisory authority of a Host Party will not apply at the level of the worldwide parent of the group unless the reporting requirements directly relate to risk of a serious impact on the ability of insurers or reinsurers in the group to pay claims in the Host Party's territory (i.e., state of the U.S. or member of the EU). Nevertheless, under the Covered Agreement Host Party supervisory authorities retain the ability to request and obtain information from an insurer or reinsurer operating in its territory for purposes of prudential insurance group supervision when such information is necessary 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 claims. If an insurer or reinsurer fails to comply with such a request, the Host Party supervisory authority may take preventative, corrective or other responsive measures.
The Home Party supervisory authority may impose a group capital assessment, which includes a worldwide group capital calculation, captures risk at the level of the entire group and may affect the insurance or reinsurance operations and activities in the territory of a Host Party. The Home Party supervisor also has the authority to impose preventative, corrective or otherwise responsive measures, including "capital measures." However, the Host Party may not impose a group capital requirement or assessment at the level of the worldwide group.
Exchange of Information
The Covered Agreement provides that both the EU and the U.S. shall encourage supervisory authorities in their jurisdictions to cooperate in exchanging information.
Entry into Force and Implementation
The Covered Agreement will enter into force seven days after the parties exchange written notifications certifying that they have completed their respective internal requirements, or such other date as the parties agree. With respect to the U.S., a Covered Agreement must be submitted to the House of Representatives' Committees on Financial Services and Ways and Means, and to the Senate's Committees on Finance and Banking, Housing and Urban Affairs. The text of the Covered Agreement was submitted to the committees on January 13, 2017, after which there is a 90-day period for review. If there is no objection to implementation, the Covered Agreement will be executed by the U.S., and will become effective when necessary actions have been taken by the EU.
After entry into force, the Parties agree to encourage relevant authorities to refrain from taking regulatory measures that are inconsistent with the terms of the Covered Agreement. Specifically, the U.S. is required to encourage each state to promptly adopt measures to reduce collateral requirements by 20 percent per year, and to amend their credit for reinsurance laws and regulations to be consistent with the terms of the Covered Agreement.
Not later than 42 months after signature of the Covered Agreement (assuming it enters into force), the U.S. will begin evaluating potential preemption of state insurance laws and regulations, as provided for under Dodd-Frank, to the extent such laws and regulations are inconsistent with the Covered Agreement, and result in less favorable treatment of an EU insurer or reinsurer than of a U.S. insurer or reinsurer domiciled, licensed or otherwise admitted in such states. Such determination must be completed not later than 60 months after the signing of the Covered Agreement. The evaluations will be prioritized based on the volume of gross ceded reinsurance in the various states.
The Treasury Department's Fact Sheet notes, however, that collateral in place and collateral requirements for current reinsurance agreements will not be affected. 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 pursuant to the Covered Agreement takes effect, and only with respect to losses incurred and reserves reported from and after the later of the date of the measure, or the effective date of the new reinsurance agreement, amendment or renewal.
In general, the Covered Agreement will apply on the later of the date of entry into force, or 60 months from the date of signature. Nevertheless, the group supervision provisions of the Covered Agreement will be applied (provisionally until the time the Covered Agreement enters into force) by the EU by ensuring that supervisory authorities and other competent authorities in member countries follow the practices set out in the group supervision provisions from the seventh day of the month following date on which the parties have notified each other that the necessary approvals for provisional application of the Covered Agreement have been completed. The U.S. will, during the same time periods, use “best efforts” to encourage supervisory authorities to follow the group supervision practices set out in the Covered Agreement.
The Covered Agreement further provides that the reinsurance provisions regarding collateral and credit for reinsurance apply with respect to EU reinsurers doing business in a state on the earlier of the time the state adopts measures consistent with the terms of the Covered Agreement, or the effective date of a determination that the laws and regulations of such state are preempted.
During the 60-month period after the beginning of the date of provisional application, supervisory authorities in the EU may not impose a group capital requirement on U.S.-based insurance and reinsurance groups with operations in the EU. If the EU does not meet its obligations with respect to eliminating local presence requirements, supervisory authorities of the U.S. may impose group capital requirements at the level of the group parent when the group has its head office or domicile in the U.S.
The provisions relating to local presence will be implemented and applicable in the EU no more than 24 months from date of signature of the Covered Agreement, provided that it is provisionally applicable, or has entered into force. The provisions relating to reinsurance collateral and credit for reinsurance will be implemented and fully applicable in the territory of both parties not later than 60 months after signing, provided the Agreement has entered into force.
U.S./EU Covered Agreement Announcements
U.S./EU Joint Statement
U.S. and EU representatives jointly announced a bilateral agreement that provides enhanced regulatory certainty for insurers and reinsurers operating in both the U.S. and the EU. The joint statement expressed that:
[w]ith regard to reinsurance, the Agreement will enhance consumer protection and will lead to the elimination of collateral and local presence requirements for EU and U.S. reinsurers operating in these markets. . . [b]y virtue of the Agreement, U.S. and EU insurers operating in the other market will only be subject to worldwide prudential insurance group oversight by the supervisors in their home jurisdiction. For the United States, this preserves the primacy of the U.S. regulators with respect to oversight of U.S. insurance groups.
Additionally, Valdis Dombrovskis, European Commission vice-president, said the Covered Agreement was a win-win deal "set to benefit insurers, reinsurers and policyholders on both sides of the Atlantic."
In the transmittal letters, as required by Dodd-Frank, to the relevant Congressional Committees, the Treasury and the USTR stated that the Covered Agreement "will affirm our U.S. system of insurance supervision, protect insurance consumers, and provide meaningful benefits for U.S. insurers and reinsurers."
Immediate Reactions on January 13, 2017
U.S. Representative Ed Royce (R-Calif.), Chairman of the House Foreign Affairs Committee and a senior member of the House Financial Services Committee, released the following statement in reaction to the USTR and the Treasury Department finalizing terms of the Covered Agreement:
After the implementation of Solvency II which disadvantaged U.S. companies, this historic agreement gives American reinsurers the opportunity to compete on a level playing field throughout Europe. We will see an end to discriminatory practices which adversely impacted the market. U.S. insurers also avoid the added European tax of global group supervision standards. Billions in savings can be reinvested in the U.S. economy and passed on to consumers.
U.S. State Supervisors and Legislators
The NAIC, which is adamant in protecting the state-based regulatory system for insurance and opposed to federal incursions into its authority, responded when Ted Nickel, NAIC president and Wisconsin Insurance Commissioner, stated in the NAIC release that:
After more than a year of secret meetings it’s disappointing that in the waning days of the administration we are finally seeing the details of what purports to be a covered agreement between the U.S. and EU. . . . [A]s most state regulators were not allowed to participate in the process, the NAIC is coordinating a thorough review of the agreement to ensure consumer protections are not compromised through the preemption of state law, and we encourage Congress to do the same. Of great concern is the potential to use this agreement as a backdoor to force foreign regulations on U.S. companies.
The National Conference of Insurance Legislators (“NCOIL”) issued a statement by its president, Rep. Steve Riggs, a Democratic member of the Kentucky House of Representatives, that stated that: "State based regulation of insurance, a system that has worked very well for three-quarters of a century, needs to be protected, from both federal and international regulation." According to Riggs, the Covered Agreement "represents an intrusion by the federal government, and by extension international authorities, which should concern all of us who have worked to ensure the success of this productive [state] regulatory system as well as the consumers protected by it."
A number of industry groups are supportive. The American Insurance Association ("AIA"), the American Council of Life Insurers ("ACLI") and the Reinsurance Association of America ("RAA") issued a joint statement:
[t]his agreement . . . seeks to resolve significant insurance and reinsurance regulatory issues for companies doing business in both jurisdictions. We have long supported the covered agreement process and look forward to reviewing the details. . . [w]e thank the U.S. and European Union parties who were involved in the negotiations for advancing this important initiative. We also applaud state regulators for their invaluable contributions and their continuing commitment to U.S. policyholders.
Others in the U.S. insurance industry are less enthusiastic. The National Association of Mutual Insurance Companies ("NAMIC"), which represents smaller domestic insurers, is much more supportive of the state system and generally favorably disposed to traditional collateral requirements. NAMIC described the Covered Agreement as "a proposed solution to an invented problem – the question of European regulators deeming our regulatory system equivalent." Charles M. Chamness, NAMIC’s president and CEO, said:
Because the agreement has the authority to pre-empt U.S. insurance law and regulation, this agreement must meet a very high standard. Setting aside the specific elements of this agreement, which we’ll comment on once our analysis is complete, we note that some provisions appear to be temporary and several areas are ambiguous. This will result in confusion and potentially endless negotiations with Europe on insurance regulation.
NAMIC further said it will work with Congress and the new Trump administration to "determine if this agreement is good for American consumers and the industry."
The European Insurance and Occupational Pensions Authority ("EIOPA") welcomed the Covered Agreement. Gabriel Bernardino, Chairman of EIOPA, said:
This Agreement represents a further step in the successful cooperation between the European Union and U.S. insurance supervisors strengthening supervisory cooperation and enhancing regulatory certainty and opportunities for (re)insurers operating on both sides of the Atlantic for the benefit of consumers. EIOPA will continue its intense cooperation with the U.S. authorities through the work of the EU-U.S. Insurance Project.
The International Underwriting Association of London ("IUA") welcomed the Covered Agreement. Chris Jones, director of legal and market services at the IUA, noted in the IUA's media release that:
A more level playing field can now be established between EU and U.S. reinsurers, both in terms of collateral treatment and mutual recognition of two powerful and respected trading blocs. Furthermore, it sends a powerful message to other jurisdictions that protectionist regulation is not in the long term interests of clients . . . [t]he London Market is a major reinsurer of U.S. risks and the IUA is pleased to see such effective cooperation between regulators and federal negotiators in the U.S. and Europe.
The Covered Agreement could be the final act of the Federal Insurance Office and was one of the final acts of President Obama’s Treasury and USTR. The Trump administration is generally skeptical of trade agreements (and even of the EU) and has vowed to dismantle Dodd-Frank. It remains to be seen whether Congress will support the Covered Agreement.
Although it can be argued that EU reinsurers are the primary beneficiaries of the Covered Agreement—which may not predict a favorable view by the new administration—the cost savings for domestic insurers associated with reduction in collateral, and the reduced regulatory burden under the group supervision provisions, may ultimately make a persuasive case for U.S. support. A final consideration is that the Covered Agreement will not apply to the United Kingdom once it exits the EU. In view of the importance of the London market, presumably, a similar bilateral agreement will be needed for the post-Brexit world.