Identify the regulatory agencies responsible for regulating insurance and reinsurance companies.
In the US, insurance business (including reinsurance) is primarily regulated at the state level. Each state has an insurance department, plus laws, regulations, policies and procedures that regulate virtually every aspect of the operations of insurers and reinsurers. States also regulate the actions of insurance intermediaries, including insurance producers, agents, brokers, reinsurance intermediaries and third-party administrators.
The Supreme Court held in United States v South-Eastern Underwriters Association, 322 US 533 (1944), that Congress had the power to regulate the insurance industry. In response, Congress enacted the McCarran–Ferguson Act, which, broadly speaking, left regulatory control over insurance to the states, as long as their laws and regulations do not conflict with federal antitrust laws on rate fixing, rate discrimination and monopolies. Some national insurance programmes, including, but not limited to, the Terrorism Risk Insurance Act, the National Flood Insurance Program, the Federal Crop Insurance Program and the Longshore and Harbor Workers’ Compensation Act, were created by federal act, and are subject to regulation by the federal government with certain regulatory responsibilities left to the states. Further, in January 2021, the Comprehensive Health Insurance Reform Act was signed into law, which amends the McCarran–Ferguson Act to apply US federal antitrust laws to the health insurance industry.
After the passage of the McCarran–Ferguson Act, each state continued to develop its own set of insurance laws, regulations and rules for state agencies to impose on the business of insurance in their respective states. As a result, insurance companies, reinsurance companies and insurance intermediaries are subject to the laws and regulations of each US jurisdiction in which they transact business. This can be onerous for companies seeking to do business nationwide.
Developments at the federal level following the 2008 financial crisis have affected certain aspects of insurance regulation in the US, including in connection with surplus lines insurance and credit for reinsurance, and have introduced a federal regulatory overlay on some of the largest US insurers. Specifically, the Dodd–Frank Wall Street Reform and Consumer Protection Act (Dodd–Frank Act) was enacted in 2010 and resulted in changes in the regulation of the US surplus lines market and credit for reinsurance requirements. These changes:
- remove the ability of multiple states to tax a surplus lines transaction by restricting such tax to an insured’s ‘home state’ (as defined under the federal legislation);
- establish uniform standards for surplus lines insurer eligibility;
- streamline surplus lines placements for larger commercial insureds that qualify as ‘exempt commercial purchasers’ under the law; and
- restrict determination of credit for reinsurance to the cedent’s domiciliary jurisdiction.
The Dodd–Frank Act also created the following:
- the Federal Insurance Office (FIO), an office of the US Department of the Treasury charged with monitoring all aspects of the insurance industry (other than health, long-term care and crop insurance), including identifying gaps in insurance regulation, and representing the federal government at the IAIS and in international negotiations regarding insurance.
- the Financial Stability Oversight Council (FSOC), an interagency body charged with identifying systemic risks in the US financial services industry and designating systemically important financial institutions (SIFIs), including insurers and reinsurers, which are to be supervised by the Board of Governors of the US Federal Reserve System (the Federal Reserve) and subject to enhanced prudential standards. The FSOC designated two insurers as SIFIs in 2013 and one insurer in 2014 but all three of those designations have since been rescinded. In December 2019, the FSOC adopted revisions to its guidance on the designation of SIFIs that prioritizes an activities-based approach to the assessment of systemic risk, pursuant to which the FSOC will pursue entity-specific SIFI designations only if a potential risk or threat cannot be adequately addressed through an activities-based approach.
In addition, the National Association of Insurance Commissioners (NAIC) continues its efforts to coordinate regulation of insurance in US jurisdictions. The NAIC is a private organisation, created and governed by the chief insurance regulators from all US jurisdictions, that serves as a vehicle for cooperation among state insurance regulators. One way the NAIC accomplishes its purpose is to propose model laws and regulations for consideration by state legislatures. In addition, the NAIC establishes that some model laws or regulations are accreditation standards. The purpose of the NAIC’s accreditation programme is for state insurance departments to meet baseline standards of solvency regulation, particularly with respect to the regulation of multi-state insurers. NAIC accreditation allows non-domestic states to rely on the accredited domestic regulator to fulfil a baseline level of effective regulatory supervision, promoting inter-state reliance and reducing regulatory redundancies. All 50 states are currently accredited.
The NAIC also helps to improve efficiency by pooling resources through its centralised facilities. For example, insurance regulators in the US use the NAIC’s financial databases, often as their primary data source. While the NAIC is a voluntary organisation and cannot mandate the states to enact any laws, it has a lot of influence. In recent years, there has been increasing pressure on states to coordinate their efforts and work towards uniformity in light of proposals to replace or supplement the state-based system of insurance regulation with a federal regulatory system.Formation and licensing
What are the requirements for formation and licensing of new insurance and reinsurance companies?
To form a US insurance company, the first step is to determine the appropriate type of company. There are two main types of insurance companies in the United States: mutual companies and stock companies. A stock insurer is a profit-making company funded by an initial capital investment by the owners of the insurer. Mutual insurers are owned by their policyholders, rather than stockholders. A third, and less common form of organisation, is a reciprocal inter-insurance exchange, which is an unincorporated association where the members agree to an exchange of contracts of insurance among themselves, and which is administered by an independent ‘attorney-in-fact’ as the managing agent.
Companies must also select a state of domicile. The factors that a company may consider in selecting a state of domicile include the location from which it will operate the business, the speed with which it wants to become licensed and the regulatory environment in that jurisdiction.
Generally, the US insurance industry consists of two major product lines: property and casualty insurance, and life and health insurance. Property and casualty insurance products include motor vehicle and homeowners’ insurance sold to individuals (personal lines of insurance) as well as products designed to protect businesses from property damage and liability (commercial lines of insurance). The life and health insurance industry sells three major types of products: life insurance, annuities and health insurance.
Every insurance company must obtain a licence or certificate of authority in its chosen state of domicile before it may begin transacting business and seek the authority to transact business in other jurisdictions. Each state has statutory minimum capital and surplus requirements for insurers authorised to transact insurance in the state, which generally are fixed amounts based on the lines of business the company seeks to write. States also require that every insurance company maintain, in addition to minimum capital and surplus, risk-based capital that is calculated according to a formula based in part on the amount and kinds of insurance it writes.
Reinsurance company licensing
Reinsurance companies may be either licensed, accredited or certified. The licensing requirements for reinsurance companies are largely the same as those applicable to insurance companies, as described above. However, subject to jurisdictional considerations concerning activities in-state that might constitute the ‘doing of an insurance business’, a non-US reinsurer may operate in the US market on an ‘unauthorised’ basis, without having to subject itself to the US insurance licensing regime.
A licensed reinsurer is one that has undergone the state’s formal application and approval process and has obtained a licence or certificate of authority to transact reinsurance business within the state. In most states, an insurance company may act as a reinsurer for any line of business it is licensed to write on a direct basis. Some states allow for a reinsurance-only licence. A reinsurer licensed in one state may be authorised as a reinsurer in another state that employs ‘substantially similar’ credit for reinsurance regulations.
Accredited reinsurers, while not formally licensed by the state, satisfy certain criteria to provide reinsurance in a particular jurisdiction. Non-US reinsurers may also be authorised as reinsurers by maintaining a multi-beneficiary trust in a qualifying US financial institution as security for their US assumed obligations.
Certified reinsurers are a relatively new class of reinsurers that have been approved to provide reduced amounts of collateral for their reinsurance obligations in states that have adopted the NAIC’s new Credit for Reinsurance Model Law and Regulation. Also, under that new model law and regulation, reinsurers in non-US jurisdictions that have entered into a ‘covered agreement’ with the United States or that have otherwise been deemed to be a ‘reciprocal jurisdiction’ will be considered to be authorised reinsurers and would not have to post any collateral for their reinsurance obligations. The criteria for certification as a certified reinsurer or reciprocal jurisdiction reinsurer generally require that the company:
- be licensed as an insurer or reinsurer in a qualified jurisdiction;
- maintain a minimum level of capital and surplus;
- maintain financial strength ratings from two or more rating agencies;
- submit to jurisdiction in the state;
- submit financial information for regulatory review; and
- satisfy other requirements established by regulators.
What licences, authorisations or qualifications are required for insurance and reinsurance companies to conduct business?
Once a company is licensed in its state of domicile, it must obtain a licence or become accredited or certified in any other US jurisdiction in which it will be authorised to conduct an insurance business. A non-US reinsurer need not comply with licensing requirements if it conducts its US reinsurance business on an unauthorised basis in compliance with the applicable state laws in the United States.
Surplus lines insurance
There are certain limited exceptions in the United States to insurance company licensing requirements, including, but not limited to, placements with surplus lines insurers. A surplus lines insurer is generally not licensed to transact business directly in any jurisdiction other than its domiciliary state. Before any business can be placed with a surplus lines insurer in a given state, the insurer must be deemed eligible under that state’s surplus lines laws and under the Dodd–Frank Act (which establishes uniform standards for surplus lines insurer eligibility), and the insurance generally must be unavailable from licensed carriers in that state. Such ‘surplus’ business must be ‘exported’ by specially licensed surplus lines brokers who make appropriate tax and other required regulatory filings. Surplus lines insurance is subject to less stringent regulation than insurance written by licensed companies, and is not covered herein.Officers and directors
What are the minimum qualification requirements for officers and directors of insurance and reinsurance companies?
States impose a variety of minimum standards for directors of insurance and reinsurance companies, including age and residency requirements. Some states also require that a specified number of directors be independent. All officers and directors of insurance and reinsurance companies must submit biographical affidavits to the insurance departments of the states in which the company is licensed, and are subject to background investigations. US states, through the NAIC, have been placing greater focus recently on enhancing reporting of corporate governance practices. The NAIC adopted a Corporate Governance Annual Disclosure model act and regulation in 2014, which requires extensive disclosure of regulated insurers’ corporate governance practices. A majority of US states have adopted the model act and regulations, and the NAIC made the model act an accreditation requirement in January 2020.Capital and surplus requirements
What are the capital and surplus requirements for insurance and reinsurance companies?
Capital standards are the main tool used by regulators to monitor the solvency of insurers and reinsurers. Insurance companies and reinsurance companies are required by state laws to have certain amounts of capital and surplus to establish and continue operations and satisfy risk-based capital requirements. The specific amounts of required capital and surplus (including risk-based capital) vary depending on the lines of business for which the insurer is licensed and the volume of business. Also, states regulate the investments of an insurance company’s assets. Only permitted assets under the investment guidelines, known as ‘admitted’ assets, may be counted towards the company’s capital and surplus.Reserves
What are the requirements with respect to reserves maintained by insurance and reinsurance companies?
In addition to setting capital requirements, state laws require insurers to set aside certain reserve amounts for future benefit and loss payments. The reserve requirements for life insurers are based on standard actuarial procedures and assumptions promulgated by the NAIC and adopted by the various states. The requirements for property and casualty insurers are more variable given the subjective factors affecting future obligations. Regulators require actuarial opinions in respect of the reserves maintained by insurance and reinsurance companies to assess whether they are establishing adequate reserves. The form and content of the actuarial opinion differs between property and casualty and life insurers.
States have recently implemented a new method for calculating life insurance policy reserves, termed principle-based reserving (PBR), which, for policies issued after the relevant effective date, replaces the prior formulaic approach to determining policy reserves with an approach that more closely reflects the risks associated with increasingly complex life insurance products using justified company experience factors, such as mortality, policyholder behaviour and expenses. PBR became effective on 1 January 2017. PBR is mandatory for all applicable life insurance policies entered into after 1 January 2020. PBR is expected to eliminate, or at least diminish, the life insurance industry’s need to use captive insurance companies to finance reserves required under prior regulations for certain term life insurance policies (known as ‘XXX reserves’) and certain universal life insurance policies (known as ‘AXXX reserves’) in cases where statutory reserves were considered excessive or redundant compared to economic reserves.Product regulation
What are the regulatory requirements with respect to insurance products offered for sale? Are some products regulated by multiple agencies?
Depending on the state and the product line, to sell its products in a state, an insurer generally must first obtain approval from the state’s insurance department for the rates and forms it proposes to use. State laws typically require that rates not be inadequate (to prevent company insolvency), excessive, discriminatory or unreasonable in respect of the benefits provided. Regulators review policy forms to confirm that they do not provide inadequate coverage, or contain provisions that could be illegal or confusing or misleading to consumers. Certain types of commercial insurance or other insurance lines are exempt from rate and form filing requirements in some states. Variable life and annuity products are also subject to regulation under federal and state securities laws. For example, most states have adopted regulations prohibiting insurers and insurance producers from recommending annuity purchases or replacements unless there is a reasonable basis to believe the annuity is ‘suitable’ for the consumer. The Securities Exchange Commission (SEC) adopted Regulation Best Interest in June 2019, which requires broker-dealers to act in the best interest of a retail customer when making a recommendation of any securities transaction or investment strategy involving securities; the ‘best interest’ standard is met by satisfying certain disclosure, care, conflict of interest and compliance obligations. In February 2020, the NAIC adopted revisions to its model ‘suitability’ regulations to clarify that all annuity transactions and recommendations must adhere to a best-interest standard, which, like the SEC regulation, is satisfied by certain disclosure, care, conflict of interest and documentation and compliance obligations. The New York insurance regulator adopted, in July 2018, amendments to its suitability regulations that impose a best-interest standard on the sale of annuity and life insurance products in New York, although these amendments were struck down as unconstitutionally vague by a New York appellate court in April 2021 and their future status remains unclear. Some types of coverage, such as workers’ compensation insurance and health insurance, may also be subject to regulation by state agencies apart from the insurance department (eg, workers’ compensation commissions and departments of public health). Several aspects of health insurance are also regulated by, and subject to laws and regulations of, federal government agencies.Regulatory examinations
What are the frequency, types and scope of financial, market conduct or other periodic examinations of insurance and reinsurance companies?
The insurance laws in most states require the insurance regulator to perform financial and market conduct examinations of licensed insurers no less than every three to five years. Financial examinations are typically conducted by the insurance regulator in the insurer’s or reinsurer’s domiciliary state. Examinations may either be routine, in the case of periodic examinations required by law or targeted, as, for example, in the case of market conduct complaints received by the regulator or the emergence of solvency concerns or other regulatory issues. Financial examinations typically focus on the financial condition of the insurer, while market conduct examinations focus on areas such as sales, advertising, claims handling and the insurer’s business practices more generally.Investments
What are the rules on the kinds and amounts of investments that insurance and reinsurance companies may make?
To ensure that an insurer’s investments are appropriate to support its liabilities, state insurance laws generally regulate the types and amounts of assets in which an insurer may invest. Permissible investments acquired or held according to the applicable law qualify as ‘admitted assets’ for purposes of inclusion in the company’s financial statements. State insurance regulation of insurance and reinsurance company investments, however, is not uniform, as the NAIC has two distinct model laws relating to insurer investments that alternatively restrict insurer investments by imposing either a ‘defined limits’ or a ‘defined standards’ approach; however, states have not generally adopted investment laws that strictly follow NAIC models. Under a defined limits approach, regulators place certain limits on amounts or relative proportions of different assets that insurers can hold to ensure adequate diversification and limit risk. Under a defined standards approach, regulators restrict investments based on a ‘prudent person’ approach, allowing for discretion in investment allocation if the insurer can demonstrate adherence to a sound investment plan.Change of control
What are the regulatory requirements on a change of control of insurance and reinsurance companies? Are officers, directors and controlling persons of the acquirer subject to background investigations?
The change of control of insurance and reinsurance companies is subject to the approval of state insurance regulatory agencies. ‘Control’ under states’ insurance laws is presumed to exist upon the acquisition of ownership of 10 per cent (5 per cent in Alabama) or more of the voting securities of an insurer or a person controlling the insurer. A person or entity seeking to acquire or merge with an insurance company or a person or entity controlling the insurer is required to file with the insurance department in the state of domicile an acquisition of control statement, commonly known as a ‘Form A’, regarding the proposed merger or acquisition. The Form A contains information about the merger or acquisition, such as the method of acquisition, identity and background of the acquirer and its directors and officers, source and amount of consideration used to fund the proposed merger or acquisition, future plans of the acquirer concerning the insurer, information about voting securities and other financial information and projections. The acquiring company is typically required to submit biographical affidavits of its officers, directors and any individuals owning a certain percentage (typically 10 per cent) of the acquiring entity either directly or indirectly. Some states also require that fingerprint cards and third-party background investigations of these directors, officers and stockholders be submitted.
State insurance departments review the Form A to determine that, after the change of control, the domestic insurer would be able to satisfy the requirements for the issuance of a certificate of authority, the merger or acquisition would not substantially lessen competition in insurance or tend to create a monopoly in the state, and the financial condition of the acquiring party will not jeopardise the financial stability of the acquired company. In some states, a hearing before the insurance commissioner is required before an approval order is issued.
Legislators and regulators in the US, including the NAIC, FIO, FSOC and certain members of Congress, have recently expressed increasing concern about the growth in the number and complexity of private equity-owned insurers. In December 2021, the NAIC issued a list of ‘Regulatory Considerations Applicable (But Not Exclusive) to Private Equity (PE) Owned Insurers’, which the NAIC and state regulators continue to review. The list recommends that regulators expand their review of potential change of control transactions to include: understanding control issues that may exist among entities with less than 10 per cent ownership interest; identifying insurer affiliates in a private equity-controlled holding company structure; analysing material provisions of investment management agreements to determine whether they are arm’s length and reasonable to the insurer; determining whether possible short-term interests of private equity ownership are properly aligned with the long-term nature of insurance liabilities, particularly with respect to life insurance; evaluating affiliate investment arrangements, including the use of offshore reinsurers and sidecar vehicles; and assessing operational, governance and market conduct practices of private equity entrants into the insurance market. Finally, in 2020 and the first half of 2021, the market experienced unprecedented levels of acquisition transaction activity, including with respect to insurers, involving special purpose acquisition companies for IPOs and business combinations with private operating companies (‘SPAC’ transactions). US regulators, particularly the SEC, which issued proposed regulations with respect to SPAC transactions in March 2022, have expressed concerns regarding these types of transactions.Financing of an acquisition
What are the requirements and restrictions regarding financing of the acquisition of an insurance or reinsurance company?
A party wishing to acquire or merge with a US insurer or reinsurer must disclose to state regulators the source and amount of the consideration to be used to fund the transaction, although such information may be kept confidential by the regulator. The Form A will not be approved if it is determined that the financial condition of the acquiring party is such that it could jeopardise the financial stability of the target company or the interests of policyholders. In most cases, the acquirer will not be permitted to use any assets of the target company to finance the acquisition, and there are limitations on the amount of debt that may be used.Minority interest
What are the regulatory requirements and restrictions on investors acquiring a minority interest in an insurance or reinsurance company?
Any person seeking to acquire ‘control’ of an insurance or reinsurance company must receive approval from the insurance regulator of the insurer’s domiciliary state before completing such acquisition. ‘Control’ under states’ insurance laws is presumed to exist upon the acquisition of ownership of 10 per cent (5 per cent in Alabama) or more of the voting securities of an insurer or a person controlling the insurer. However, a person acquiring a minority, but more than 10 per cent, interest in an insurer may elect to submit a ‘disclaimer of control’ to the domiciliary regulator to rebut the presumption of control, and thereby be excused from a Form A filing and not be considered a controlling person for insurance regulatory purposes following the acquisition. The disclaimer of the control process is generally less burdensome than the Form A process, and typically requires disclosure of all material relationships between the parties as well as the basis for disclaiming control. Approval of a ‘disclaimer of control’ is subject to the regulator’s discretion. In 2021, the NAIC adopted revisions to its statutory accounting rules to change the definition of ‘related parties’ for purposes of statutory accounting to include, among other things, parties who have disclaimed control of an insurer.Foreign ownership
What are the regulatory requirements and restrictions concerning the investment in an insurance or reinsurance company by foreign citizens, companies or governments?
There are no per se restrictions under state insurance laws on investments in insurance or reinsurance companies by foreign citizens or companies. In reviewing an application seeking approval of a proposed acquisition of control of an insurer, the state insurance commissioner may deny the application if he or she determines that the competence, experience or integrity of those persons who would control the target company are such that it would not be in the interests of the policyholders of the target company or the public to permit the investment. Also, many states have ‘government ownership’ statutes, which generally provide that no certificate of authority or licence to transact certain, or any, lines of insurance within a state will be issued or continued if the insurer is owned or controlled by any other state or foreign government or political subdivision thereof, subject to certain exceptions that may be available in a state. Outside of the insurance regulatory context, there are also non-insurance federal reporting requirements in connection with foreign investments in US business enterprises (eg, the US Department of Commerce reporting requirements).
Also, acquisitions by a foreign acquirer may be subject to review and scrutiny by the Committee on Foreign Investment in the United States (CFIUS) if the acquisition could potentially threaten US national security, which includes, in the context of insurance acquisitions, concerns relating to a foreign acquiror’s access to personal confidential or identifying information of US persons. CFIUS is an inter-agency committee of the US government that reviews the national security implications of foreign investments in US companies or operations. CFIUS is chaired by the Secretary of the Treasury and includes representatives from 16 US departments and agencies.Group supervision and capital requirements
What is the supervisory framework for groups of companies containing an insurer or reinsurer in a holding company system? What are the enterprise risk assessment and reporting requirements for an insurer or reinsurer and its holding company? What holding company or group capital requirements exist in addition to individual legal entity capital requirements for insurers and reinsurers?
Following the adoption by the NAIC of amendments to the model holding company act in 2010 and 2014, US states amended their insurance holding company laws to modify their group supervisory framework and provide regulators with new tools for evaluating enterprise risks within insurance groups. The amendments include several notable features, such as:
- expanding regulators’ ability to investigate a parent or any affiliate within an insurance holding company system that could pose a reputational or financial risk to an insurer;
- providing domiciliary regulators of internationally active insurance groups greater authority over the holding company system of such groups;
- requiring submission of a new annual Enterprise Risk Report (Form F) aimed at reducing potential risks faced by regulated insurance companies that may arise from issues at their non-regulated affiliates;
- enhancing regulators’ rights to access information (including books and records) regarding parents and affiliates to better ascertain the financial condition of an insurer; and
- codifying regulators’ ability to participate in supervisory colleges.
Also, all states have enacted a NAIC model regulation regarding an insurer’s own risk and solvency assessment (ORSA), which requires every US insurance and reinsurance company (or their holding company group) that exceeds certain annual written premium thresholds to complete a self-assessment of their risk management, stress tests and capital adequacy yearly, and the filing of a summary ORSA report.
In late 2020, the NAIC adopted a group capital calculation (GCC) framework for US insurance groups along with related holding company-level reporting requirements. All US states are expected to adopt the GCC revisions to the holding company act by November 2022. The GCC employs an aggregation methodology that utilises existing state-based capital calculations (ie, risk-based capital) for US-domiciled insurance companies. The GCC is intended to serve as an analytical tool for evaluating a firm’s capital position at the group level and is not intended as a prescribed group capital requirement.
At the US federal level, the Dodd–Frank Act established the Federal Insurance Office (FIO) to monitor the insurance industry and identify gaps in regulation that could contribute to a systemic crisis, and granted the Board of Governors of the Federal Reserve System (Federal Reserve) significant regulatory powers over systemically important insurers and other insurers that are affiliated with an insured depository institution. Until the enactment of the Dodd–Frank Act, the Federal Reserve and other federal banking agencies generally had regulatory authority over insurance groups only to the extent an insurance group owned a bank or a savings and loan company, with the parent company qualifying as a bank holding company (BHC) or savings and loan holding company (SLHC) (a small number of insurance groups currently qualify as SLHCs, although there are currently no insurance-based BHCs). The Financial Stability Oversight Council (FSOC), established pursuant to the Dodd–Frank Act and composed of federal financial regulators, state regulators, and an independent insurance expert appointed by the President, has the authority to designate an insurance group as a systemically important financial institution (SIFI) to be subject to enhanced prudential standards and supervision by the Federal Reserve. Currently, no insurance entity is designated as a SIFI. In September 2019, the Federal Reserve issued a notice of proposed rulemaking that would establish capital requirements for insurance-based SLHCs, and could in the future apply to insurer SIFIs if any are designated. The proposed capital framework, termed the Building Block Approach (BBA), is also a form of ‘aggregation method’ and is designed to adjust and aggregate existing legal entity capital requirements into a group-level capital framework for insurance-based SLHCs. In January 2022, the Federal Reserve issued a notice of proposed rulemaking that would establish a framework for the supervision of insurance-based SLHCs that, among other things, provides supervisory expectations with respect to governance, controls, and capital and liquidity management and proposes a unique supervisory rating system for such insurance groups. Neither of these proposed rulemakings had been finalised as at March 2022.Reinsurance agreements
What are the regulatory requirements with respect to reinsurance agreements between insurance and reinsurance companies domiciled in your jurisdiction?
States protect policyholders against insurer insolvency by requiring minimum financial reserves to pay losses. At the same time, insurance companies seek to decrease or diversify their risk and lessen the number of reserves they must carry by reinsuring a portion of their liabilities.
Unlike primary insurance, states generally do not regulate the terms, rates or forms of reinsurance contracts. Rather, states regulate reinsurance by granting or withholding credit for reinsurance on the ceding company’s statutory financial statements. Insurance companies may only ‘credit’ loss reserves by amounts transferred to reinsurers that meet certain conditions. Although states do not generally review and approve reinsurance agreements (unless the transaction is between affiliates or involves the transfer of a significant amount of business), to take credit for reinsurance ceded to another company, the agreement must contain certain minimum provisions (eg, insolvency provisions protecting insureds).Ceded reinsurance and retention of risk
What requirements and restrictions govern the amount of ceded reinsurance and retention of risk by insurers?
Certain states restrict insurers from ceding a material portion of liabilities to one reinsurer without prior approval and require the ceding company to retain some portion of direct insurance liabilities. Fronting arrangements, whereby a licensed carrier issues a policy and cedes 100 per cent of the liabilities to an unlicensed company, have historically triggered heightened regulatory scrutiny in the United States, as regulators may view the transaction as a way for the reinsurer to circumvent state licensing and solvency requirements. Although fronting arrangements are not prohibited per se, state regulators may take issue with a transaction where the ceding company retains no risk, particularly where the assuming company also services the underlying policies. Reinsuring a significant portion of an insurer’s in-force business or line of business may also be subject to prior regulatory approval under ‘bulk reinsurance’ statutes. Finally, states also impose separate concentration limits on how much business may be ceded to a single counterparty.Collateral
What are the collateral requirements for reinsurers in a reinsurance transaction?
Only when ceding to licensed or accredited reinsurers, reinsurers domiciled in another US state, or reinsurers that maintain a multi-beneficiary trust, can the ceding company automatically (ie, without a requirement that the reinsurer post collateral) take statutory financial statement credit for liabilities ceded, although certified reinsurers meeting certain standards may be allowed to post no or a reduced amount of collateral, and reinsurers in ‘reciprocal jurisdictions’ will be able to post no collateral once states have adopted the most recent amendments to the NAIC’s model credit insurance laws and regulations. All states are expected to have adopted these amendments by September 2022. Reciprocal jurisdictions automatically include any jurisdiction that is subject to a ‘covered agreement’ with the United States, and thus include all EU member states and the UK. Under ‘covered agreements’ entered into between the United States and the EU, and between the United States and the UK, states are required to eliminate collateral requirements for EU/UK reinsurers by 2022 or be subject to federal pre-emption. The NAIC has also determined that Bermuda, Japan and Switzerland are ‘reciprocal jurisdictions’ and it is expected, but cannot be guaranteed, that states will follow the NAIC in recognising those jurisdictions as reciprocal jurisdictions. Where a reinsurer is not licensed, accredited, certified or otherwise authorised, the reinsurer must provide some form of collateral to allow a deduction from the liabilities carried on the reinsured company’s statutory financial statements. Reinsurers may provide collateral directly to the ceding company, typically by establishing a trust or providing a letter of credit.Credit for reinsurance
What are the regulatory requirements for cedents to obtain credit for reinsurance on their financial statements?
If the reinsurer is licensed or accredited, is domiciled in another US state, or maintains a multi-beneficiary trust in the United States, the ceding company may take full credit for the reinsurance on its statutory financial statements. Until a few years ago, a reinsurer not meeting such requirements was required to post collateral or provide letters of credit in an amount at least as great as the liabilities reinsured (often with a 2 per cent buffer) for the ceding company to obtain full credit for the reinsurance. Now, many states have adopted laws allowing certified reinsurers to post collateral in lesser amounts on a sliding scale (from zero to 100 per cent depending on the ‘rating’ assigned to the reinsurer) if they are from qualified jurisdictions and otherwise satisfy specified certification criteria. Reinsurers from ‘reciprocal jurisdictions’ (non-US jurisdictions that have entered into a ‘covered agreement’ with the United States or that have otherwise been deemed to be a reciprocal jurisdiction) will be permitted to post no collateral, provided the reinsurer maintains the minimum capital and surplus requirements of its domiciliary jurisdiction and satisfies certain other requirements. It is expected that by September 2022 all states will have adopted amendments to their credit for reinsurance laws such that EU member states and the UK, and likely Bermuda, Japan and Switzerland, will be recognised as ‘reciprocal jurisdictions’ by all states.
A covered agreement is defined in the Dodd–Frank Act as a written agreement regarding prudential measures concerning the business of insurance or reinsurance that is entered into between the United States and one or more foreign governments and relates to the recognition of prudential measures that achieves a level of protection for consumers that is substantially equivalent to the level of protection achieved under state insurance regulation. On 22 September 2017, the US Trade Representative and Treasury, on behalf of the United States, and the European Union, signed a covered agreement intended to address group supervision and reinsurance regulation. In the United States, once fully implemented, the agreement requires US states to eliminate all reinsurance collateral requirements on qualifying EU-based reinsurers and provide them equal treatment with US reinsurers or be subject to federal pre-emption if not accomplished within five years from signing of the agreement (ie, September 2022). In December 2018, the United States and the United Kingdom signed a covered agreement the terms of which are substantially similar to the Covered Agreement. The UK–US covered agreement was entered into to maintain regulatory certainty and market continuity after the United Kingdom left the European Union.Insolvent and financially troubled companies
What laws govern insolvent or financially troubled insurance and reinsurance companies?
The laws of the state in which an insurance company is domiciled are the primary source of law applicable to insolvent or financially troubled insurance companies. If the state insurance commissioner determines, through a review of a company’s financial information, that the company is unable to pay its outstanding lawful obligations, or the admitted assets of the company are less than the aggregate amount of its liabilities, the commissioner may order the company to eliminate the impairment or discontinue the issuance of any new policies, or both, while the impairment exists. Depending on the severity of the impairment, the insurance commissioner may also seek an order to rehabilitate or liquidate the financially impaired insurance or reinsurance company. Typically, the insurance commissioner in the insurance company’s domiciliary state serves as the receiver in any formal delinquency proceeding, subject to review by a supervising court. Also, an insurance commissioner may revoke or suspend the licence of an insurance or reinsurance company deemed to be insolvent, regardless of whether it is domiciled in the state. States also have guarantee funds, capitalised through assessments on licensed insurers, to supplement payments to insureds in the event of the insolvency of an insurer.Claim priority in insolvency
What is the priority of claims (insurance and otherwise) against an insurance or reinsurance company in an insolvency proceeding?
The priority of claims (insurance and otherwise) in an insolvency proceeding involving an insurance or reinsurance company is determined by the insurance laws in the insurance or reinsurance company’s domiciliary state. The classes of claims are typically listed in the domiciliary state’s insurance laws, with payment of administrative expenses of the estate paid first and payments to shareholders and other owners of the company paid last. Claims of policyholders for benefits under their insurance policies are invariably ahead of claims of general creditors. As claims are paid, the highest priority of claims is paid first, and every claim in each successive class must be paid in full before members of the next lower priority class receive any payment. If there are not sufficient assets to pay a particular class in full, the creditors of that class will share in any distribution on a pro-rata basis based upon the assets available and the total amount of claims in that class.Intermediaries
What are the licensing requirements for intermediaries representing insurance and reinsurance companies?
Insurance intermediaries such as producers, agents and brokers are subject to licensing requirements in any state in which they are transacting business. Depending on the state, other intermediaries may also require special licensure to conduct business in the state, including managing general underwriters or agents, claims adjusters, third-party administrators and reinsurance intermediaries. To obtain a licence, many states require individual agents to pass a minimum competency examination and be screened for past criminal conduct. Sanctions, including licence suspensions and fines, are employed to punish fraud.