Reinsurance Focus

During the first half of 2015, state legislatures and state insurance departments continued to revise state credit for reinsurance laws and regulations. The majority of these legislative and regulatory developments are due to states seeking to modernize their reinsurance laws and adopt the National Association of Insurance Commissioners’ (“NAIC”) Credit for Reinsurance Model Law. These changes are summarized below:

Arizona
House Bill 2352 approved by the Governor on March 30, 2015 and filed with the Secretary of State on March 31, 2015, amended Arizona Revised Statutes section 20-261.03 and created sections 20-261.05, 20-261.06, 20-261.07 and 20-261.08 to adopt the NAIC Credit for Reinsurance Model Law. House Bill 2352’s requirements for credit for reinsurance apply to all cessions after the effective date of the act under reinsurance agreements that have an inception, anniversary or renewal date that is not less than six months after the effective date of the act.

House Bill 2352 authorizes the Department of Insurance (the “Department”) to adopt rules to implement the credit for reinsurance provisions, including rules identifying the requirements for a jurisdiction to be considered a qualified jurisdiction by the director of the Department. However, the Department is exempt from the rulemaking requirements of title 41, chapter 6 Arizona Revised Statutes for two years after the effective date of House Bill 2352.

Arkansas
Senate Bill 881 (codified as Act 1223 of the 90^th Regular Session and effective April 7, 2015) conforms Arkansas’ Credit for Reinsurance Law in Sections 23-62-305 through 23-62-308 to the NAIC Credit for Reinsurance Model Law, effective six months after the effective date of Senate Bill 881. Senate Bill 881 also adds Section 23-62-309, entitled “Applicability – Reinsurance Agreements,” to clarify that Sections 23-62-305 through 23-62-307 apply to any cession of a reinsurance agreement if that reinsurance agreement has an inception, anniversary, or renewal date not less than six months after the effective date of Senate Bill 881.

Colorado
The Colorado Department of Insurance (the “Department”) adopted 3 CCR 702-3, entitled “Credit for Reinsurance” effective January 1, 2015, which sets forth the rules and procedural requirements that the Commissioner deems necessary to carry out the provisions of Section 10-3-701 et. seq., C.R.S., regarding the conditions and circumstances under which a domestic insurer may reduce their liabilities, or establish an asset associated with risks reinsured. Regulation 3 CCR 702-3 is part of the Insurance’s efforts to update its regulations to ensure they meet NAIC accreditation requirements. It is anticipated that the Department will continue rulemaking for regarding life and health reinsurance agreements and property and casualty reinsurance programs later in 2015.

Delaware
Regulation 1003 relating to Credit for Reinsurance (formerly Regulation 79) was amended effective January 11, 2015 for NAIC accreditation requirements.

District of Columbia
On March 11, 2015, District of Columbia Bill 20-0537 (“DC B 20-0537”), entitled the “Insurance Holding Company and Credit for Reinsurance Modernization Amendment Act of 2014″ became effective. The District’s Law on Credit for Reinsurance Act of 1993 was amended to modernize reinsurance regulation, in coordination with the Nonadmitted and Reinsurance Reform Act of 2010 to establish requirements to regulate reinsurers, to grant, suspend, and revoke the accreditations of United States-based reinsurers and certifications of non-United States-based reinsurers for which credit for reinsurance will be allowed, to establish and publish a list of qualified non-United States domiciliary jurisdictions of assuming insurers, and to receive notice from, and monitor the concentration of risks of, ceding insurers.

Florida
The Florida Office of Insurance Regulation (“FOIR”) has initiated rulemaking to amend Rule 69O-144.005, entitled “Credit for Reinsurance” and Rule 69O-114.007, entitled “Credit for Reinsurance from Eligible Reinsurers” to conform with the NAIC Credit for Reinsurance Model Law for accreditation purposes. Proposed changes include:• Replacing references of “eligible reinsurer” with “certified reinsurer”;

• Clarifying and expanding the documentation required to be filed with the FOIR for an insurer to obtain and maintain the status of a certified reinsurer;
• Clarifying process and regulatory responsibilities when the certified reinsurer’s financial condition changes;
• Clarifying disclosure requirements of the OIR when it receives an application from a reinsurer;
• Adding reinsurance concentration disclosure requirements; and
• Adding language that would allow the trusteed surplus of trusteed reinsurers to drop below $20 million if the trusteed reinsurer is no longer underwriting new business and demonstrates that surplus below $20 million was warranted.

During the rulemaking process, the OIR has filed notices of change to the proposed rules to address comments from the Joint Administrative Procedures Commission (“JAPC”) to reconsider clarification of standards and guidelines for the exercise of OIR’s judgment in determining that a certified insurer was unable or unwilling to meet its contractual obligations. A final public hearing on the proposed rule before the Financial Services Commission is scheduled for June 23, 2015.

Massachusetts
House Bill 4326, effective April 2, 2015, amends provisions of Massachusetts General Laws 175:20A regarding accreditation of assuming reinsurers. House Bill 4326 sets forth requirements concerning eligibility for certification, minimum capital and surplus requirements, certification application requirements, and criteria for the assignment of ratings to certified reinsurers by the Commissioner.

Nebraska
Legislative Bill 298 (“LB 298”) updates Nebraska’s statutes related to credit for reinsurance by reflecting the most recent version of the NAIC Credit for Reinsurance Model Law. LB 298 amends section 44-416.06, which establishes when credit for reinsurance is allowed and addresses concentration of risk. LB 292 also addresses:

• Accredited reinsurers and clarifies what a reinsurer must demonstrate to the Director to become accredited.
• Reinsurance ceded to an assuming reinsurer that maintains a trust in a qualified United States financial institution and situations when a principal regulator of the trust may allow for a reduction in the required trust surplus.
• A new category of allowable credit for reinsurance from a certified reinsurer.
• Associations of incorporated or individual unincorporated underwriters becoming certified reinsurers.
• Assignment by the Director of a rating for each certified reinsurer and requires the director to publish a list of certified reinsurers and their ratings. A certified reinsurer is obligated to secure obligations at a level consistent with its rating as specified in rules and regulations. The bill provides direction to the certified reinsurer on how to secure its obligations in a variety of situations.
• NAIC certified reinsurers and inactive certified reinsurers.
• The process of the Director to suspend or revoke a reinsurer’s accreditation or certification. A reinsurer has a right to a hearing. It also addresses the credit for reinsurance after a suspension or revocation.
• Concentration of risk by requiring a ceding insurer to take steps to manage its reinsurance recoverables proportionate to its own book of business and requires a ceding insurer to diversify its reinsurance program by placing duties to report to the Director when the amount of reinsurance in one reinsurer or group of affiliated reinsurers meets certain thresholds.

Finally, LB 292 amends section 44-416.07 by clarifying the securities the Director of Insurance may approve to secure obligations. LB 292 was approved by the Governor on March 12, 2015 and becomes effective 90 days after the adjournment of the Nebraska legislature, which occurred on May 29, 2015.

Nevada
Senate Bill 67 (SB 67), effective July 1, 2015, adopts various NAIC model laws and acts, including the NAIC Credit for Reinsurance Model Law. Specifically, SB 67 requires:

• The Commissioner to assign a rating to each certified reinsurer, giving due consideration to the financial strength ratings that have been assigned by rating agencies deemed acceptable to the Commissioner pursuant to regulation. The Commissioner shall publish a list of all certified reinsurers and their ratings.
• Sets forth the criteria a certified reinsurer must secure obligations assumed from U.S. ceding insurers at a level consistent with its rating, as specified in regulations promulgated by the Commissioner.

Texas
Senate Bill 1093, signed into law and effective September 1, 2015, amends Sections 492.104(b) and 493.104(b) of the Texas Insurance Code to remove the criteria that securities be readily marketable over a national exchange and have a maturity date of not later than one year to be acceptable as security for the payment of reinsurance obligations for life, health, and accident insurance companies and related entities or for property and casualty insurers, as applicable.

Vermont
The Vermont Department of Financial Regulation published proposed rules for Regulation 97-3 (Revised) Credit for Reinsurance (“Proposed Rule 15P006”) on January 28, 2015. Proposed Rule 15P006 sets forth rules and procedural requirements under which a domestic insurance company may take credit for insurance ceded to a reinsurer. It also imposes new notice requirements on ceding insurers regarding concentration of risk, and requires inclusion of certain clauses in the reinsurance agreement for ceding insurers to receive credit for reinsurance. A public hearing on Proposed Rule 15P006 was held on February 27, 2015. The deadline for public comment on Proposed Rule 15P006 was March 6, 2015.

Washington
House Bill 1077, effective July 24, 2015, revises the statutes regarding when a Washington domestic insurer may take credit for reinsurance ceded to another insurance company by adding the categories of an accredited reinsurer and a certified reinsurer. The bill requires the Commissioner to register assuming insurers meeting certain requirements either as an accredited assuming insurer or certified assuming insurer. House Bill 1077 provides the option that an insurance company may become an accredited reinsurer by filing certain information with the Commissioner. House Bill 1077 provides the option that the Commissioner may certify an insurance company as an eligible reinsurer by meeting certain requirements and filing information with the Commissioner. The Commissioner must create and publish a list of qualified jurisdictions under which an assuming insurer is licensed and domiciled is eligible to be considered for certification by the Commissioner. House Bill 1077 requires the Commissioner to assign a rating to each certified reinsurer and then publish a list of all certified reinsurers and their ratings. Finally, the Commissioner is authorized to engage in rulemaking to implement House Bill 1077.

Wisconsin
The Office of the Commissioner of Insurance published a statement of scope for a proposed rule to modernize Chapter Ins. 52 Wis. Adm. Code so that it aligns with the Nonadmitted and Reinsurance Reform Act of 2010 and the more recent amendments to the NAIC Credit for Reinsurance Model Law from which Wisconsin’s regulation is based.
The proposed amendments will allow the use of certified reinsurers. Reinsurers would be certified by the Commissioner at different levels based on their financial strength ratings. The collateral requirements for certified reinsurers would differ based on the reinsurer’s certification level. Reinsurers with a higher level of certification would have lower collateral requirements than are traditionally required to be credited. Reinsurers certified at lower levels would have the same collateral requirements as current law to be credited. By making these revisions, Wisconsin would modernize its reinsurance provisions and these changes would be consistent with changes made or in the process of being made in other states.

Conclusion
Insurers and reinsurers will continue to face an evolving regulatory landscape concerning state credit for reinsurance laws as more states continue to amend their statutes and engage in rulemaking to implements those statutory changes.

This post written by Kelly A. Cruz-Brown.

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In late May, the United States Court of Appeals for the District of Columbia Circuit affirmed a grant of summary judgment to a reinsurer in a dispute with the IRS regarding the imposition of U.S. excise taxes on a wholly foreign retrocession arrangement. The case involved Validus Reinsurance, Ltd., which is organized under the laws of and with a principal place of business in Bermuda. The court found that the relevant provision of the Internal Revenue Code did not apply extraterritorially and ordered the return of the taxes paid by Validus. Validus is a foreign reinsurance company with no operations in the United States. However, Validus does sell reinsurance to insurance companies selling policies covering risks, liabilities, and hazards within the United States. Validus also purchases retrocessions for its own reinsurance, often from other non-U.S.-based retrocessionaires. The transactions at bar involved a U.S.-based risk with reinsurance issued by Validus and a retrocession issued by a foreign retrocessionaire.

Congress had expanded the excise tax applicable to foreign insurance in order to “eliminate an unwarranted competitive advantage now favoring foreign insurers,” which were not subject to U.S. income tax laws. After another amendment, the particular provision of the Code section at issue, § 4371, requires an excise tax of one cent per dollar of premium paid on foreign-issued “reinsurance covering any of contracts taxable” as casualty insurance or life insurance. Because the retrocession is covering reinsurance that covers the taxable underlying contract, the court had to resolve an ambiguity in the statute. Looking to the fact that the government’s proposed reading would lead to a “cascading tax theory” with no limit as to the number of times that the government could collect tax on retrocessions with some underlying U.S.-based risks, the court determined that Congress had not shown an intent for the law to apply this extraterritorially. Under the canon of statutory interpretation against implying a reading of extraterritoriality absent a showing of intent by Congress, this transaction was an overbroad reading of the statute. Validus Reinsurance, Ltd. v. United States, No. 13-109 (D.C. Cir. May 26, 2015).

This post written by Zach Ludens.

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On April 28, 2015, Montana Governor Steve Bullock signed into law amendments to Montana’s law regarding captive insurers. Significantly, the amendments make it possible for public entities in Montana to set up captives. Additionally, the amendments allow captives in Montana to be organized as limited liability companies. Such LLCs must be established with a minimum of five members. John Jones, President of the Montana Captive Insurance Association (“MCIA”), called these amendments “meaningful improvements to what is already one of the country’s premier captive domiciles.” The amendments, spearheaded by the MCIA and the Montana Commissioner of Securities and Insurance, aim to make Montana a more attractive destination for companies looking to establish or re-domesticate captives.

This post written by Zach Ludens.

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The Director of the Federal Insurance Office (FIO), Michael McRaith, recently testified before the House Financial Services Subcommittee on Housing and Insurance regarding the impact international regulatory standards have on the competitiveness of United States insurers. Citing to the FIO’s 2014 Annual Report, McRaith noted that, in the aggregate, insurers operating in the U.S. continue to show resilience in the aftermath of the 2008 financial crisis. At year-end 2013, the life and health sector reported $335 billion in capital and surplus, and the property and casualty sector reported approximately $665 billion in capital and surplus. McRaith testified that the pace of globalization in insurance markets has “increased exponentially and is expected to continue to grow in the coming years.” Due to this global economic growth, many jurisdictions, both developing and well-established, are modernizing insurance supervisory regimes. These jurisdictions include Mexico, Canada, Australia, China, and South Africa.

McRaith cited to a recent agreement among members of the International Association of Insurance Supervisors (IAIS), as publicly described in March 2015, where members agreed on the “ultimate goal” of a single insurance capital standard (ICS) that will include a common methodology by which ICS achieves comparable, i.e., substantially the same, outcomes across jurisdictions. That agreement followed the IAIS October 2014 annual meeting where IAIS adopted an approach to the Basic Capital Requirement (BCR) for globally systemically important insurers. McRaith also noted that the European Commission was recently given the mandate to pursue an agreement with the U.S. to “facilitate trade in reinsurance and related activities” and to “recognize each other’s prudential rules and help supervisors exchange information.” McRaith concluded his testimony by stating that “U.S. insurance authorities are positioned to provide U.S. leadership that complements the shared interest in a well-regulated insurance market that fosters competition, promotes financial stability, and protects consumers.” McRaith’s April 29, 2015, testimony can be found here.

This post written by Renee Schimkat.

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On April 24, 2015, the Internal Revenue Service proposed regulations directed to “situations in which a hedge fund establishes a purported foreign reinsurance company in order to defer and reduce the tax that otherwise would be due with respect to investment income.” The IRS proposed regulations designed to clarify its applicable tax rules, by attempting to define exceptions to “passive income” from foreign insurance companies. Such income (earned from investments) is taxed at higher rates than income from insurance business, which is taxed only when it is realized, and at lower capital gains rates. The proposed regulations seek to clarify when investment income earned by a foreign insurance company is derived in the “active conduct” of an “insurance business,” and thus whether it qualifies for the passive income exception.

The proposal provides that “insurance business” means “the business activity of issuing insurance and annuity contracts and the reinsuring of risks underwritten by insurance companies, together with those investment activities and administrative services that are required to support or are substantially related to insurance and annuity contracts issued or reinsured by the foreign insurance company.” The proposed regulations “do not set forth a method to determine the portion of assets held to meet obligations under insurance and annuity contracts.” The IRS requests comments by July 23, 2015, “on appropriate methodologies for determining the extent to which assets are held to meet obligations under insurance and annuity contracts.”

This post written by Michael Wolgin.

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The Ohio Department of Insurance has proposed a new rule, Rule 3901-11-05 (the “Proposed Rule”), to establish a process and method that allow a special purpose financial insurance company captive (a “SPFIC Captive”) to request the use of an alternative reserve methodology other than that found in the National Association of Insurance Commissioner’s (“NAIC”) Accounting Practices and Procedures Manual.

The Proposed Rule requires a request to use an alternative principle-based valuation method to be accompanied by a written actuarial opinion that is signed by the appointed actuary for the SPFIC Captive and the ceding insurer. The Proposed Rule prescribes certain criteria for the alternative reserve methodology being requested:

• Must be a principle-based valuation method that uses one or more methods or one or more assumptions proposed by the SPFIC Captive.
• Must address all material risks associated with the contracts being valued and their supporting assets and determined capable of materially affecting the valuation of its obligations with respect to the risks assumed. Examples of risks to be included in the principle-based valuation method include but are not limited to risks associated with policyholder behavior, such as lapse and utilization risk, mortality risk, interest rate risk, asset default risk, separate account fund performance, and the risk related to the performance of indices for contractual guarantees.
• Must be consistent with current actuarial standards of practice.
• Must consider the risk factors, risk analysis methods, and models that are incorporated in the SPFIC Captive’s overall risk assessment process. The overall risk assessment process may include, but is not limited to, asset adequacy testing, GAAP analysis, internal capital evaluation process and internal risk management and solvency assessments.
• Must incorporate appropriate margins for uncertainty and/or adverse deviation for any assumptions not stochastically modeled.

The SPFIC Captive is required to provide any information the superintendent may require to assess the proposed alternative methodology. If an alternative methodology is approved by the superintendent, then the SPFIC Captive must use the alternative methodology until, and unless, the superintendent approves an another alternative method. Finally, upon the superintendent’s request, the SPFIC Captive is required to secure the affirmation of an independent qualified actuary that the alternative methodology complies with the criteria set forth in the Proposed Rule. The independent qualified actuary must be approved by the department and provide a written actuarial opinion detailing their affirmation and a report supporting that opinion to the superintendent. The independent qualified actuary report must comply with division (E)(3) of section 3964.03 of the Ohio Revised Code.

This post written by Kelly A. Cruz-Brown.
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On April 21, 2015, the Council of the European Union (“Council”) issued a mandate to the European Commission (“Commission”) to negotiate an agreement with the United States on reinsurance. The mandate consists of a decision authorizing the opening of talks and directives for the negotiation of the agreement. The Commission will negotiate on the EU’s behalf, in consultation with a Council committee. The agreement will be concluded by the Council with the consent of the European Parliament.

These negotiations would be initial steps towards possible removal of collateral requirements in both jurisdictions in order to ensure a risk-based determination for all reinsurers in relation to credit for reinsurance. The Commission likely will negotiate with the Federal Insurance Office (“FIO”), which has authority under the Dodd-Frank Act to negotiate international agreements on behalf of the United States. Any such agreement reached by the FIO would pre-empt state laws, in this case the Model Credit for Reinsurance Act. It will be interesting to see how the NAIC reacts to this development.

This post written by Kelly A. Cruz-Brown.

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Effective February 25, 2015, Montana’s surplus lines law, Section 33-2-301 and 33-2-302, M.C.A., (the “Surplus Lines Insurance Law”) was expanded to authorize natural disaster multi-peril insurance to be sold as surplus lines insurance in the State of Montana. House Bill 94, passed by the 64th Montana Legislature and signed into law, expanded the Surplus Lines Insurance Law to include natural disaster multi-peril insurance, a new type of insurance defined by House Bill 94 as “any bundled flood, earthquake, and landslide insurance.”

This post written by Kelly A. Cruz-Brown.

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House Bill 1180 (2015), signed into law February 27, 2015, amends Chapter 56-46 of the South Dakota Insurance Code, Captive Law, to allow the formation and regulation of agency captive insurance companies in South Dakota. As defined in House Bill 1180, an agency captive insurance company is either: i) an insurance company that is owned, controlled or under common ownership or control by an insurance agency, brokerage, or reinsurance intermediary that only insures the risks of insurance or annuity contracts placed by or through the agency, brokerage or reinsurance intermediary; or ii) owned or controlled by a producer of service contracts or warranties that only reinsures the contractual liability arising out of service contracts or warranties sold through such producer. An agency captive insurance company may be formed as in the same manner as a pure captive insurance company. An agency captive insurance company must comply with the following financial reporting requirements:

• Submit annually no later than six months after the close of its financial year to the director a report of its financial condition using statutory accounting principles certified under oath by two of its officers. An agency captive insurance company may make written application for permission to file the annual report on a fiscal year end date that is consistent with its parent company’s fiscal year;
• Provide a report of its financial condition audited by an independent certified public accountant every five years pursuant to Chapter 58-43 if it has annual direct premiums written of less than $2.5M dollars;
• If an agency captive insurance company has $2.5M dollars or more of annual direct premiums written, it shall provide a report of its financial condition audited by an independent certified public accountant every three years pursuant to Chapter 58-43; and,
• File an actuarial opinion following the year of operation and in connection with its audited statement of financial condition.

Regarding financial and business operations, an agency captive insurance company is not subject to any restrictions on allowable investments and may make a loan to its parent or affiliated entities. However, any investment that threatens the agency captive insurance company’s solvency or liquidity may be limited or prohibited by the Director of the Division of Insurance. Furthermore, loans to parents or affiliated entities of an agency captive insurance company is subject to prior approval by the Director of the Division of Insurance. Finally, an agency captive insurance company may enter into any arrangement to provide risk management services to a controlled unaffiliated business or an unaffiliated business; however, it may not accept any insurance risk from an unaffiliated business.

This post written by Kelly A. Cruz-Brown.

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An Illinois circuit court entered an agreed order of rehabilitation against a reinsurer, Millers Classified Insurance Company, following a complaint for rehabilitation filed by the Illinois Department of Insurance. Millers Classified’s board of directors had passed a corporate resolution on December 16, 2014 agreeing to the entry of the order of rehabilitation. The effect of the order was to create an estate comprising of all of the company’s assets and liabilities to be managed by an appointed rehabilitator. The order specifically allowed all policies where Millers Classified was the ceding company to remain in place subject to further review. All policies where Millers Classified was the assuming or retrocessional reinsurer were cancelled on a cut-off basis effective upon the order’s entry. State of Illinois ex. rel. Stephens v. Millers Classified Insurance Co., Case No. 2015CH (Ill. Cir. Ct. Jan. 20, 2015).

This post written by Leonor Lagomasino.

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