NAIC approves changes to collateral requirements in the US

On 8 December 2008, the National Association of Insurance Commissioners ("NAIC") adopted the Reinsurance Regulatory Modernization Framework Proposal (the "Proposal"). The Proposal amends the rules under which non-US reinsurers active in the US market have to provide collaterals of 100% of their liabilities to US cedants.

The current rules

Currently, non-US reinsurers are compelled to collaterise their liabilities indirectly, under rules governing "reinsurance credits" (the "Credit Rules"). The Credit Rules only allow US cedants to take credit for their reinsurance arrangements on their balance sheet if (i) the reinsurer is licensed or accredited by the domiciliary state of the US cedant; or (ii) the reinsurer provides a collateral, either set up for the benefit of a specific US cedant, or in the form of a multiple beneficiary trust ("MBT"). An MBT must secure all gross liabilities of the reinsurer to all its US ceding insurers, plus a $20 million trusteed surplus. In the case of Lloyd's, the surplus required is $100 million. Collaterals for individual cedants do not require a surplus, although they are unpractical for large reinsurers that provide cover to a multitude of US insureds.

As well as trusts set up for individual cedants or MBTs, collaterals often take the form of letters of credits provided by banks. Funds made available through the collaterals must cover all gross liabilities to US cedants, including paid losses, adjustment expenses and reserves, unearned premium reserves, known losses, Incurred But Not Reported Losses and contingent commissions.

There is no licence or accreditation a national level. Hence reinsurers, US or non-US alike, need to be either licensed of accredited in each of the US state where they operate to avoid having to provide a collateral. Reinsurers can only become accredited if they are already licensed by a US state and maintain a "policyholder surplus" of at least $20 million.

All change

The Proposal establishes a new regulatory regime. Key proposed changes include:

1. Mutual recognition: non-US regulatory bodies will be able to certify non-US reinsurers, and such certification will be valid within the US. As a first step, the new NAIC Reinsurance Supervision Review Department (RSRD) will be entrusted to evaluate the regulatory regime of other countries and establish standards for certification on a cross border basis.
2. Single reinsurance regulation framework across the US: this will allow reinsurers to rely on a licence granted by one state, or certification granted by one foreign regulator, to operate in all US States.
3. Two new classes of reinsurers: US domiciled national reinsurers ("National Reinsurers"), and non-US "Port of Entry" reinsurers ("POE Reinsurers").
4. Collaterals based partly on the financial ratings of reinsurers: POE Reinsurers enjoying strong ratings from credit agencies (e.g. AAA from Standard & Poor) will not be required to post any collateral. The level of collateral will then increase on a sliding scale (from 10% to 100%), depending on the financial ratings. National Insurers will not be required to post collaterals unless their financial rating is below BBB+, at which stage the level of the collateral will amount to 75% of liabilities. POE Reinsurers who resist enforcement of a final US judgment will also be required to post 100% collateral, as will reinsurers who participate in any solvent scheme of arrangement or similar procedure involving a US cedant.
5. A number of contractual clauses will be compulsory, including the familiar service of suit clause, which will require POE Reinsurers to submit to a US court of competent jurisdiction, and appoint an agent for service of process in the US.

Changes will not happen overnight. The Proposal only sets out the new proposed regime in broad outline. The Reinsurance Task Force now needs to work on the detailed changes required to implement the Proposal, and the US government will need to take the necessary legislative steps to turn it into law. The new regulatory regime will only apply to reinsurance contracts entered into or renewed on or after the Proposal has been implemented.