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Reinsurance

Last Updated 9/19/19

Issue: Reinsurance, often referred to as insurance of insurance companies, is a contract of indemnity between a reinsurer and an insurer. In this contract, the insurance company, i.e. the cedent, transfers risk to the reinsurance company which assumes all or part of one or more insurance policies issued by the cedent. Reinsurance contracts may be negotiated either directly with a reinsurer or arranged through the use of a third-party, a reinsurance broker or intermediary. Reinsurers themselves may also buy reinsurance protection which is called retrocession primarily for the purpose of further spreading risk and reducing the impact of catastrophic loss events.

Reinsurance is an essential mechanism by which insurance companies manage risks and the amount of capital they must hold to support those risks. Insurers may use reinsurance to best achieve a targeted risk profile. In the reinsurance agreement, the reinsurer's obligation arises only when the company's liability under its original insurance policy or reinsurance agreement has been incurred. The extent of that obligation is defined by the specific terms and conditions of the applicable reinsurance agreement. Absent specific agreement to the contrary, there is no privity of contract between the reinsurer and any party other than the company defined as the "reinsured" in the reinsurance agreement.

Reinsurance transactions in the insurance industry can become really complex. Companies may employ numerous reinsurance transactions with a variety of specific details, but typically, there are seven basic explanations to account for the companies' desire to engage in reinsurance: 1) Expand the Insurance Company's Capacity; 2) Stabilize Underwriting Results; 3) Financing; 4) Provide Catastrophe protection; 5) Withdraw from a Line or class of business; 6) Spread of risk; and 7) Expertise.

While the U.S. reinsurance sector continues to be an important source of capacity for domestic insurers, state regulators have long-recognized the need for both U.S. and non-U.S. reinsurance capacity to fulfill the needs of the U.S. marketplace. Consequently, the U.S. has developed a system of reinsurance regulation that has led to the development of an open but secure reinsurance market where nearly half of the reinsurance premiums are reinsured outside the country.

The regulation of reinsurance in the U.S. takes in consideration the domicile of the reinsurer and whether the reinsurer is licensed in a U.S. jurisdiction. Licensed reinsurers are subject to the same state-based regulation as other licensed insurers. When an insurer cedes business to a licensed reinsurer, the cedent is permitted under regulatory accounting rules to recognize a reduction in its liabilities for the amount of ceded liabilities, without a regulatory requirement for the reinsurer to post any collateral to secure the reinsurer's payment of the reinsured liabilities.

Status: On June 25, 2019, the NAIC Executive (EX) Committee and Plenary adopted revisions to the Credit for Reinsurance Model Law (#785) and Credit for Reinsurance Model Regulation (#786), which implement the reinsurance collateral provisions of the Covered Agreements with the European Union (EU) and the United Kingdom (UK). These revisions create a new type of jurisdiction, which is called a Reciprocal Jurisdiction and eliminate reinsurance collateral requirements and local presence requirements for EU and UK reinsurers that maintain a minimum amount of own-funds equivalent to $250 million USD and a solvency capital requirement (SCR) of 100% under Solvency II. The revisions also provide Reciprocal Jurisdiction status for accredited U.S. jurisdictions and Qualified Jurisdictions if they meet certain requirements in the credit for reinsurance models. U.S. states must adopt these revisions prior to October 1, 2022 or face potential federal preemption by the Federal Insurance Office. To avoid preemption, the laws must be enacted prior to October 1, 2022, and must adhere exactly to the models as they have been adopted by the NAIC.

Before the 2019 revisions, on November 6, 2011, the NAIC adopted revisions to Model #785 and Model #786 which allowed reduced reinsurance collateral requirements for certified reinsurers that are licensed and domiciled in Qualified Jurisdictions, which are Bermuda, France, Germany, Ireland, Japan, Switzerland and the UK.

Prior to the end of 2019, the Reinsurance (E) Task Force and the Qualified Jurisdiction (E) Working Group are planning to adopt revisions to the Process for Developing and Maintaining the NAIC List of Qualified Jurisdictions to incorporate the 2019 revisions to Model #785 and Model #786. Once this is complete, the Working Group will need to complete re-evaluations of the seven existing Qualified Jurisdictions and complete initial evaluations of Bermuda, Japan and Switzerland as Reciprocal Jurisdictions. Additionally, the Task Force exposed revisions to the Reinsurance Ceded section of the NAIC Accreditation Program Manual to incorporate the 2019 revisions to the models as an accreditation standard, effective on October 1, 2022 to coincide with the federal preemption date.

 

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