Security From Unlicensed Foreign Reinsurers: Are the U.S. Practices a Violation of International Trade Conventions?

Gregory S. Arnold, University of Connecticut School of Law

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Research paper in connection with an Insurance Solvency Seminar.

Abstract

The world's financial markets are in a maelstrom of regulatory convergence and reform. The European Union claims to be close to eliminating barriers to open financial services markets, including reinsurance and retrocession, and the U.S. is demanding more reinsurance capacity from reinsurers worldwide.

The critics claim that the U.S. system of requiring collateral security from non-U.S., unlicensed reinsurers is anti-competitive and discriminatory. Those with a vested interest in maintenance of the status quo argue that the reinsurance collateral security requirements are prudential measures that are in place for the protection of policy holders and the solvency of the ceding, primary insurance companies.

The European Union’s Reinsurance Directive still has not been implemented into national law in each of the EU Member States, but that regulatory measure has nonetheless emboldened reinsurance companies, reinsurance markets and financial regulators in Europe to push for federal regulation of insurance in the U.S. This is partly under the misguided assumption that federal regulation of insurance in the U.S., by way of an optional federal charter ("OFC") or otherwise, would somehow lead to the relaxing of the reinsurance collateral security requirements.

At the same time, larger insurance companies and some trade groups in the U.S. are interested in an OFC, because of the heavy administrative burden and expense of complying with insurance regulation in fifty-one jurisdictions. Neither the impetus from the U.S. insurance companies and trade groups, nor the added push from European regulators or vocal markets like Lloyd’s, have lead to enactment of the National Insurance Act, the SMART Act, or similar such legislation.

Such proposals themselves included the framework for the imposition of reinsurance collateral requirements , without telegraphing such prospects. Even the U.S. Treasury, in proposing the Office of Insurance Oversight (“OIO”), such that the U.S. Treasury could act as “the lead regulatory voice in the promotion of international insurance regulatory policy for the United States…” , recognizes that “[a] current contentious issue on the U.S.-E.U. reinsurance agenda relates to the state requirements for collateral posted by non-U.S. reinsurers.”

There is a safe-harbor-symmetry in those proposed pieces of legislation and the EU’s Reinsurance Directive, which has been enacted into national law in some EU Member States. That Directive allows EU Member States to impose “pledging of assets” requirements upon reinsurers from third countries, including the U.S..

Although the criticisms against the U.S. in the reinsurance collateral debate may not be warranted, the U.S. is proposing ways to relax collateral requirements to accommodate reinsurers domiciled outside the U.S. The methods by which it chooses to make such accommodations have themselves come under legal scrutiny, essentially because those methods build upon the continuation of the system of state regulation of insurance. The U.S., guided by the NAIC and the frontrunner state of New York, has embarked upon a regulatory reform framework that, for the NAIC, involves Mutual Recognition Agreements (“MRA’s”) and, at least with New York’s plan, Memoranda of Understanding (“MuO’s”) with insurance and financial services regulators outside the U.S.

Scope, focus and page limitations of this research article prohibit a full discussion of the separate treaty and constitutional law issues raised by these MRA’s and MuO’s, so this paper is limited to the analysis of the current collateral security requirements by the states in the U.S., and not these recent regulatory reforms.

With respect to the current reinsurance collateral security requirements, this article discusses legal issues in the context of the World Trade Organization (“WTO”) General Agreement on Trade in Services (“GATS”). The GATS treaty “…marks the first time that services have been covered by a global trade agreement. As a result, financial services liberalization now falls within the purview of the World Trade Organization.” Salient portions of GATS, for this analysis, are the most-favoured-nation (“MFN”) obligations; national treatment commitments; recognition requirements; and compensatory adjustments occasioned by disputed withdrawal of financial sector commitments. The very important role of the prudential carve-out, which the U.S. and other GATS Member States rely upon to justify disparate treatment, is critical to this analysis of GATS and reinsurance collateral security, and therefore receives a thorough analysis here.

Because it is difficult to escape the intersection of GATS, reinsurance reform and U.S. Constitutional law, this article at least makes a cursory discussion of the latest NAIC reinsurance regulatory reform framework and related complications, and then points the reader in the direction of some current sources of analysis on those emerging issues.

This article concludes that the actions of the various states in the U.S. are not in violation of GATS, because of the legitimate application of the prudential carve-out exception justifies any arguable technical violations. The article makes some practical observations of the U.S. regulatory system compared with other systems, and makes some recommendations on the wisdom of the U.S. retreating to historical reliance upon the Credit for Reinsurance Model Law.