Treasury publishes highly-anticipated notice of proposed rulemaking to update credit for reinsurance rules for Treasury-listed surety companies

Eversheds Sutherland (US) LLP

Eversheds Sutherland (US) LLP

The US Department of the Treasury (Treasury), Bureau of the Fiscal Service (Fiscal Service) has published a Notice of Proposed Rulemaking relating to the federal regulations governing the corporate Federal surety bond program (Program). The Notice requests comments on proposed changes designed to bring the Program’s credit for reinsurance rules into line with state insurance laws and the Covered Agreements between the United States and the European Union and the United States and the United Kingdom (Covered Agreements), as well as other changes. Comments are due by May 2, 2022.

The Program’s credit for reinsurance rules

Insurers seeking to underwrite or reinsure Federal surety bond obligations are required to obtain a certificate of authority from Treasury and comply with Program requirements administered by Fiscal Service. These requirements are codified in federal law (31 U.S.C. 9304-9308) and federal regulations (31 CFR part 223), and increasingly over the years are reflected in guidance issued by Fiscal Service on its website and in the form of annual letters to executive officers of surety companies reporting to Treasury (commonly referred to as Certified or T-Listed Companies). Treasury’s uncodified guidance for T-Listed Companies covers a wide range of issues, including application requirements, annual reporting requirements, rules governing the valuation of assets and liabilities and rules governing credit for reinsurance.

One of the most notable requirements for T-Listed Companies is the “10% Underwriting Limit,” which provides that no T-Listed Company may underwrite any risk on any bond or policy (including surety bonds and non-surety bonds) that is greater than 10% of the insurer’s paid-up capital and surplus, as determined by Treasury. Risks in excess of the 10% Underwriting Limit are commonly referred to as “Excess Risks.” Treasury’s 10% Underwriting Limit is similar to the “single risk rule” that exists under state insurance laws, but it differs in one significant respect: the reinsurance that an insurer can use to satisfy the cap. Under state insurance laws, insurers are allowed credit for any reinsurance arrangements that are recognized under state law (i.e., reinsurance ceded to reinsurers that are licensed or accredited in the cedent’s state of domicile or maintain collateral in accordance with the state’s rules). In contrast, for purposes of Treasury’s 10% Underwriting Limit, T-Listed Companies are only allowed credit for reinsurance ceded to: (1) with respect to risks running to the United States (i.e., Federal bonds), reinsurance ceded to another T-Listed Company, and (2) with respect to all other risks, reinsurance ceded to insurers approved by Treasury to provide reinsurance within the Program (i.e., T-Listed Companies and Treasury Admitted Reinsurers) or a pool of such companies, a recognized Federal agency or instrumentality or a reinsurer that posts collateral in accordance with Treasury rules. As a result, many insurers have found that, for purposes of the 10% Underwriting Limit, they are unable to take credit for reinsurance arrangements that are otherwise recognized under state insurance law and for purposes of their statutory financial statements.

Treasury also requires that T-Listed Companies annually prepare a Treasury Schedule F (Summary of Ceded Reinsurance) that only reflects reinsurance ceded to “Treasury Authorized” reinsurers or otherwise supported by Treasury recognized collateral (which cannot be the same collateral used to satisfy the 10% Underwriting Limit). This Treasury Schedule F can then be used by Treasury for purposes of calculating an insurer’s capital and surplus for purposes of the 10% Underwriting Limit and evaluating the insurer’s solvency generally. In this regard, Treasury’s instructions to the T-Listing application note that “A Company must have reinsurance, the majority of which is Treasury recognized, or its application will not be considered.”

Developments in state credit for reinsurance rules

Treasury’s Notice of Proposed Rulemaking recognizes that there have been a number of significant insurance regulatory developments that affect Treasury-regulated companies’ reinsurance arrangements since the Program regulations were last updated. Those developments include:

  • Amendments to the National Association of Insurance Commissioners (NAIC) Credit for Reinsurance Model Law (#785) and Model Regulation (#786) (Credit for Reinsurance Models or Models) that permit US domestic insurers ceding reinsurance to qualified non-US reinsurers domiciled in qualified jurisdictions to receive credit for the reinsurance with reduced or eliminated collateral requirements; and
  • The completion and entry into force of the Covered Agreements that, among other things, eliminate collateral requirements for qualified reinsurers domiciled in the EU or UK that assume business from US cedents. For more information on the Covered Agreements, see our client alert.

Together, these developments have led to calls from industry for Treasury to bring the Program’s reinsurance rules into line with state law – and these calls have only increased with the September 2022 deadline for the Federal Insurance Office (FIO) within Treasury to preempt state credit for reinsurance rules that are inconsistent with the Covered Agreements fast approaching.

Proposed changes to Program regulations

On December 30, 2019, Fiscal Service published a Federal Register Notice (2019 Notice) indicating that it was considering modernizing and improving the Program in light of, inter alia, the credit for reinsurance developments discussed above. Among other items, the 2019 Notice indicated that Fiscal Service was considering amendments to: (1) the approach or methodology it uses to value the assets and liabilities of a company applying for T-Listing, (2) the approach or methodology it uses to determine the credit allowed for reinsurance and/or the recognition of a company as a Treasury Admitted Reinsurer, and (3) the permissible methods for limiting risk in excess of a company’s 10% Underwriting Limit.

More than three years later, on March 3, 2022, Fiscal Service published the present Notice of Proposed Rulemaking. In summary, the Notice of Proposed Rulemaking proposes to update the Program regulations in three respects:

  1. By adding two new categories of reinsurers that are eligible for recognition as Treasury authorized reinsurers;
  2. By providing additional detail as to how Treasury conducts its financial analysis of T-Listed Companies (including its valuation of company assets and liabilities); and
  3. By reorganizing the regulations to provide additional information for T-Listed Companies and clarifying “longstanding” Treasury policies.

New categories of Treasury authorized reinsurers

The Notice of Proposed Rulemaking propose to add two new categories of reinsurers that are eligible for recognition as Treasury authorized reinsurers for purposes of: (1) reinsuring Excess Risks not running to the US (i.e., risks other than Federal surety bonds), and (2) obtaining credit for reinsurance generally. The first category, “Complementary Reinsurers,” would include those reinsurers that are: (1) domiciled in a non-US jurisdiction that is subject to an in-force Covered Agreement (currently the EU and UK); and (2) recognized by at least one state as a Reciprocal Jurisdiction Reinsurer. T-Listed Companies ceding reinsurance to companies recognized as Complementary Reinsurers would receive credit for the ceded reinsurance without it being secured by collateral, provided the reinsurance was ceded after the Complementary Reinsurer was recognized as a Reciprocal Jurisdiction Reinsurer. For more information on Reciprocal Jurisdiction Reinsurers, see our client alert.

The second category, so-called “Alien Reinsurers,” would include reinsurers that are: (1) based in a jurisdiction that the NAIC recognizes as a Qualified Jurisdiction or a non-Covered Agreement Reciprocal Jurisdiction (currently Bermuda, Switzerland and Japan); and (2) recognized by at least one state as a Certified Reinsurer (as defined by the Credit for Reinsurance Models) or a non- Reciprocal Jurisdiction Reinsurer that is domiciled in a non-Covered Agreement jurisdiction. T-Listed Companies ceding reinsurance to companies recognized as Alien Reinsurers would be eligible to receive credit for the ceded reinsurance to the extent allowed by the ceding company's state of domicile. Treasury would also retain the authority to require an Alien Reinsurer to post additional collateral if it determined that either the T-Listed Company or the Alien Reinsurer may be unable to carry out its obligations.

Both Complementary Reinsurers and Alien Reinsurers would be required to apply to Treasury for recognition of their status (and annual renewal of such recognition) and meet and maintain all capital and surplus, solvency and market conduct requirements under the applicable Covered Agreement or for continued eligibility as a Certified or Reciprocal Jurisdiction Reinsurer (as applicable).

While the Proposed Rulemaking would provide a pathway to make certain non-US reinsurers eligible for recognition and bring Program regulations more in line with the NAIC Credit for Reinsurance Models, Treasury’s credit for reinsurance rules still would not be in complete alignment with state rules. For example, where the Models generally permit insurers to obtain credit for reinsurance ceded to US reinsurers licensed or accredited in the cedent’s state of domicile, the Proposed Rulemaking would continue to require such reinsurers to obtain and maintain recognition from Treasury as either a T-Listed Company or Admitted Reinsurer. Non-US reinsurers that are not domiciled in a Qualified Jurisdiction or Reciprocal Jurisdiction also would continue to be ineligible for Treasury Authorized status.

Other proposed changes

The Notice of Proposed Rulemaking also marks a departure from Fiscal Service’s longstanding policy of providing certain information regarding filing and financial requirements and reporting obligations through the annual letters to T-Listed Companies referenced above and the Fiscal Service website in favor of codifying that guidance in federal regulations. If adopted, the Program regulations would also be amended to provide that:

  • No company that exists primarily to insure or reinsure business of its parent, affiliated company or controlled unaffiliated business, is eligible for T-Listing (proposed Section 223.1);
  • T-Listed Companies must notify Fiscal Service of certain changes that may have a significant impact on their financial statements or solvency, such as changes in capital levels, changes in the owners of 5% or more of any class of the company’s stock, mergers and other material restructuring and amendments to governing documents (proposed Section 223.7); and
  • For purposes of the 10% Underwriting Limit, a “single risk” is defined as the total risk under one bond or policy regardless of the number of individual risks under that bond or policy (proposed Section 223.10).

Comments on the Proposed Rulemaking are requested by May 2, 2022, and on the following questions in particular:

  1. Does Treasury's proposal to recognize two new classes of reinsurers benefit the surety industry without significantly increasing risks?
  2. Should Treasury consider alternative approaches to credit for reinsurance than those proposed in §§ 223.9, 223.11 and 223.12?
  3. In §§ 223.2, 223.7, 223.8 and 223.9, Treasury proposes publishing, without substantive change, several requirements that have been previously contained in annual guidance or on the surety program's website. Should Treasury consider modifying these regulations or not codifying them in the regulations?
  4. Does the proposed reorganization of part 223 make the regulations clearer and easier to follow, and would additional changes more effectively accomplish this goal?
  5. Are there additional changes Treasury should consider to better help the surety program accomplish its mission of evaluating and approving surety companies to do business with the United States?

[View source.]

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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