The Federal Insurance Office (FIO) has called for a covered agreement for reinsurance collateral requirements imposed on non-U.S. insurers, stating that such agreements may be necessary to impose uniformity on a prudential insurance matter of national interest.1 “Covered agreements” are provided for in the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) and can be a vehicle for preemption of state insurance laws or, as some might say, a vehicle for regulatory reform.2 This article describes covered agreements, the negotiation and implementation of a covered agreement, and the circumstances under which a covered agreement may be used to preempt state insurance laws.
What is a Covered Agreement?
Dodd-Frank filled a void in the state-based insurance regulatory system by providing a means for the U.S. to enter into agreements with other countries to address international regulatory issues. Even proponents of the state-based system have lamented the lack of a single voice in international insurance matters. Although Dodd-Frank did not completely solve that problem, the creation of FIO and the authority for covered agreements bring us closer to a potential solution.
The primary authority to negotiate a covered agreement lies with the Secretary of the Treasury and the United States Trade Representative (USTR). FIO is tasked with providing assistance to the United States Department of the Treasury in negotiating covered agreements. This is consistent with FIO’s charge to develop federal policy on prudential aspects of international insurance matters.
Unlike treaties, a covered agreement under Dodd-Frank does not have to be ratified by the U.S. Senate. It is interesting to note that while the U.S. must be one of the parties to a covered agreement, the other party need not be a foreign country. The other party to a covered agreement could be a regulatory body such as the Prudential Regulatory Authority in the United Kingdom or BaFin, the German insurance regulatory authority.
Not all aspects of insurance regulation are fair game for a covered agreement. Covered agreements are limited to prudential matters and may not be used to preempt certain areas of state regulation. There is a savings provision in Dodd-Frank that preserves state regulation of rates, premiums, underwriting and sales practices as well as state insurance coverage requirements, application of state antitrust laws and state capital and solvency standards except to the extent capital and solvency standards result in less favorable treatment of non-U.S. insurers.3
In addition to being limited to prudential matters, by definition, a covered agreement “achieves a level of protection for insurance or reinsurance consumers that is substantially equivalent to the level of protection achieved under State insurance or reinsurance regulation.”4 Similar to how the term “substantially equivalent” is used in insurance law, under Dodd-Frank it means that there should be a “similar outcome in consumer protection.”5
Covered Agreement Process
Dodd-Frank provides a series of procedural requirements for negotiating and implementing covered agreements. Before initiating negotiations, the Treasury Secretary and USTR must consult with specific congressional committees - the House Committee on Financial Services, the House Committee on Ways and Means, and the Senate Committee on Banking, Housing and Urban Affairs and the Senate Committee on Finance. In consulting with these committees, the Treasury Secretary and USTR must describe the nature of the agreement, how and the extent to which it will achieve the purposes, policies, priorities and objectives of FIO set forth in Dodd-Frank, and the “general effect” of the agreement on existing state laws.6
Once a covered agreement has been negotiated, the Treasury Secretary and USTR must jointly comply with a series of additional procedural steps before a covered agreement takes effect, including submitting the final text of the agreement to the specified congressional committees on a day on which both Houses of Congress are in session. A covered agreement cannot take effect until 90 days after the final text is submitted.7 Dodd-Frank does not require approval of a covered agreement by those congressional committees. A covered agreement is a means of preempting state insurance regulation without an act of Congress.
Preemption of State Insurance Measures
A covered agreement may be used to preempt regulatory guidance and practices, not just state laws. The preemption provision in Dodd-Frank applies to state insurance measures. A state insurance measure is defined as “any state law, regulation, administrative ruling, bulletin, guideline or practice.”8 Thus, FIO’s preemption power under Dodd-Frank could extend to desk-drawer rules and other regulatory practices which may not be found in state law.
FIO’s power to preempt state insurance measures is significant but it is not unfettered. In order to preempt a state insurance measure, the FIO Director has to first notify and consult with the affected state and with the USTR about the potential inconsistency between a state insurance measure and a covered agreement. Notice of a potential inconsistency will be published in the Federal Register and the FIO Director must consider comments submitted by interested parties.9
After the initial notice process has been completed, the FIO Director may determine whether and to what extent a state insurance measure should be preempted. There is a two-part test for this determination. The FIO Director must determine that (1) the state insurance measure results in less favorable treatment of a non-U.S. insurer as compared to an insurer that is domiciled or licensed in that state; and (2) the state insurance measure is inconsistent with the covered agreement. A determination of preemption is limited to the subject matter of the covered agreement and, as discussed above, must result in a level of protection that is substantially equivalent to that provided by state regulation.”10
Once a determination is made, notice is again given to the affected state and to the congressional committees. The FIO Director decides when the determination will become effective. A determination that a state insurance measure is preempted by a covered agreement is subject to both administrative and judicial review under the federal Administrative Procedures Act.
A Covered Agreement for Reinsurance Collateral Reform
FIO has acknowledged that it is taking steps to initiate a covered agreement for reinsurance collateral requirements.11 Currently, all states require non-U.S. reinsurers to post collateral to cover their liabilities in the U.S. Although many states now permit lower levels of collateral as a result of amendments to the model laws on credit for reinsurance, other states continue to require collateral equal to 100% of the U.S. liabilities. FIO has suggested that a covered agreement should be based upon the Credit for Reinsurance Model Law and Credit for Reinsurance Model Regulation (collectively, the model law) as revised and adopted by the National Association of Insurance Commissioners (NAIC) but there have been discussions about eliminating all collateral requirements.
Foreign insurers and others have long argued that the collateral requirements place non-U.S. reinsurers at a competitive disadvantage vis-a-vis reinsurers that are domiciled in the U.S. Since those collateral requirements do not apply to U.S. domiciled reinsurers, the first part of the preemption test is met — the state insurance measure results in less favorable treatment of a non-U.S. reinsurer than a reinsurer domiciled or licensed in a particular state. The second part of the preemption test would be satisfied should any states have collateral requirements that are inconsistent with the covered agreement.
The analysis, however, does not stop there. The analysis continues with the definition of a covered agreement. There can be no preemption unless the covered agreement provides a level of protection that is substantially equivalent to the level of protection achieved under the state regulation.12 In states that have adopted the model law, collateral has been reduced for certain non-U.S. reinsurers from 100% to 20% of U.S. liabilities. One could certainly make the argument that a state law that requires the posting of collateral equal to 100% of a reinsurer’s U.S. liabilities seemingly affords greater protection than a law that permits collateral equal to 20% of liabilities. One could argue that a covered agreement based upon the model law does not afford substantially the same level of protection as a state law that requires 100% collateral. Under this reasoning about the level of protection, the laws in states that have not adopted the model law would not be subject to preemption.
It may not be that simple. The model law requires an evaluation of the credit rating of a reinsurer, whether courts in the other country would enforce a U.S. judgment, the quality of regulation in the foreign jurisdiction and other factors. It is possible that consideration of these factors could result in a determination that a covered agreement provides a level of protection substantially equivalent to posting collateral.
Maybe more significant, however, is the fact that the states, collectively thorough the NAIC, have adopted the model law and will soon include it as an accreditation standard for the NAIC’s Financial Regulation Standards and Accreditation Program. If a covered agreement is based upon the NAIC model law, it may be difficult to challenge it on grounds that it does not provide substantially equivalent protection as state law. There will be a different discussion should a covered agreement purport to eliminate collateral requirements.
Conclusion
FIO is moving towards a covered agreement for reinsurance collateral and there is speculation that other subjects are under consideration as well. The negotiation, implementation and preemption processes are likely to take a long time to complete. In the meantime, perhaps the very real threat of preemption will spur states to take their own actions to avoid a potential loss of authority.
1. How to Modernize and Improve the System of Insurance Regulation in the United States, Federal Insurance Office, U.S. Dept. of the Treasury (Dec. 2013), available at http://www.treasury.gov/initiatives/fio/reports-and-notices/Documents/How%20to%20Modernize%20and%20Improve%20the%20System%20of%20Insurance%20Regulation%20in%20the%20United%20States.pdf; see also Michael McRaith, Remarks of Federal Insurance Office (FIO) Director Michael McRaith at Standard and Poor’s 30th Annual Insurance Conference, June 5, 2014, available at http://www.treasury.gov/press-center/press-releases/Pages/jl2419.aspx.
2. Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111-203, § 313, 12A Stat. 1376 (2010).
3. 31 U.S.C. § 313(j).
4. 31 U.S.C. § 313(r)(2).
5. 31 U.S.C. § 313(r)(9).
6. 31 U.S.C. § 314(b).
7. 31 U.S.C. § 314(c).
8. 31 U.S.C. § 313(r)(7).
9. 31 U.S.C. § 313(f).
10. 31 U.S.C. § 313(f)(1)(B).
11. Annual Report on the Insurance Industry, Federal Insurance Office, U.S. Dept. of the Treasury, (September 2014), available at http://www.treasury.gov/initiatives/fio/reports-and-notices/Documents/2014_Annual_Report.pdf.
12. 31 U.S.C. § 313(r)(2).