New York Amends Credit for Reinsurance Regulation, Relaxing Unauthorized Reinsurer Collateral Requirements

The New York State Insurance Department (NYID) recently promulgated a Tenth Amendment to New York Regulations 17, 20 and 20-A (11 NYCRR 125) (the Amendment), effective January 1, 2011, which authorizes the NYID Superintendent (the Superintendent) to reduce the amount of collateral required for domestic insurers to receive full financial statement credit for reinsurance ceded to unauthorized reinsurers satisfying the requirements detailed below. However, the collateral reductions are only applicable to “funds withheld” collateral arrangements (which include Regulation 114 trusts and qualifying letters of credit). The Amendment does not allow any reduction in US trust funds for the benefit of all US cedents as established by accredited reinsurers.

The Amendment also imposes new obligations relating to management of credit risk upon all ceding insurers authorized to do business in New York, regardless of whether the reinsurers to which they cede risk are authorized in the state.

Relaxation of Unauthorized Reinsurer Collateral Requirements

With respect to reinsurance contracts entered into or renewed on or after January 1, 2011, the Amendment authorizes the Superintendent to reduce the amount of collateral unauthorized and unaccredited reinsurers must post for domestic cedents to receive credit for reinsurance ceded for property, casualty, life, annuity and accident and health risks. The Amendment only addresses the amount of collateral that must be provided to a cedent under a reinsurance treaty as security for the payment of obligations thereunder. Heretofore, the cedent could only take credit to the extent of the value of that collateral, i.e., full credit for liabilities ceded required 100% collateralization. Now, as detailed below, the rating of the reinsurer, as assigned by the Superintendent, will determine whether and how much collateral must be provided.

The Amendment also permits foreign ceding insurers licensed in New York to take credit for reinsurance recognized by the cedent’s state of domicile, provided that the state of domicile is an NAIC-accredited state or has financial solvency requirements substantially similar to the requirements necessary for NAIC accreditation. This conforms to the requirements of The Nonadmitted and Reinsurance Reform Act, part of the Dodd-Frank Wall Street Reform and Consumer Protection Act, which will go into effect this summer.

Level to Which Collateral May be Reduced
Under the Amendment, the Superintendent shall assign ratings to unauthorized reinsurers ranging from Secure-1 to Vulnerable-5, and the amount of collateral required is based upon the rating assigned. The minimum amounts required to be withheld for a cedent to receive full credit for reinsurance are as follows:

The Superintendent’s discretion in assigning ratings is restricted by the financial strength ratings assigned to reinsurers by approved rating agencies, as a reinsurer’s rating cannot be higher than its lowest corresponding rating from any of the four rating agencies listed below.

In assigning such ratings, the Superintendent may consider any information he or she deems relevant, including the reinsurer’s business practices in dealing with its cedents, any regulatory actions against the reinsurer, and the reinsurer’s annual financial statement regulatory filings, and actuarial opinions.

Eligibility Requirements
To be eligible for reduced collateral under the Amendment, an unauthorized reinsurer must:

• maintain financial strength ratings on a stand-alone basis from at least two approved rating agencies;
• meet the solvency requirements imposed by its domiciliary regulator;
• be authorized in its domiciliary jurisdiction to assume the kind of reinsurance at issue; and
• maintain at least $250 million in policyholder surplus.

Alien unauthorized reinsurers must also be domiciled in a jurisdiction:

• that has executed a memorandum of understanding with the Superintendent addressing matters the Superintendent “deems relevant for proper oversight of reinsurance transactions”;
• which grants US reinsurers reciprocal access to that jurisdiction on terms that are at least as favorable as those of New York.

Required Contract Provisions
To be eligible for reduced collateral, the reinsurance contract between a cedent and an unauthorized reinsurer must:

• include an acceptable insolvency clause;
• require the unauthorized reinsurer to designate an agent for service of process in New York or in the cedent’s state of domicile; and 
• include specific language consenting to the jurisdiction of U.S. courts and specifying the state law to govern disputes.

Reinsurance contracts with alien unauthorized reinsurers must also provide that the reinsurer will fund the entire amount for which the cedent has taken credit for reinsurance recoverable within 30 days after an order of rehabilitation, liquidation or conservation has been entered against the cedent.

Filing Requirements and Fees
To be eligible for reduced collateral reinsurers must:

• File an application for eligibility to request a rating from the Superintendent, accompanied by a non-refundable fee in the amount of $10,000.
• Agree to notify the Superintendent within thirty days of receiving notification of any change in its domiciliary license status or its rating status.
• Submit the following to the NYID on an annual basis:
  • A renewal application accompanied by a $5,000 fee;
  • A list of all disputed or overdue recoverables;
  • A report similar to the applicable NAIC Annual Filing Blank, either Schedule F or Schedule S;
  • Audited financials; and
  • A certificate of good standing from domiciliary regulator, also indicating that the regulator will provide the Superintendent with financial and operational information.

New Risk Management Requirements Applicable to All Cedents

The Amendment also imposes new obligations upon all ceding insurers authorized to do business in New York relating to the management of credit risk in ceding reinsurance. These obligations apply to such cedents effective January 1, 2011.

Financial Prudence Required
The Amendment requires that cedents “at all times act with financial prudence when entering into any reinsurance arrangement” and “properly consider and account for all factors associated with such an agreement.” Eight such factors are specified, including the following:

• The net risk to be retained;
• Concentration of risk on a net and gross basis; and
• The basis for selection of an assuming insurer including methodology for assessing its security.

Reporting Requirements
The Amendment also imposes new notification requirements upon cedents relating to the concentration of risk in an individual reinsurer or group of affiliated reinsurers. Ceding insurers are required to notify the Superintendent under the following circumstances and demonstrate that they are safely managing the exposure at issue:

• Managing Reinsurance Recoverables – Ceding insurers must notify the Superintendent within 30 days after a reinsurance recoverable from a single insurer or group of affiliated insurers exceeds 50% of the cedent’s last reported surplus to policyholders, or after it is determined that a reinsurance recoverable is likely to exceed this limit.
• Diversification – Cedents are also required to notify the Superintendent within 30 days after ceding an amount that is more than 20% of its total gross written premium in the prior calendar year to any reinsurer, group of reinsurers, or group of affiliated reinsurers, or after the cedent has determined that a single cession is likely to exceed this limit.

With this change, New York and Florida now constitute the vanguard of states to accept that lower collateral requirements for reinsurance ceded to highly rated reinsurers makes sound commercial sense. As a result of Dodd-Frank’s restriction on the ability of non-domiciliary states to determine credit for reinsurance, cedents will no longer need to comply with the toughest standards among the states in which they are licensed, and need only concern themselves with meeting the domestic requirements. This can create winners and losers among cedents when it comes to availability and pricing of reinsurance on the assumption that unauthorized reinsurers will be keener to write reinsurance for cedents domiciled in states where less collateral is required of them. In turn, this should put pressure on state regulators to keep in step with those states that have reduced the collateral requirement so as not to disadvantage their domestic companies. Since this is a step that has already been endorsed by the NAIC, it is highly likely other states will shortly join the trend.