Reinsurance

Last Updated 4/07/16

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 November 6, 2011, the NAIC Executive (EX) Committee and Plenary adopted revisions to the Credit for Reinsurance Models (Credit for Reinsurance Model Law (#785) and Credit for Reinsurance Model Regulation (#786.) These revisions serve to reduce reinsurance consumer protection collateral requirements for certified reinsurers that are licensed and domiciled in Qualified Jurisdictions. As of April 1, 2016, 32 jurisdictions have adopted Model #785 with 22 also adopting Model #786, representing approximately 66% of total premiums. Under the previous version of the Credit for Reinsurance Models, in order for U.S. ceding insurers to receive reinsurance credit, the reinsurance was required to be ceded to U.S.-licensed reinsurers or secured by collateral representing 100% of U.S. liabilities for which the credit is recorded.

Under the revised Credit for Reinsurance Models, the approval of Qualified Jurisdictions is left to the authority of the states; however, the models provided that a list of Qualified Jurisdictions would be created through the NAIC committee process.

In 2012, the NAIC Reinsurance (E) Task Force was charged to develop an NAIC process to evaluate the reinsurance supervisory systems of non-U.S. jurisdictions, for the purposes of developing and maintaining a list of jurisdictions recommended for recognition by the states as Qualified Jurisdictions. The evaluation of non-U.S. jurisdictions is intended as an outcomes-based comparison to financial solvency regulation under the NAIC Financial Regulation Standards and Accreditation Program (Accreditation Program), adherence to international supervisory standards, and relevant international guidance for recognition of reinsurance supervision. As of January 1st 2015, there were seven non-U.S. jurisdictions designated as Qualified Jurisdictions.

NAIC also formed the Reinsurance Financial Analysis (E) Working Group in order to provide advisory support and assistance to states as well as guidance and expertise on reinsurance regulatory policy and practices.  It also functions as a forum for discussion among NAIC jurisdictions of reinsurance issues.