Insurance regulation in a nutshell

Section III.10.Regulation of Reinsurance

A key asset of insurers, particularly property/casualty insurers, is recoverables under reinsurance ceded to reinsurers under a reinsurance agreement. Reinsurance has been defined as “an insurance transaction by which the assuming insurer agrees to indemnify the ceding insurer in whole or in part against liability or losses that the ceding insurer might incur under a separate contract of insurance with its insured.”⁴⁰
The rules governing whether or not “credit for reinsurance” will be allowed a domestic ceding insurer as either an asset or a reduction from liability on account of reinsurance ceded on the balance sheet of the domestic insurer are set out in the NAIC Credit For Reinsurance Model Act⁴¹ and the NAIC Credit For Reinsurance Model Regulation.⁴² For financial statement reporting purposes, a ceding insurer’s liability for any given policy will be reduced (“credit for reinsurance” will be allowed) for reinsurance ceded to a reinsurer that meets certain standards.
In general, under the Model Act, credit for reinsurance will be allowed under the following situations: (i) the reinsurer is licensed to transact insurance in the state, (ii) the reinsurer is an accredited reinsurer in the state (is licensed in at least one state, maintains surplus of at least $20 million and files certain documents with the state insurance regulator), (iii) maintains at least $20 million in surplus and is domiciled in a state that has substantially similar reinsurance credit rules as the ceding insurer’s state of domicile, or (iv) the reinsurer establishes a multiple beneficiary trust funded by permitted investments (and in certain cases, a surplus) enough to collateralize the entire obligations ceded to the reinsurer by all U.S. ceding insurers (Lloyd’s maintains such a trust).⁴³
If the reinsurer does not meet these standards, then credit for reinsurance ceded to an unauthorized reinsurer will be allowed if the reinsurance recoverables are fully collateralized by certain permitted security – funds withheld by the ceding insurer, a special reinsurance letter of credit or assets deposited in the single beneficiary reinsurance trust.⁴⁴
Credit for reinsurance will generally be allowed under state law only if the reinsurance agreement contains the following provisions: (i) an insolvency clause;⁴⁵ (ii) a service of suit clause, in the case of cessions to an unauthorized or unaccredited reinsurer;⁴⁶ (iii) an entire contract provision;⁴⁷ (iv) a provision that settlements under the agreement be made no less frequently that quarterly;⁴⁸ and (v) that the agreement meet requirements for “risk transfer.”⁴⁹