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Senator Dodd's Financial Reform Bill Includes Provisions for Regulation of Reinsurance and Surplus Lines

The following article summarizes the current activity surrounding possible regulation of Reinsurance and Surplus Lines Insurance as contained in Senator Dodd’s bill. In an environment where federal regulation to avoid future bail outs is the order of the day, it’s easy to appreciate how financial institution regulation might lead to federal regulation of insurance companies. The authors shed light on the pertinent provisions of pending legislation as well as the problem of dual regulation at state and federal levels. We found the article to be timely and informative.

Written By Attorneys: Francine L. Semaya and William K. Broudy
Nelson, Levine, de Luca & Horst

This article is an interpretation of current law and is offered for informational purposes only. This material is not legal advice and should not be construed or used as a substitute for the advice of an attorney.

With the support of the Obama Administration, Connecticut Senator Christopher Dodd, Chairman of the Senate Committee on Banking, Housing and Urban Affairs, has released the Restoring American Financial Stability Act of 2010 (the "Act"). The Act is a revised version of similar legislation first proposed by Senator Dodd in November 2009. It includes sections establishing an Office of National Insurance as well as the Nonadmitted and Reinsurance Reform Act of 2010, but clearly exempts "the business of insurance" from the definition of a financial product or service.

While the focus of the Act is on the regulation of financial institutions other than insurance companies, large insurance companies could be subject to its provisions when they experience financial difficulty. The Act creates a nine-member Financial Stability Oversight Council, consisting of existing federal financial regulators plus an independent member, and chaired by the treasury secretary. With a two-thirds vote by the Council, regulation of a non-bank financial company by the Federal Reserve can occur under the Act. The Senate Committee's summary of the Act states that: "With this provision, the next AIG would be regulated by the Federal Reserve." Accordingly, a large insurance company deemed financially troubled could well be brought under this new federal regulatory system, a result unwelcome to state insurance regulators as well as a substantial majority of insurance companies.

With an eye toward preventing future federal government bailouts, the Act calls for the creation of a $50 billion fund, to be funded by large financial firms, to be used for any liquidation. A large insurance company could be tapped for assessments to such a fund, and such payments would be in addition to existing state statutory requirements for assessments for state insurance guaranty funds. Insurance-industry representatives are lobbying hard to exempt insurers from this proposed federal funding requirement.

The Act also creates the Consumer Financial Protection Bureau (the "Bureau"), to be housed at the Federal Reserve, led by an independent director. Section 1027 (f) of the Act provides an exemption from the authority of the Bureau over insurance, as follows:

(1) No provision of this title shall be construed as altering, amending or affecting the authority of any State insurance regulator to adopt rules, initiate enforcement proceedings, or take any other action with respect to a person regulated by a State insurance regulator. Except as provided in paragraph (2), the Bureau shall have no authority to exercise any power to enforce this title with respect to a person regulated by a state insurance regulator.

(2) Paragraph (1) does not apply to any person described in such paragraph, to the extent that such person is engaged in the offering or provision of any consumer financial product or service, or is otherwise subject to any Federal financial consumer law.

The foregoing preserves state regulation of insurance, except with respect to the provision of a consumer financial product or service by a regulated party. Section 1002 (13) (B) of the Act expressly excludes the business of insurance from the definition of a financial product or service. Section 1002 (3) of the Act defines the business of insurance as "the writing of insurance or the reinsuring of risks by an insurer..."

The Office of National Insurance

On December 11, 2009, the House of Representatives passed the Wall Street Reform and Consumer Protection Act of 2009 (H.R. 4173), a counterpart to the Act. It was referred to the Senate Committee on Banking, Housing and Urban Affairs with no action taken by the Senate. Among many other things, H.R. 4173 authorizes the Federal Insurance Office ("FIO"), summarized by the Congressional Research Service as follows:

Establishes in the Treasury the Federal Insurance Office (FIO) to: (1) monitor the insurance industry; (2) recommend to the Financial Services Oversight Council that it designate an insurer as one subject to stricter standards; (3) assist in administering the Terrorism Insurance Program; and (4) perform other related duties. Preempts a state insurance measure only to the extent it: (1) directly results in less favorable treatment of a non-U.S. insurer domiciled in a foreign jurisdiction that is subject to a covered agreement than a U.S. insurer domiciled, licensed, admitted, or otherwise authorized in that state; and (2) is inconsistent with such a covered agreement. Requires the FIO Director to study and report to specified congressional committees on: (1) the global reinsurance market; and (2) how to modernize and improve the system of insurance regulation in the United States.

Senator Dodd's Office of National Insurance Proposal, found in Sections 501 and 502 of the Act, although substantially similar to the FIO, differs in a number of ways from the bill adopted by the House.

One major difference between the measures is the availability of subpoena power in the Act to obtain data or information from insurance companies, which was dropped from the House bill authorizing FIO. The Act has a 30-day waiting period for a determination of inconsistency of a state insurance measure to become effective, while the House Bill sets a 90-day waiting period.

The Act calls upon the ONI to study:
''(A) The costs and benefits of potential Federal regulation of insurance across various lines of insurance (except health insurance).

''(B) The feasibility of regulating only certain lines of insurance at the Federal level, while leaving other lines of insurance to be regulated at the State level.

The latter concept appears to keep alive the idea of a federal charter for insurers, although the optional federal charter concept has not been part of the federal regulation conversation recently because it raises the potential for dual regulation of insurance (state and federal), an idea that has become somewhat unfavorable recently.

Reinsurance

The reinsurance provisions of the Act focus on credit for reinsurance, reinsurance agreements and regulation of reinsurer solvency. The Act provides that if the state of domicile of a ceding insurer is accredited by the NAIC or has financial solvency requirements substantially similar to the requirements for NAIC accreditation and recognizes credit for reinsurance for ceded risk, then no other state may deny credit for reinsurance. The Act limits the applicability of the laws of a non-domiciliary state to a reinsurer with respect to reinsurance agreement language and interpretation. This provision does not affect the applicability of non-domiciliary state laws with respect to taxes and assessment on insurance companies or insurance income.

Regulation of reinsurer insolvency is reserved to a reinsurer's state of domicile if the domiciliary state is accredited by the NAIC or has financial solvency requirements substantially similar to the requirements for NAIC accreditation. Other than the filing of financial statements, no state other than the state of domicile of a reinsurer may require the reinsurer to provide any financial information other than the information the reinsurer is required to file with its domiciliary state, if NAIC accreditation is in place or NAIC accreditation standards are in effect. The House Bill includes identical language with respect to reinsurance.

The reinsurance provisions fall short in providing a regulatory environment satisfactory to ceding insurers. It does not include provisions dealing with collateral requirements or a regulatory scheme focused on life reinsurance, which differs substantially from property/casualty reinsurance.

Nonadmitted Insurance

The Nonadmitted and Reinsurance Reform Act of 2010, included in the Act, sets forth a new regulatory scheme for the nonadmitted insurance market. The language in the Act is identical to the language in the House Bill dealing with nonadmitted insurance. The House has passed legislation three times including the most recent nonadmitted insurance proposal.

Only the home state of an insured may require any premium tax payment for nonadmitted insurance. The states may enter into a compact or otherwise establish procedures to allocate among the states the premium taxes paid to an insured's home state.

The placement of nonadmitted insurance shall be subject to the statutory and regulatory requirements of only the insured's home state. No state other than the insured's home state may require a surplus lines broker to be licensed to sell, solicit or negotiate nonadmitted insurance with respect to such insured. The Act expressly preempts the application of any state law other than the law of the home state of the insured. The preemption provision straddles the line between state and federal regulation of nonadmitted insurance.

The Act creates the concept of an "exempt commercial purchaser," defined as an entity that employs a risk manager and meets various specified requirements for annual premium paid for commercial property/casualty insurance, net worth and number of employees. A surplus lines broker seeking to obtain nonadmitted insurance for an exempt commercial purchaser is not required to comply with state laws requiring a due diligence search for the full amount or type of insurance from admitted carriers if the broker discloses to the exempt commercial purchaser that the insurance may or may not be available from the admitted market. After disclosure by the broker, the exempt commercial purchaser will be required to advise the broker in writing that the broker may proceed to procure the insurance from a nonadmitted insurer.

The definition of "nonadmitted insurer" expressly omits risk retention groups.

Conclusion

The insurance industry is lobbying for a full exemption from the financial oversight aspects of the Act. Insurance companies are not expected to and do not pose systemic risk to the economy, but the need to bail out AIG has kept the potential for some federal oversight of the insurance industry squarely in the picture. Some state regulators support the Federal Insurance Office concept, particularly because a state cannot enter into an agreement with a foreign country, and the U.S. must speak with one voice in this global economy. Federal government involvement would clearly enhance the position of the U.S. insurance industry in the global marketplace. Given its effect on a wide range of financial institutions, and significant revisions yet to come, the likelihood of quick approval of the Act is questionable.

© 2010 Nelson Levine de Luca & Horst

Reprinted with permission of the authors.

This publication is part of Blackman Kallick’s marketing of professional services, and is not written tax advice directed at the specific facts and circumstances of any person and/or entity. Contents of this publication are of a general nature, and you should not act on this information without obtaining professional advice from your business advisor that is appropriately tailored to your individual needs and circumstances. This written advice is not intended or written to be used, and cannot be used by any taxpayer, for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.