The Bilateral Covered Agreement: Regulating a Global Insurance Marketplace

The so-called covered agreement between the United States and the European Union is expected to level the playing field for US insurers and reinsurers operating in Europe while further confirming that the US insurance regulatory system meets the goals of insurance sector oversight, policyholder protection, and national and global financial stability.

In a joint statement issued at the time the measure was signed on September 22, 2017, US and EU officials said they see the bilateral covered agreement benefiting both EU and US insurers and reinsurers "by offering them enhanced regulatory certainty, while maintaining robust consumer protections." As such, the measure is widely seen as reducing the regulatory burden on insurers and reinsurers based on both sides of the Atlantic as they do business in one another's markets.

The agreement, formally titled "Bilateral Agreement between the United States of America and the European Union on Prudential Measures Regarding Insurance and Reinsurance," addresses three areas of insurance and reinsurance regulation: group supervision; reinsurance supervision, including collateral and local presence requirements; and the exchange of information between supervisory authorities.

The measure is seen as a significant step in increasing US companies' competitiveness in both domestic and foreign markets while making insurance and reinsurance regulations more efficient and appropriate. It also affirms the existing US system of state-based insurance regulation. It is expected to reduce costs both for US insurers and for personal and commercial lines policyholders in the United States.

While some provisions of the agreement took effect with its signing in September, others might take up to 5 years to be fully implemented.

The Agreement's History

The US-EU covered agreement had its genesis in Title V of the Dodd-Frank Act, which authorized the secretary of the Treasury and the Office of the United States Trade Representative (USTR), jointly, to negotiate and enter into a covered agreement between the United States and one or more foreign governments, authorities, or regulatory entities. Such an agreement is an international agreement relating to "the recognition of prudential measures with respect to the business of insurance or reinsurance that 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," as described on the Treasury's website.

The United States and European Union began negotiations on the agreement in November 2015 with those negotiations resulting in a final legal text that was submitted to Congress in January, during the final days of the Obama administration.

The Treasury and USTR, as well as the European Union, announced their intentions to sign the covered agreement in July, leading to the September signing ceremony at the Treasury Department.

Numerous insurance and reinsurance industry trade organizations have supported the agreement, as has RIMS, the risk management society™. While the National Association of Insurance Commissioners (NAIC) initially expressed reservations, a statement at the time of the agreement's signing from NAIC President and Wisconsin Insurance Commissioner Ted Nickel said, "We are pleased to see Treasury and USTR clarify their interpretation of the covered agreement, as we have asked, in key areas like capital, group supervision, reinsurance, and the Joint Committee." The statement indicated that the NAIC was pleased to see the agreement affirming the primacy of a state-based US insurance regulatory system and said that in the months ahead the NAIC will assess the covered agreement's impact on state regulation and consider any insurance regulatory changes that might be required.

For their part, US officials indicated their commitment to "regular and substantive engagement with stakeholders" throughout the implementation of the covered agreement, while also making "every effort to ensure that the EU implements its obligations while carrying out the United States' own obligations."

The Key Benefits

The Treasury Department has noted that the covered agreement allows US insurers operating in Europe "to avoid burdensome worldwide group capital, governance, and reporting requirements under the EU's 'Solvency II' prudential regulatory system for insurers, as well as EU local presence and collateral requirements for US reinsurers." At the same time, the Treasury said, through the covered agreement the United States commits to eliminating state-based reinsurance collateral requirements "as applied to cessions to EU reinsurers that meet the consumer protection standards specified in the agreement."

In a recent briefing paper, A.M. Best noted that the elimination of the collateral requirements is a particularly significant feature of the agreement for European reinsurers. US states have 5 years to fully implement the collateral elimination requirements, however, and the provision only applies to reinsurers that meet specified financial strength and market conduct requirements. In addition, the collateral elimination requirements do not apply to reinsurance agreements in place before the covered agreement is applied or to losses incurred or reserves posted before the covered agreement's application.

From a regulatory perspective, put simply, the covered agreement provides for relying on the home supervisor of US or EU insurance groups to supervise activities at the worldwide level.

The covered agreement limits the worldwide application of the European Union's prudential group insurance measures on US insurers operating in the European Union. The measure provides that US insurers and reinsurers can operate in the European Union without the US company's parent being subject to Solvency II's group level governance, solvency and capital, and reporting requirements.

The covered agreement also reinforces the notion that the European Union's system of prudential insurance supervision is not the US system. While the agreement does not require the development of a group capital standard or requirement in the United States, it does anticipate states developing a groupwide capital assessment such as the group capital calculation currently being developed by the states through the NAIC.

The reporting provisions of the covered agreement protect US insurance groups with EU affiliates from "expansive reporting requirements relating to worldwide operations at the group level while enhancing regulatory cooperation," according to a Treasury policy statement on the agreement.

Information Exchange

Indeed, the covered agreement also emphasizes the need for the exchange of information between US and EU regulators and sets out some mechanisms for facilitating such information sharing.

If necessary, US insurance supervisors can obtain information about the parents of EU insurers doing business in the United States to protect against any possibility of harm to US policyholders, threats to the insurers' financial stability, or any serious impact on the insurers' ability to pay claims in the United States, according to the Treasury policy statement.

US regulators also will receive Own Risk and Solvency Assessment (ORSA) summary reports from EU regulators for the worldwide group ORSA for EU insurance companies operating in a US regulator's territory. In addition, under the covered agreement, US state prudential insurance group supervision reporting requirements continue to apply at the level of the EU parent insurer if such requirements "directly relate to the risk of a serious impact on the ability of insurers in the group to pay claims in the United States," the Treasury statement said.

The Treasury statement noted that the United States "expects that close supervisory cooperation between and among US and EU insurance supervisory authorities will continue." That cooperation may include supervisory colleges and the exchange of information, the statement said, noting that the covered agreement "acknowledges the increased globalization of insurance and reinsurance markets and the associated need for cooperation between US and EU insurance supervisors regarding the exchange of confidential information."

To that end, the United States is encouraging US insurance regulators to cooperate in sharing information with their EU counterparts consistent with a Model Memorandum of Understanding Provisions on Exchange of Information between Supervisory Authorities included as an annex to the covered agreement. Such steps are intended to enhance regulatory cooperation and information sharing while maintaining a high level of protection of company confidentiality.

The Road Forward

There is widespread agreement that the provisions of the bilateral covered agreement should provide considerable benefits for insurers and reinsurers in both the United States and the European Union, as well as to their personal and commercial lines customers.

Of course, as with any such pact, for all its apparent benefits, the covered agreement may have certain additional consequences for some insurers and reinsurers. In its recent briefing paper, A.M. Best noted that "measures that reduce the regulatory burden for foreign companies and promote the cross-border flow of business increase competition in local markets, leading to negative pricing pressure."

As a result, the agreement might have a "detrimental impact" on the performance of domestic reinsurers operating in the United States and the European Union, Best said, even as that increased competition in local reinsurance markets could stand to benefit domestic primary insurers able to take advantage of lower rates.

Also significant is the fact that the provisions of the US-EU covered agreement will not apply to Lloyd's and London market reinsurers after the implementation of "Brexit" and the United Kingdom leaving the European Union. That potentially sets the stage for negotiation of a similar US-UK covered agreement in the future.

With years of work remaining to fully implement its provisions, the September signing of the bilateral covered agreement was but a first step, if a significant one. Perhaps the most significant aspect of that step is the recognition it reflects of an ever more global insurance and reinsurance marketplace and the need to rationalize regulatory approaches to best serve the companies and consumers doing business in that market.