On September 22, 2017, nearly two years after negotiations began, the US Department of the Treasury, the US Trade Representative and the European Union executed the Bilateral Agreement between the United States of America and the European Union on Prudential Measures Regarding Insurance and Reinsurance (commonly referred to as the “Covered Agreement”). As described in detail in Mayer Brown’s January 20, 2017, Legal Update, the Covered Agreement finalizes the approaches agreed upon between the United States and the European Union regarding several areas of insurance regulation that have long been a source of controversy: reinsurance collateral requirements, group supervision, the exchange of information between regulators and local presence requirements in the European Union.

With the execution of the Covered Agreement, the clock begins ticking for US state legislators and regulators to change their credit for reinsurance laws to eliminate requirements that EU reinsurers hold collateral against the US risks they have reinsured. Indeed, the Covered Agreement calls for the US states to reduce collateral requirements by 20 percent each year over the next five years. Accordingly, the policy statement by the Trump administration that was released upon the signing of the Covered Agreement encouraged each US state to promptly adopt relevant credit for reinsurance laws and regulations consistent with the Covered Agreement’s provisions on reinsurance collateral and to phase out the amount of collateral required to allow full credit for reinsurance for cessions to EU reinsurers.

Because many states have recently adopted laws allowing for collateral reduction by certified reinsurers, those states may not need to make significant changes to their laws in order to be compliant with the Covered Agreement (and presumably the existing certified reinsurer provisions would continue to apply to non-EU reinsurers). However, the states that have not adopted the certified reinsurer provisions will need to undertake significant revisions to their laws in order to conform with the Covered Agreement’s requirements. Given that the Covered Agreement calls for the United States to begin deliberations on the federal preemption of state insurance laws that are inconsistent with the Covered Agreement by July 2020—for which a determination must be completed within 18 months after deliberations begin—it is likely that the National Association of Insurance Commissioners’ (NAIC) Reinsurance Task Force will soon begin the process of adopting new amendment language for the model credit for reinsurance law and regulation for consideration by the states.

The Covered Agreement will have ripple effects beyond US-EU reinsurance. Reinsurers in commercial centers outside of the European Union, such as Bermuda, Japan and Switzerland, have already sought to level the playing field by urging the NAIC at its August 2017 Reinsurance Task Force meeting to make any proposed changes to the model credit for reinsurance law and regulation apply not only to EU reinsurers but also to certified reinsurers domiciled in jurisdictions deemed to be qualified jurisdiction by the NAIC; some of these reinsurers may also decide to establish operations in the European Union, or shift capacity there, in order to benefit from the Covered Agreement. Banks that work with EU reinsurers to provide letters of credit to US ceding companies will also be affected to the extent that demand for the product decreases; the same is true for trustees of credit for reinsurance trust accounts.

It is important to note that the required changes in state laws may take up to five years to implement, and, once implemented, those changes will only apply to prospective transactions. As a consequence, reinsurers with collateral arrangements already in force will need to maintain those arrangements going forward, absent a commercial agreement with their ceding companies to allow for reduced/eliminated collateral. Moreover, the Covered Agreement specifically contemplates that reinsurers and ceding companies will have the ability to privately negotiate the collateral requirements that the parties deem appropriate, in keeping with the increased use of “comfort trusts” and similar arrangements to mitigate credit exposure to reinsurers in the wake of the financial crisis. So, while credit for reinsurance trusts and letters of credit may no longer be required by law in many circumstances once the provisions of the Covered Agreement are fully implemented, ceding companies will still be able to require that EU reinsurers provide collateral protection, though such requests will now need to be resolved through commercial negotiations rather than through deference to regulatory requirements.