Key Legislative and Regulatory Developments Concerning Reinsurance: 2015 and Beyond ARIAS US Fall Conference – November 13, 2015

Presenters: Robert A. Whitney, Principal, Sparhawk Advisors Daniel Schelp, Managing Counsel, National Association of Insurance Commissioners Elizabeth Kelleher Dwyer, Esq., General Counsel, Rhode Island Department of Business Regulation – Insurance Division Robert Alan Wake, General Counsel, Maine Bureau of Insurance Tracey Laws, Senior Vice-President and General Counsel, Reinsurance Association of America Key Legislative and Regulatory Developments2

Robert A. Whitney, Sparhawk Advisors “Introduction to the Key Legislative and Regulatory Issues” Key Legislative and Regulatory Developments3

The insurance industry is now global in scope, which insurance and reinsurance companies operating all over the world. The greatest concern for regulators in the United States has always been insurer insolvency. Even after the recent recession, however, insurer insolvencies have been negligible. Other than the well- reported case of AIG accepting funds from the Troubled Asset Relief Program (or “TARP”) only two other troubled insurers - Allstate and Lincoln National - ultimately received any relief funds whatsoever. On the whole, the financial condition of the world-wide insurance and reinsurance industry has proved to be strong and resilient, and at no point did any insurance activity result in any significant impact to the reinsurance market, let alone the larger economy. Key Legislative and Regulatory Developments4

Nevertheless, there have been sustained calls for reform of U.S. insurance and reinsurance regulation. Much of the complaints have centered on the fact that the insurance sector is alone among financial services in being subject primarily to a state-based regulatory system. Under such a system, it is presumed that that efficiency, fairness, economic growth, and transparency have not been maximized as they could have been under a single, national system of regulation. Also, the complainants point to other developed countries in the world that have national insurance regulatory frameworks in place, and many – such as those in the European Union (“EU”) - have moved to a single regulatory paradigm across national boundaries. Key Legislative and Regulatory Developments5

The primary goal of reinsurance regulation is to ensure that reinsurers are able to meet their obligations for losses paid by ceding companies. Like a primary insurer, a reinsurer licensed in a state is subject to that state’s solvency requirements. These requirements (e.g., minimum capital levels) vary among the states. However, unlike a primary insurer, a reinsurer does not have to be licensed in each state in which it operates. Key Legislative and Regulatory Developments6

An individual state is typically unable to directly impose its solvency standards on reinsurers in other states or countries. As such, each state is able to focus only on the regulation of those ceding insurers and reinsurers within its own jurisdiction. In an attempt to deal with this situation, the National Association of Insurance Commissioners (“NAIC”) has worked to develop minimum standards to encourage uniform reinsurance regulation within the country. Key Legislative and Regulatory Developments7

A reinsurer licensed by a state is subject to the full spectrum of insurance regulations to which a primary insurer is subject. While state insurance laws vary, most are based in large part on model laws and regulations developed by the NAIC. U.S. regulators uniformly recognize that given the enormity of the insurance marketplace, the reinsurance capacity can only be satisfied by allowing non-U.S. insurers to assume reinsurance business in the U.S. In fact, nearly one-half of the reinsurance premiums are reinsured outside of the U.S. Key Legislative and Regulatory Developments8

The NAIC has increased reinsurance reporting requirements for the annual financial statements that insurers file with state regulators. These requirements allow state regulators to better assess the impact of reinsurance on the financial condition of insurers. In particular, new reporting requirements quantify overdue reinsurance and enable regulators to better detect potential problems with uncollectible reinsurance. Key Legislative and Regulatory Developments9

Potentially uncollectible reinsurance has always been seen as a significant problem to insurance regulators and well as industry members. One challenge for regulators has been where there has been a lack of oversight over reinsurers domiciled abroad and not licensed in any U.S. state. Since U.S. regulators cannot directly regulate such non-U.S. companies, the indirect mechanism by which state regulators have exerted control over the reinsurance market has been through the “credit for reinsurance” laws. Key Legislative and Regulatory Developments10

Dan Schelp, National Association of Insurance Commissioners “NAIC and Captive Reinsurance Transactions Involving XXX/AXXX Financial Transactions – Latest Developments” Key Legislative and Regulatory Developments11

Key Legislative and Regulatory Developments12 State Regulation Of XXX/AXX Captive Reinsurance Transactions Traditional captive insurers may not be subject to Statutory Accounting Principles (“SAP”), and were excluded from the NAIC Accreditation Program. National Association of Insurance Commissioners (“NAIC”) became concerned with captive reinsurance being done by life insurers on XXX/AXXX policies. Section 6, NAIC Model 830 (“XXX”): Reserving requirements for level term life (and similar) products. Reserves based on specified interest rates and mortality tables. Section 7, NAIC Model 830 (“AXXX”): Reserving requirements for Universal Life Insurance policies that Contain a Secondary Guarantee (“ULSG”).

XXX/AXXX Regulatory Problem XXX/AXXX Reserves were established too high, sometimes 3-4 times the economic value of reserves. Insurers began reserve financing transactions by ceding reserve values to captives and Special Purpose Vehicles (“SPVs”), which backed reserves with letters of credits (“LOC”) and parental guarantees (“PG”) for the non-economic portion. Reserves at ceding insurer stayed the same. Captive reinsurance increased statutory surplus for the ceding insurer, but decreased admitted assets backing reserves (because LOCs and PGs are not admitted assets). Insurers considered the result to be a more reasonable regulatory reserve (closer to economic reality). Key Legislative and Regulatory Developments13

XXX/AXXX Reinsurance Framework NAIC addressed these concerns through adoption of XXX/AXXX Reinsurance Framework in 2014, which requires the direct ceding company to do following: Book the full statutory reserve. Reserves are supported by reinsurance requiring a tiered system of collateral supporting the reserves. Disclose assets/securities supporting reserves. Hold appropriate RBC capital charge. Key Legislative and Regulatory Developments14

Implementation of Framework: AG 48 AG 48 defines the “Actuarial Method” used to determine the reserve level that must be supported by certain defined assets called “Primary Security”. This reserve level is called the “Required Level of Primary Security.” Actuarial Method is based on Principle-Based Reserving (“PBR”) and modified VM-20 of the Valuation Manual. Reserves above-PBR requirements would be supported by “Other Security” deemed acceptable by the commissioner. AG 48 requires the appointed actuary to issue a Qualified Actuarial Opinion if the required amount of either Primary Security or Other Security is not held by a covered captive reinsurer in a XXX/AXXX reinsurance transaction. Key Legislative and Regulatory Developments15

Statutory Reserves (No change in calculation) Statutory Reserves Minus PBR-Level Reserves PBR-Level Reserves (“Actuarial Method”) “Other Security” “Primary Security:” Cash, some SVO-Listed, Comm. Loans CM3+, policy loans, certain derivatives Collateral Reserves XXX/AXXX Reinsurance Framework Tiers Key Legislative and Regulatory Developments16

Implementation: XXX/AXXX Model Regulation NAIC Reinsurance Task Force exposed revisions to Credit for Reinsurance Model Law (#785) and new XXX/AXXX Model Regulation on August 16, Model Regulation is designed to incorporate requirements of AG 48, and will eventually become the new Accreditation Standard for all states. Task Force had conference call on October 26, 2015 to discuss. Key Legislative and Regulatory Developments17

Other Key NAIC Issues: Accreditation. In Summer 2015, the NAIC revised Part A Accreditation Preamble to scope in captive reinsurance transactions involving XXX/AXXX, variable annuity (VA), and long- term care (LTC) business into the accreditation requirements effective January 1, 2016, although VA and LTC provisions not yet effective. PBR. PBR should largely address the perceived reserving redundancies that have precipitated captive financing transactions. PBR is expected to become operative on January 1, Key Legislative and Regulatory Developments18

Remaining issues: Should #785 be applicable to reinsurance other than XXX/AXXX? Consequence Options (credit for reinsurance penalty rather than nonqualified actuarial opinion). Revisions to Actuarial Method and timing issues. Exemption for “Professional” Reinsurers. Model Law to be adopted in 2015, Model Regulation expected in Key Legislative and Regulatory Developments19

Elizabeth Kelleher Dwyer, Esq., Rhode Island Department of Business Regulation – Insurance Division “Rhode Island’s Voluntary Restructuring of Solvent Insurers Statute – Recent Developments” Key Legislative and Regulatory Developments20

Key Legislative and Regulatory Developments21 Rhode Island Statute – Title 27, Chapter 14.5 Created as an Economic Development Measure in 2002 to foster a “center of excellence” in run-off Insurer MUST be a Rhode Island domiciled insurer, commercial lines property and casualty insurer in run-off and solvent and adequately reserved Provides an alternative to the traditional options available for insurers in run-off All statutes and regulations applicable to Rhode Island domiciled Insurance Companies are applicable

Procedure Redomestication of Company to Rhode Island Commutation Plan Approval of Commutation Plan by the Department Approval of Commutation Plan by the Court Final Discharge of Obligations Insurance Business Transfer Approval of IBT Plan by the Department Approval of IBT Plan by the Court Novation of Insurance Contracts Key Legislative and Regulatory Developments22

Department Review St andard – plan would not materially adversely affect the interest of creditors or policyholders Department will focus on the actuarial calculations – purpose to analyze whether proposal shortchanges creditors Notice – Manner of identifying last know address could lend credibility to plan Timeframe for review depends upon completeness of information Regulations detail information required Any unusual circumstance should be explained. Not designed for insurer that wants to commute obligations at less than the equivalent of full value or novate policies into a undercapitalized company Key Legislative and Regulatory Developments23

Ultimate Goals Establish Rhode Island as the center of excellence for insurer run-offs in the United States Build a suitable regulatory infrastructure to ensure efficient and appropriate implementation and oversight of commutation plans and insurers in run-off Reduce the number of insolvencies (and therefore the costs of insolvencies to the industry and to the public) Reduce administrative expenses of long term run-offs making more funds available for creditors and shareholders Key Legislative and Regulatory Developments24

Successful Commutation Plan Commercial reinsurer o Has not issued policy in 20 years o Redomesticated specifically to take advantage of statute Department conducted “due diligence” examination and allowed redomestication o At request of company reviewed proposed Plan during examination to inform company of any immediate problems o This was not a binding opinion and Department could change position if additional information developed Key Legislative and Regulatory Developments25

Proceedings took place before Superior Court business calendar with significant experience in insolvencies and non insurer receiverships o Constitutional challenge under contract clause o Court held their was no “substantial impairment” o State interest in Orderly Resolution of Insurance Run- Offs Key Legislative and Regulatory Developments26

Robert Alan Wake, Maine Bureau of Insurance “Emerging Reinsurance Issues” Key Legislative and Regulatory Developments27

Key Legislative and Regulatory Developments28 Emerging Reinsurance Issues Collateral Reform Alternative Markets Impact on Arbitration

Key Legislative and Regulatory Developments29 Collateral Reform Reinsurance is a global market o “Unlicensed” reinsurers must post collateral means “non-U.S.” reinsurers must post collateral NAIC answer: Certified Reinsurers FIO answer? Covered Agreement

Certified Reinsurers Reinsurer must be domiciled in Qualified Jurisdiction Collateral reduction depends on rating Rating standards and minimum capital ($250M) set by regulation Parties can agree contractually to higher collateral than law requires Key Legislative and Regulatory Developments

Alternative Markets Cat Bonds and Other Insurance-Linked Securities Sidecars, Protected Cells, and Other Alternative Structures XXX/AXXX and AG48 Variable Annuities and Long-Term Care New Frontiers Key Legislative and Regulatory Developments31

What Does It Mean for Arbitrators? Disputes Over Reduced Collateral “Other Security” for XXX/AXXX Treaties What if Captive Treaties Need to be Enforced? Key Legislative and Regulatory Developments32

Enforcement of Captive Treaties “These are just financing arrangements” “This is just self-insurance” Related Parties Don’t Always Stay “Related” Key Legislative and Regulatory Developments33

Enforcement of Captive Treaties - What’s the Problem? Not Drafted With Enforcement in Mind Long-tail liabilities Spin-offs Third-party investors Ceding Company Receivership Holding Company Bankruptcy Key Legislative and Regulatory Developments34

Tracey Laws, Reinsurance Association of America “(Re)insurance Regulatory Issues between U.S. & EU” Key Legislative and Regulatory Developments35

Key Legislative and Regulatory Developments36

US/EU Issues – Equivalence & “Covered Agreements” (Re)insurance Regulatory Issues between U.S. & EU U.S. Companies Operating in EU o Market Access (Poland) o Additional Requirements for Market Access (Netherlands) o Solvency II being applied to U.S. companies/branches (U.K.) o Collateral (could continue) o What else? Key Legislative and Regulatory Developments37

Key Legislative and Regulatory Developments38 EU Companies operating in U.S. Collateral Group Capital?

How to Solve These Issues? Solution(s) needs to be: Timely (Solvency II in effect on 1/1/16) Provide Uniformity and Predictability Enforceable Key Legislative and Regulatory Developments39

Solutions: Equivalence Process in EU Equivalence for: Reinsurance, Group Supervision for non-EU based companies o Temporary (5 year) or Full/Permanent Equivalence  Switzerland (Full)  Bermuda (Full expected)  Japan (?)  8 countries have applied for Temporary Equivalence Would Still Need to Resolve Issues of EU Based Companies in U.S. Key Legislative and Regulatory Developments40

“Covered Agreement” between U.S. and EU What is it? o Created by Dodd-Frank; Executed by USTR and the Federal Insurance Office Process Issues o EU o U.S. What Can It Address? Key Legislative and Regulatory Developments41

Players/Politics Treasury & USTR NAIC/State Regulators Industry Congress European Commission/Parliament/Member States/European Industry Key Legislative and Regulatory Developments42

Important for these two large, well- regulated jurisdictions – U.S. and EU - to resolve their issues because of (increasing) trade barriers around the world Key Legislative and Regulatory Developments43

QUESTIONS? Key Legislative and Regulatory Developments44