Martin Membery and Andrew Holland of Sidley Austin discuss the signing of the EU-US bilateral covered agreement and who will potentially benefit from it
Who does the signing of the EU-US bilateral covered agreement affect?
Martin Membery: The insurers and reinsurers that will potentially benefit from the covered agreement are those that have international business that, one way or another, spans the EU and the US, in particular US reinsurers providing reinsurance cover to EU cedents; US insurance groups with EU insurance subsidiaries; and EU reinsurers providing cover to US cedents.
What benefits will those insurers and reinsurers gain?
Membery: The two key areas addressed by the covered agreement concern group supervision and reinsurance collateral or local presence requirements.
In relation to group supervision, as the US is not currently considered to be equivalent to the EU for group supervision purposes—absent agreeing ‘other measures’ with EU regulators under Solvency II—under the current regime, US insurance groups with EU-based insurance subsidiaries are potentially exposed to having their US and other non-EU operations subject to EU group supervision under Solvency II.
The covered agreement precludes EU insurance regulators from applying Solvency II group supervision to the non-EU parts of US headquartered insurance groups. US insurance groups operating in the EU will be supervised at the worldwide group level only by the relevant US insurance supervisors, and will not therefore have to meet EU worldwide group capital, reporting or governance requirements. Equally EU insurers operating in the US will be supervised at the worldwide group level only by the EU insurance regulators.
Andrew Holland: Ultimately, it is expected that the full implementation of the covered agreement will result in elimination of collateral requirements for many EU-based reinsurers who assume reinsurance from US cedents. Historically, the requirement imposed on US ceding companies to obtain credit for reinsurance was to hold 100 percent collateral from their reinsurers.
We have, however, over the past few years moved to the certified reinsurer concept, where certain highly-rated financially strong companies from approved qualified jurisdictions have been able to post reduced levels of collateral.
When fully implemented, the covered agreement will eliminate those collateral requirements for EU-based reinsurers, one way or another. However, there still will be some specific quantitative measures for EU-based reinsurers to qualify.
The ‘one way or another’ means that either the US states will act to adopt a credit-for-reinsurance regime that is in accordance with the covered agreement, or they will end up in a position where state law can be pre-empted through a process set out in the Dodd-Frank Act and involving the US Federal Insurance Office. Although the EU-US covered agreement has been signed, the elimination of collateral requirements could take up to five years.
Membery: The reinsurance collateral and local presence aspects of the covered agreement also apply the other way round, potentially benefitting US reinsurers providing cover to EU-based cedents.
The position in the EU is currently somewhat patchy. There are some countries such as the UK, where US reinsurers can provide cover to UK-based cedents without local presence or collateral requirements. Equally, there are certain other European jurisdictions where this is not the case.
The covered agreement, once in full force of effect, will level the playing field so US reinsurers meeting the requisite qualifying criteria (regarding financial strength and market conduct) will not be treated any differently to EU-based reinsurers in this respect.
Now the agreement has been made, what happens next? What are the implementation stages of the agreement?
Holland: The section that will receive the most attention is the elimination of collateral requirements. The US has a fair amount of time to act. The preliminary process of reviewing the status of state law does not start for 42 months. However, it is expected that the process could move more quickly and that there will be a more proactive approach by states.
Membery: The European Commission has indicated that certain parts of the agreement, such as group supervision, will be provisionally applied swiftly following the signature.
Earlier this year, S&P Global Ratings suggested that the covered agreement is one key area where the Dodd-Frank Act has worked as intended, do you agree with that statement? If yes, why?
Holland: I would agree with the statement that it has worked as intended, however I think it has not been as quickly as was intended. It has taken us some time to get to this point and we’re only at the first stage where we have a covered agreement with the EU. It remains to be seen whether we will have covered agreements with any other jurisdictions that are important from a US perspective, for example Bermuda.
And on the European side, what will happen in the UK, post-Brexit?
Membery: For as long as the UK remains part of the EU (or can rely upon appropriate transitional measures conferring the same benefits), UK-based reinsurers, including Lloyd’s syndicates, will receive the same benefits under the covered agreement as their EU counterparts.
Once the UK has left the EU, it would not automatically benefit from the covered agreement, and the UK would need to negotiate an equivalent agreement with the US on a bilateral basis in order for UK-based reinsurers to continue to receive these benefits.
