Insurance and Reinsurance in USA 2024

Insurance and Reinsurance in USA 2024

INSURANCE AND REINSURANCE 2024

USA

William D Torchiana, Marion Leydier, Nicholas F Menillo

(Sullivan & Cromwell LLP)

REGULATION

Regulatory agencies

1. Identify the regulatory agencies responsible for regulating insurance and reinsurance companies.

In the United States, insurance business (including reinsurance) is primarily regulated at the state level. Each state has an insurance department, plus laws, regulations, policies and procedures that regulate many aspects of the operations of insurers and reinsurers. States also regulate the actions of insurance intermediaries, including insurance producers, agents, brokers, reinsurance intermediaries, claims adjusters and third-party administrators.

The Supreme Court held in United States v South-Eastern Underwriters Association, 322 US 533 (1944), that Congress had the power to regulate the insurance industry. In response, Congress enacted the McCarran–Ferguson Act, which, broadly speaking, left regulatory control over insurance to the states, as long as their laws and regulations do not conflict with federal antitrust laws on rate fixing, rate discrimination and monopolies. Some national insurance programs, including, but not limited to, the Terrorism Risk Insurance Act, the National Flood Insurance Program, the Federal Crop Insurance Program and the Longshore and Harbor Workers’ Compensation Act, were created by federal act, and are subject to regulation by the federal government with certain regulatory responsibilities left to the states. Further, in January 2021, the Comprehensive Health Insurance Reform Act was signed into law, which amends the McCarran–Ferguson Act to apply US federal antitrust laws to the health insurance industry.

After the passage of the McCarran–Ferguson Act, each state continued to develop its own set of insurance laws, regulations and rules for state agencies to impose on the business of insurance in their respective states. As a result, insurance companies, reinsurance companies and insurance intermediaries are subject to the laws and regulations of each US jurisdiction in which they transact business. This can be onerous for companies seeking to do business nationwide.

Developments at the federal level following the 2008 financial crisis have affected certain aspects of insurance regulation in the US, including in connection with surplus lines insurance and credit for reinsurance, and have introduced a federal regulatory overlay on some of the largest US insurers. Specifically, the Dodd–Frank Wall Street Reform and Consumer Protection Act (Dodd–Frank Act) was enacted in 2010 and resulted in changes in the regulation of the US surplus lines market and credit for reinsurance requirements. These changes:

• remove the ability of multiple states to tax a surplus lines transaction by restricting such tax to an insured’s ‘home state’ (as defined under the federal legislation);
• establish uniform standards for surplus lines insurer eligibility;
• streamline surplus lines placements for larger commercial insureds that qualify as ‘exempt commercial purchasers’ under the law; and
• restrict determination of credit for reinsurance to the cedent’s domiciliary jurisdiction.

The Dodd–Frank Act also created the following:

• The Federal Insurance Office (FIO), an office of the US Department of the Treasury charged with monitoring all aspects of the insurance industry (other than health, long-term care and crop insurance), including identifying gaps in insurance regulation, and representing the federal government at the IAIS and in international negotiations regarding insurance.
• The Financial Stability Oversight Council (FSOC), an inter-agencybody charged with identifying systemic risks in the US financial services industry and designating systemically important financial institutions (SIFIs), including insurers and reinsurers, which are to be supervised by the Board of Governors of the US Federal Reserve System (the Federal Reserve) and subject to enhanced prudential standards. Currently, no insurance entity is designated as a SIFI, as all initial designations were subsequently overturned or rescinded. In December 2019, the FSOC amended its guidance on the designation of SIFIs (originally adopted in 2012), which prioritized an activities-based approach to identifying and addressing potential risks to financial stability, with entity-specific determinations (i.e, SIFI designations) pursued ‘only if a potential risk or threat cannot be adequately addressed through an activities-based approach.’ However, in November 2023, the FSOC adopted revised guidance that, among other things, eliminates the prioritization of an activities-based approach set forth in the 2019 guidance, and largely reverts to the 2012 guidance under which the FSOC had initially designated four non-bank SIFIs, including three insurance groups.

In addition, the National Association of Insurance Commissioners (NAIC) continues its efforts to coordinate regulation of insurance in US jurisdictions. The NAIC is a private organization, created and governed by the chief insurance regulators from all US jurisdictions, that serves as a vehicle for cooperation among state insurance regulators. One way the NAIC accomplishes its purpose is to propose model laws and regulations for consideration by state legislatures. In addition, the NAIC establishes that some model laws or regulations are accreditation standards. The purpose of the NAIC’s accreditation program is for state insurance departments to meet baseline standards of solvency regulation, particularly with respect to the regulation of multi-state insurers. NAIC accreditation allows non-domestic states to rely on the accredited domestic regulator to fulfil a baseline level of effective regulatory supervision, promoting inter-state reliance and reducing regulatory redundancies. All 50 states are currently accredited.

The NAIC also helps to improve efficiency by pooling resources through its centralized facilities. For example, insurance regulators in the United States use the NAIC’s financial databases, often as their primary data source. While the NAIC is a voluntary organization and cannot mandate the states to enact any laws, it has a lot of influence. In recent years, there has been increasing pressure on states to coordinate their efforts and work towards uniformity in light of proposals to replace or supplement certain aspects of the state-based system of insurance regulation with federal regulatory requirements.

Formation and licensing

2. What are the requirements for formation and licensing of new insurance and reinsurance companies?

To form a US insurance company, the first step is to determine the appropriate type of company. Most US insurance companies are organized either as mutual companies or stock companies. A stock insurer is a company funded by an initial capital investment by the owners of the insurer. Mutual insurers are owned by their policyholders, rather than stockholders. Other, less common, types of US insurance companies include, among others, a reciprocal inter-insurance exchange, which is an unincorporated association where the members agree to an exchange of contracts of insurance among themselves, and which is administered by an independent attorney-in-fact as the managing agent.

Companies must also select a state of domicile. The factors that a company may consider in selecting a state of domicile include the location from which it will operate the business, the speed with which it wants to become licensed, the regulatory environment in that jurisdiction, and the jurisdiction’s insurance laws governing matters such as permissible investments for a domestic insurance company and regulatory approval requirements for dividends and transactions with affiliates.

Generally, the US insurance industry consists of three major product lines: property and casualty insurance, life insurance and annuities, and health insurance. Property and casualty insurance products include automobile, homeowners’ and other types of insurance sold to individuals (personal lines of insurance) as well as products designed to protect businesses from property damage and liability (commercial lines of insurance). The life insurance industry sells two major types of products: life insurance and annuities. Life insurance companies may also offer certain types of health insurance. Health insurers sell a variety of health insurance products, ranging from comprehensive major medical coverage to products providing coverage for specific health services (dental, vision, et cetera), products intended to supplement the coverage provided under certain US federal programs (e.g, Medicare supplement), and products offering health coverage triggered under specific circumstances (e.g, specified disease coverage).

Once the domiciliary state of the insurance company has been selected and the insurance products that it will write have been identified, an application is required to be submitted to that state’s domiciliary insurance regulator to obtain approval for the organization and licensure of that insurance company in that state. Among other things, such application is typically required to include disclosures concerning:

• the proposed owners of the insurance company;
• the insurance group’s consolidated financial statements;
• the business plan for the insurance company, including financial projections;
• biographical affidavits; and
• in some states, fingerprint cards for the proposed directors and executive officers of the insurance company and any individuals that will control the insurance company (and, depending on the state, potentially also of the directors and executive officers of the business entities that will control the insurance company).

A license issued to an insurance company in its domiciliary state generally does not, on its own, enable that insurance company to transact an insurance business in other states. To the extent the insurance company desires to transact an insurance business in other states, it will typically need to obtain licenses or other authorizations to do so. Such licenses or other authorizations may be sought only after the insurance company has obtained a license in its domiciliary state.

An insurance company that desires to obtain a license in its domiciliary state or any other state is required to comply with that state’s minimum capital and surplus requirements.

The process for forming and obtaining a license for a reinsurance company is the same as the process for forming and obtaining a license for an insurance company.

Other licenses, authorizations and qualifications

3. What licenses, authorizations or qualifications are required for insurance and reinsurance companies to conduct business?

The licenses or other authorizations required to transact a particular type of insurance business in a state differ from state to state. As a general matter, in most cases, an insurance company is required to obtain a license in a state before it may write direct insurance business in that state.

There are certain limited exceptions in the United States to insurance company licensing requirements, including, but not limited to, placements with eligible surplus lines insurers. A surplus lines insurer is generally not licensed to transact business directly in any US jurisdiction (except, potentially, its domiciliary US state). Before any business can be placed with a surplus lines insurer in a given state, the insurer must be deemed eligible under that state’s surplus lines laws and in accordance with the Dodd–Frank Act (which establishes uniform standards for surplus lines insurer eligibility), and the insurance must typically be unavailable from licensed carriers in that state. Such surplus lines business must be ‘exported’ by specially licensed surplus lines brokers who make appropriate tax and other required regulatory filings. Surplus lines insurance is subject to less stringent regulation than insurance written by licensed companies and is not covered herein.

Most US states also permit certain kinds of business to be written in the state by an insurer that neither holds a license in a state nor is an eligible surplus lines insurer in the state. For example, several states permit unlicensed insurers to write certain forms of marine, aviation or transportation insurance in the state. The requirements for writing such business on an unlicensed, or ‘unauthorized, basis, and the kinds of business that may be written on such basis, vary from state to state, and are not covered herein.

A reinsurance company is not required to have a license in a US state in order to be able to assume business via reinsurance from cedents domiciled in that state. Subject to jurisdictional considerations with respect to activities in-state that might constitute the ‘doing of an insurance business’, a non-US reinsurer may operate in the US market on an unauthorized basis, without having to subject itself to the US insurance licensing regime.

However, the insurance laws of all US states provide that, if a cedent domiciled in a state cedes business to a reinsurer that is neither licensed nor holds accredited reinsurer, certified reinsurer, or reciprocal jurisdiction reinsurer status in the state, the reinsurer will be required to post 100 percent collateral to secure its obligations under the reinsurance agreement in order for the cedent to be able to receive credit for the reinsurance in its financial statements. Permitted types of collateral for this purpose include a letter of credit meeting certain requirements, a trust meeting certain requirements (including, among other things, with respect to permitted assets to be held in the trust account), funds withheld on the cedent’s balance sheet that comprise certain permitted assets, or a multi-beneficiary trust, maintained in a qualifying US financial institution as security for the reinsurer’s obligations under its reinsurance agreements with all US cedents.

licenses and accredited reinsurer status are typically available in US states to US-domiciled reinsurance companies. The licensing requirements for reinsurance companies are largely the same as those applicable to insurance companies. A licensed reinsurer is one that has undergone the state’s formal application and approval process and has obtained a license or certificate of authority to transact reinsurance business within the state. In most states, an insurance company may act as a reinsurer for any line of business it is licensed to write on a direct basis. Some states allow for a reinsurance-only license. A reinsurer licensed in one state may be authorized as a reinsurer in another state that employs ‘substantially similar’ credit for reinsurance regulations. Accredited reinsurers, while not formally licensed by the state, satisfy certain criteria (such as certain minimum capital and surplus requirements) in order to provide reinsurance in a particular jurisdiction.

A non-US reinsurer that is domiciled in a ‘qualified jurisdiction’ (ie, Bermuda (for certain classes of reinsurers only), France, Germany, Ireland, Japan, Switzerland or the United Kingdom) and that meets certain other criteria described below may apply for certified reinsurer status in a state. Certified reinsurer status permits a non-US reinsurer to post reduced collateral (the amount of such reduction is based on the reinsurer’s ratings) with respect to reinsurance it assumes from cedents domiciled in the state without jeopardizing the cedent’s ability to obtain full credit for the reinsurance in its financial statements. Moreover, a non-US reinsurer that is domiciled in a ‘reciprocal jurisdiction’ (i.e, all European Union jurisdictions, the United Kingdom, Bermuda (for certain classes of reinsurers only), Japan or Switzerland) and that meets certain other criteria described below may apply for reciprocal jurisdiction reinsurer status in a state. Reciprocal jurisdiction reinsurer status permits a non-US reinsurer to post zero collateral with respect to reinsurance it assumes from cedents domiciled in the state without jeopardizing the cedent’s ability to obtain full credit for the reinsurance in its financial statements. The criteria for certification as a certified reinsurer or reciprocal jurisdiction reinsurer generally require that the reinsurer:

• be licensed as an insurer or reinsurer in a qualified jurisdiction or reciprocal jurisdiction (as applicable);
• maintain a minimum level of capital and surplus;
• for certified reinsurers only, maintain financial strength ratings from two or more rating agencies;
• for reciprocal jurisdiction reinsurers only, maintain a minimum solvency or capital ratio;
• submit to jurisdiction of the state;
• submit financial information for regulatory review; and
• satisfy other requirements established by regulators.

Officers and directors

4. What are the minimum qualification requirements for officers and directors of insurance and reinsurance companies?

States impose a variety of minimum standards for directors of insurance and reinsurance companies, which in some states may include minimum age, residency or US citizenship requirements. Some states also require that a specified number of directors of the insurance company be independent unless an exemption applies. In addition, all states require that an insurance company establish an audit committee that includes independent directors unless an exemption applies. Such exemptions are typically available, for example, to an insurance company that reported less than US$300 million in direct written and assumed premium in the prior year or that is owned by a public holding company that complies with certain requirements, including audit committee independence requirements, set forth under US federal securities laws. All officers and directors of insurance and reinsurance companies must submit biographical affidavits to the insurance departments of the states in which the company is licensed, and are subject to background investigations; some states also require such individuals to submit fingerprint cards. US states through the NAIC have been placing greater focus recently on enhancing reporting of corporate governance practices. The NAIC adopted a Corporate Governance Annual Disclosure model act and regulation in 2014, which requires extensive disclosure of regulated insurers’ corporate governance practices. All US states have adopted the model act and regulation, which are also an NAIC accreditation requirement.

Capital and surplus requirements

5. What are the capital and surplus requirements for insurance and reinsurance companies?

Capital standards are the main tool used by regulators to monitor the solvency of insurers and reinsurers. Insurance companies and reinsurance companies are required by the laws of each state in which they are licensed to have certain minimum amounts of capital and surplus to establish and continue operations in that state. The specific amounts of minimum required capital and surplus vary depending on the lines of business for which the insurer is licensed in the state.

States also require a domestic insurance company to annually calculate its risk-based capital ratio pursuant to a formula based in part on the amount and kinds of insurance the insurance company writes. If an insurance company’s risk-based capital ratio falls under certain specified thresholds, its domiciliary state insurance regulator is statutorily authorized to take certain regulatory actions against that insurance company.

The insurance company’s total capital and surplus is calculated as the difference between its admitted assets and its liabilities. To qualify as an admitted asset, an asset must comply with the applicable criteria under the statutory accounting rules promulgated by the NAIC and qualify as a permitted investment for the insurance company under the insurance laws of its domiciliary state.

Reserves

6. What are the requirements with respect to reserves maintained by insurance and reinsurance companies?

In addition to setting capital requirements, state laws require insurers to set aside certain reserve amounts for future benefit and loss payments. The reserve requirements for life insurers are based on standard actuarial procedures and assumptions promulgated by the NAIC and adopted by the various states. The requirements for property and casualty insurers are more variable given the subjective factors affecting future obligations. Regulators require actuarial opinions in respect of the reserves maintained by insurance and reinsurance companies to assess whether they are establishing adequate reserves. The form and content of the actuarial opinion differs between property and casualty and life insurers.

States have implemented a new method for calculating life insurance policy reserves, termed principle-based reserving (PBR), which, for policies issued after the PBR effective date, replaces the prior formulaic approach to determining policy reserves with an approach that more closely reflects the risks associated with increasingly complex life insurance products using justified company experience factors, such as mortality, policyholder behavior and expenses. PBR is mandatory for all applicable life insurance policies entered into after 1 January 2020. PBR was designed to eliminate, or at least diminish, the life insurance industry’s need to use captive insurance companies to finance reserves required under prior regulations for certain term life insurance policies (known as XXX reserves) and certain universal life insurance policies that employ secondary guarantees (known as AXXX reserves) in cases where statutory reserves were considered excessive or redundant compared to economic reserves.

Product regulation

7. What are the regulatory requirements with respect to insurance products offered for sale? Are some products regulated by multiple agencies?

Depending on the state and the product line, the policy form for an insurance product may be required to meet certain specified criteria or contain certain required provisions.

State laws typically require that rates not be inadequate (to prevent company insolvency), excessive, discriminatory or unreasonable in respect of the benefits provided. Furthermore, depending on the state and the product line, in order to sell its insurance products in a state, an insurer generally must first file the rates and forms for the product with the state’s insurance regulator, and, in certain cases, obtain approval from the state’s insurance regulator for the rates and forms it proposes to use. Certain insurance lines (such as, for example, certain types of commercial property and casualty coverage) are exempt from rate and form filing and approval requirements in some states. Regulators review policy forms to confirm that they do not provide inadequate coverage or contain provisions that could be illegal or confusing or misleading to consumers.

In addition to the regulation of insurance products by US state insurance regulators, certain types of life insurance policies and annuity contracts (e.g, variable life and annuity products) are also subject to regulation under federal and state securities laws. For example, most or all states have adopted regulations prohibiting insurers and insurance producers from recommending annuity purchases or replacements unless there is a reasonable basis to believe the annuity is ‘suitable’ for the consumer. The Securities Exchange Commission (SEC) adopted Regulation Best Interest in June 2019, which requires broker-dealers to act in the best interest of a retail customer when making a recommendation of any securities transaction or investment strategy involving securities; the best interest standard is met by satisfying certain disclosure, care, conflict of interest and compliance obligations. In addition, following an earlier initiative that was struck down in the courts, the US Department of Labor proposed in November 2023 a set of fiduciary ‘best interest’ regulations that would apply, among other things, to insurance products sold or marketed with respect to employee benefit plans or individual retirement accounts. In February 2020, the NAIC adopted revisions to its model suitability regulations to clarify that all annuity transactions and recommendations must adhere to a best interest standard, which, like the SEC regulation, is satisfied by certain disclosure, care, conflict of interest and documentation and compliance obligations. The New York insurance regulator adopted, in July 2018, amendments to its suitability regulations that impose a best interest standard on the sale of annuity and life insurance products in New York. Some types of coverage, such as workers’ compensation insurance and health insurance, may also be subject to regulation by state agencies apart from the insurance department (eg, workers’ compensation commissions and departments of public health). Several aspects of health insurance are also regulated by, and subject to laws and regulations of, federal government agencies.

Regulatory examinations

8. What are the frequency, types and scope of financial, market conduct or other periodic examinations of insurance and reinsurance companies?

The insurance laws in all states require the insurance regulator to perform financial examinations of domestic insurers no less than every three to five years. Financial examinations typically focus on the financial condition of the insurer. Insurance laws also require or authorize the conduct of market conduct examinations by state insurance regulators. Market conduct examinations may either be routine, in the case of periodic examinations required by law, or targeted, as, for example, in the case of market conduct complaints received by the regulator or the emergence of regulatory issues or concerns. Market conduct examinations focus on areas such as licensing requirements, sales, advertising, claims handling and the insurer’s business practices more generally.

Investments

9. What are the rules on the kinds and amounts of investments that insurance and reinsurance companies may make?

In order to ensure that an insurer’s investments are appropriate to support its liabilities, state insurance laws generally regulate the types and amounts of assets in which an insurer may invest. Permissible investments acquired or held pursuant to the applicable law qualify as ‘admitted assets’ for purposes of inclusion in the company’s financial statements. State insurance regulation of insurance and reinsurance company investments, however, is not uniform, as the NAIC has two distinct model laws relating to insurer investments that alternatively restrict insurer investments by imposing either a ‘defined limits’ or a ‘defined standards’ approach; however, states have not generally adopted investment laws that strictly follow the NAIC models. Under a defined limits approach, regulators place certain limits on amounts or relative proportions of different assets that insurers can hold to ensure adequate diversification and limit risk. Under a defined standards approach, regulators restrict investments based on a ‘prudent person’ approach, allowing for discretion in investment allocation if the insurer can demonstrate adherence to a sound investment plan.

The assets in which a US insurance company may invest are also impacted by various rules and specifications adopted by the NAIC. For example, the NAIC publishes statutory accounting rules, which include requirements that certain types of assets must meet in order to qualify as admitted assets. In addition, the NAIC adopts rules governing the treatment of various investments in the NAIC’s instructions for calculating risk-based capital. Finally, the NAIC establishes rules for assigning NAIC Designations to debt instruments in which insurance companies invest, which are intended to measure the debt instrument’s credit quality for regulatory purposes. The NAIC periodically revises its statutory accounting rules, risk-based capital calculations and procedures for obtaining NAIC Designations. For example, currently, the NAIC is engaged in a comprehensive project that is intended to result in revisions to certain statutory accounting rules, risk-based capital charges and NAIC Designations for certain types of structured securities and securities issued by the insurance company’s affiliates or other related parties.

Change of control

10. What are the regulatory requirements on a change of control of insurance and reinsurance companies? Are officers, directors and controlling persons of the acquirer subject to background investigations?

The change of control of insurance and reinsurance companies is subject to the approval of state insurance regulatory agencies. ‘Control’ under states’ insurance laws is generally defined as the possession, direct or indirect, of the power to direct or cause the direction of the management and policies of a person, and is presumed to exist upon the acquisition of ownership of 10 percent (5 percent in one state, Alabama) or more of the voting securities of an insurer or a person controlling the insurer. Even in the absence of ownership of 10 percent (or, in Alabama, 5 percent) of voting securities, control can be established if other indicia of control exist (for example, through contractual rights to direct or cause the direction of the management and policies of an insurer or a person controlling the insurer, board representation, et cetera). A person or entity seeking to acquire or merge with an insurance company or a person or entity controlling the insurer is required to file with the insurance department in the insurance company’s state of domicile (and in any state where the insurance company is considered to be commercially domiciled by virtue of writing a specified percentage of its direct insurance business in the state) an acquisition of control statement, commonly known as a ‘Form A’, regarding the proposed merger or acquisition. The Form A contains information about the merger or acquisition, such as the method of acquisition, identity and background of the acquirer and its directors and officers, source and amount of consideration used to fund the proposed merger or acquisition, future plans of the acquirer with respect to the insurer, information about voting securities and other financial information and projections. The acquiring company is typically required to submit biographical affidavits of its officers, directors and any individuals owning a certain percentage (typically 10 percent) of the acquiring entity either directly or indirectly, as well as any individuals proposed to become executive officers or directors of the domestic insurer. Some states also require that fingerprint cards and third-party background investigations of these directors, officers and stockholders be submitted.

State insurance departments review the Form A to determine that, after the change of control:

• the domestic insurer would be able to satisfy the requirements for the issuance of a certificate of authority;
• the merger or acquisition would not substantially lessen competition in insurance or tend to create a monopoly in the state;
• the proposed acquirer and the individuals who have submitted biographical affidavits have not demonstrated untrustworthiness; and
• the financial condition of the acquiring party will not jeopardize the financial stability of the acquired company.

In some states, a hearing before the insurance commissioner is required before an approval order is issued.

Legislators and regulators in the United States, including the NAIC, FIO, FSOC and certain members of Congress, have recently expressed increasing concern about the growth in the number and complexity of private equity-owned insurers. In December 2021, the NAIC issued a list of ‘Regulatory Considerations Applicable (But Not Exclusive) to Private Equity (PE) Owned Insurers’, which the NAIC and state regulators continue to review. The list recommends that regulators expand their review of potential change of control transactions to include:

• understanding control issues that may exist among entities with less than 10 percent ownership interest;
• identifying insurer affiliates in a private equity-controlled holding company structure;
• analyzing material provisions of investment management agreements to determine whether they are arm’s length and reasonable to the insurer;
• determining whether possible short-term interests of private equity ownership are properly aligned with the long-term nature of insurance liabilities, particularly with respect to life insurance;
• evaluating affiliate investment arrangements, including the use of offshore reinsurers and sidecar vehicles; and
• assessing operational, governance and market conduct practices of private equity entrants into the insurance market.

The list also notes that state insurance regulators may consider mandating that a private equity acquirer of a US insurance company agree to certain commitments as part of the regulatory approval process for such acquisition. In addition, in April 2022, the New York insurance regulator issued a circular letter, which indicates concerns regarding transactions where an acquiring party acquires, directly or indirectly, less than 10 percent ownership in a New York domestic insurer (thereby staying under the statutory presumption of control under the New York Insurance Law), but obtains rights that provide it with a ‘controlling’ influence over the insurer (via board seats, contractual relationships, et cetera) without having obtained the New York insurance regulator’s prior approval.

Financing of an acquisition

11. What are the requirements and restrictions regarding financing of the acquisition of an insurance or reinsurance company?

A party wishing to acquire or merge with a US insurer or reinsurer must disclose to state regulators the source and amount of the consideration to be used to fund the transaction, although such information may be kept confidential by the regulator. The Form A will not be approved if it is determined that the financial condition of the acquiring party is such that it could jeopardize the financial stability of the target company or the interests of policyholders. In most cases, the acquirer will not be permitted to use any assets of the target company to finance the acquisition, and there are limitations on the amount of debt that may be used. Depending on the state, pledging the stock or assets (or both) of a domestic insurance company in connection with the debt financing may also be prohibited or subject to restrictions or limitations.

Minority interest

12. What are the regulatory requirements and restrictions on investors acquiring a minority interest in an insurance or reinsurance company?

Because of the relatively low threshold at which a presumption of control is triggered under state insurance laws, even acquisitions of a minority interest may be considered to result in control under such laws.

Any person seeking to acquire control of an insurance or reinsurance company must receive approval from the insurance regulator of the insurer’s domiciliary state (and, if the insurance company is considered to be commercially domiciled in any state, also the insurance regulator of such state) prior to completing such acquisition. ‘Control’ under states’ insurance laws is typically defined as the possession, direct or indirect, of the power to direct or cause the direction of the management and policies of a person, whether through the ownership of voting securities, by contract (except a commercial contract for goods or non-management services) or otherwise. Control is presumed to exist upon the acquisition of ownership of 10 percent (5 percent in Alabama) or more of the voting securities of an insurer or a person controlling the insurer.

A person acquiring a minority, but more than 10 percent, direct or indirect interest in an insurer may be able, depending on the facts and circumstances, to submit a ‘disclaimer of control’ to the domiciliary insurance regulator (and the regulator of any state where the insurance company is commercially domiciled, if applicable) to rebut the presumption of control in lieu of submitting a Form A filing. If the disclaimer of control is approved, such person will not be considered a controlling person of the insurance company for insurance regulatory purposes following the completion of the acquisition. The disclaimer of control process is generally less burdensome than the Form A process, and typically requires disclosure of all material relationships between the parties as well as the basis for disclaiming control. Approval of a disclaimer of control is subject to the regulator’s discretion. In 2021, the NAIC adopted revisions to its statutory accounting rules to change the definition of ‘related parties’ for purposes of statutory accounting to include, among other things, parties that have disclaimed control of an insurer. These rules require certain additional disclosures concerning parties that have disclaimed control of an insurer to be included in that insurer’s statutory financial statements.

Foreign ownership

13. What are the regulatory requirements and restrictions concerning the investment in an insurance or reinsurance company by foreign citizens, companies or governments?

There are no per se restrictions under state insurance laws on investments in insurance or reinsurance companies by foreign citizens or companies, but government investments may be restricted in other ways, as discussed below. In reviewing an application seeking approval of a proposed acquisition of control of an insurer, the state insurance commissioner may deny the application if he or she determines that the competence, experience or integrity of those persons who would control the target company are such that it would not be in the interests of the policyholders of the target company or the public to permit the investment. Also, many states have ‘government ownership’ statutes, which generally provide that no certificate of authority or license to transact certain, or any, lines of insurance within a state will be issued or continued if the insurer is owned or controlled by any other state or foreign government or political subdivision thereof, subject to certain exceptions that may be available in a state. Outside of the insurance regulatory context, there are also non-insurance federal reporting requirements in connection with foreign investments in US business enterprises (e.g, the US Department of Commerce reporting requirements).

Also, acquisitions by a foreign acquirer may be subject to review and scrutiny by the Committee on Foreign Investment in the United States (CFIUS) if the acquisition could potentially threaten US national security, which includes, in the context of insurance acquisitions, concerns relating to a foreign acquiror’s access to personal confidential or identifying information of US persons. CFIUS is an inter-agency committee of the US government that reviews the national security implications of foreign investments in US companies or operations. CFIUS is chaired by the Secretary of the Treasury and includes representatives from 16 US departments and agencies.

Group supervision and capital requirements

14. What is the supervisory framework for groups of companies containing an insurer or reinsurer in a holding company system? What are the enterprise risk assessment and reporting requirements for an insurer or reinsurer and its holding company? What holding company or group capital requirements exist in addition to individual legal entity capital requirements for insurers and reinsurers?

Following the adoption by the NAIC of amendments to the model holding company act in 2010 and 2014, US states amended their insurance holding company laws to modify their group supervisory framework and provide regulators with new tools for evaluating enterprise risks within insurance groups. The amendments include several notable features, such as:

• expanding regulators’ ability to investigate a parent or any affiliate within an insurance holding company system that could pose a reputational or financial risk to an insurer;
• providing domiciliary regulators of internationally active insurance groups greater authority over the holding company system of such groups;
• requiring submission of a new annual Enterprise Risk Report (Form F) aimed at reducing potential risks faced by regulated insurance companies that may arise from issues at their non-regulated affiliates;
• enhancing regulators’ rights to access information (including books and records) regarding parents and affiliates to better ascertain the financial condition of an insurer; and
• codifying regulators’ ability to participate in supervisory colleges.

Also, all states have enacted the NAIC model regulation regarding an insurer’s own risk and solvency assessment (ORSA), which requires every US insurance and reinsurance company (or their holding company group) that exceeds certain annual written premium thresholds to complete a self-assessment of their risk management, stress tests and capital adequacy yearly, and the filing of a summary ORSA report.

In late 2020, the NAIC adopted a group capital calculation (GCC) framework for US insurance groups along with related holding company-level reporting requirements. As of January 2024, statutes setting forth these amendments had been adopted by nearly 30 US states. The GCC employs an aggregation methodology that utilizes existing state-based capital calculations (i.e, risk-based capital) for US-domiciled insurance companies. The GCC is intended to serve as an analytical tool for evaluating a firm’s capital position as the group level and is not intended as a prescribed group capital requirement.

At the US federal level, the Dodd–Frank Act established the FIO to monitor the insurance industry and identify gaps in regulation that could contribute to a systemic crisis and granted the Board of Governors of the Federal Reserve significant regulatory powers over systemically important insurers. Until the enactment of the Dodd–Frank Act, the Federal Reserve and other federal banking agencies generally had regulatory authority over insurance groups only to the extent an insurance group owned a bank or a savings and loan company, with the parent company thereby qualifying as a bank holding company (BHC) or savings and loan holding company (SLHC) (a small number of insurance groups currently qualify as SLHCs). In October 2023, the Federal Reserve adopted a regulatory capital framework for SLHCs and BHCs that are predominantly engaged in insurance activities. The proposed capital framework, termed the Building Block Approach or BBA, is designed to adjust and aggregate existing legal entity capital requirements into a group-level capital framework (based on US RBC) for insurance organizations supervised by the Federal Reserve. In September 2022, the Federal Reserve adopted rules to establish a framework for the supervision of such SLHCs/BHCs that, among other things, provides supervisory expectations with respect to governance, controls, and capital and liquidity management and proposes a unique supervisory rating system for such insurance groups.

The Financial Stability Oversight Council (FSOC) established pursuant to the Dodd–Frank Act and composed of federal financial regulators, state regulators, and an independent insurance expert appointed by the President, has the authority to designate an insurance group as a systemically important financial institution (SIFI) and subject it to enhanced prudential standards and supervision by the Federal Reserve. Currently, no insurance entity is designated as a SIFI, as all initial designations were subsequently overturned or rescinded. In December 2019, the FSOC amended its interpretive guidance on designating SIFIs (originally adopted in 2012), which prioritized an activities-based approach to identifying and addressing potential risks to financial stability, with entity-specific determinations (i.e, SIFI designations) pursued ‘only if a potential risk or threat cannot be addressed through an activities-based approach’. However, in November 2023, the FSOC adopted revised guidance that, among other things, eliminates the prioritization of an activities-based approach set forth in the 2019 guidance, and largely reverts to the 2012 guidance under which the FSOC had initially designated four non-bank SIFIs, including three insurance groups.

Reinsurance agreements

15. What are the regulatory requirements with respect to reinsurance agreements between insurance and reinsurance companies domiciled in your jurisdiction?

States protect policyholders against insurer insolvency by requiring minimum financial reserves to pay losses. At the same time, insurance companies seek to decrease or diversify their risk and lessen the number of reserves they must carry by reinsuring a portion of their liabilities.

Unlike primary insurance, states generally do not regulate the terms, rates or forms of reinsurance contracts. Rather, states regulate reinsurance by granting or withholding credit for reinsurance on the ceding company’s statutory financial statements. Insurance companies may only credit loss reserves by amounts transferred to reinsurers that meet certain conditions. Although states do not generally review and approve reinsurance agreements (unless the transaction is between affiliates, involves the transfer of a significant amount of business or is an ‘assumption reinsurance’ transaction in which the reinsurer becomes directly responsible for paying obligations under the underlying insurance policies in place of the cedent), in order to take credit for reinsurance ceded to another company, the agreement must contain certain minimum provisions (e.g, insolvency provisions protecting insureds).

Ceded reinsurance and retention of risk

16. What requirements and restrictions govern the amount of ceded reinsurance and retention of risk by insurers?

Certain states restrict insurers from ceding a material portion of liabilities to one reinsurer or reinsurers from assuming a material amount of insurance business under a reinsurance agreement without prior regulatory approval. In addition, certain states require the ceding company to retain some portion of direct insurance liabilities. Fronting arrangements, whereby a licensed carrier issues a policy and cedes 100 percent (or substantially all) of the liabilities to an unlicensed company, have historically triggered heightened regulatory scrutiny in certain US states, as regulators may view the transaction as a way for the reinsurer to circumvent state licensing and solvency requirements. Although fronting arrangements are not prohibited per se in most states, state regulators may take issue with a transaction where the ceding company retains no risk, particularly where the assuming company also services the underlying policies. Reinsuring a significant portion of an insurer’s in-force business or line of business may also be subject to prior regulatory approval under ‘bulk reinsurance’ statutes. States also impose separate concentration limits on how much business may be ceded to a single counterparty. Finally, statutory accounting rules require that reinsurance transactions pass certain ‘risk transfer’ tests in order to be eligible for reserve credit treatment, thereby prohibiting credit for reinsurance on the statutory financial statements for reinsurance arrangements where proper ‘risk transfer’ is not present (e.g, certain types of so-called ‘finite reinsurance’).

Collateral

17. What are the collateral requirements for reinsurers in a reinsurance transaction?

Only when ceding to licensed or accredited reinsurers, reinsurers domiciled in another US state or reciprocal jurisdiction reinsurers can the ceding company automatically (i.e, without a requirement that the reinsurer post collateral) take statutory financial statement credit for liabilities ceded. In addition, a certified reinsurer may post reduced collateral (with the reduction in such collateral dependent on its ratings) without jeopardizing the ceding company’s ability to take full statutory financial statement credit for liabilities ceded to that reinsurer.

Where a reinsurer is not licensed and does not have another status that permits it to post zero collateral without jeopardizing the cedent’s ability to take full credit for reinsurance, the reinsurer must provide some form of collateral to allow a deduction from the liabilities carried on the reinsured company’s statutory financial statements. Reinsurers may provide collateral directly to the ceding company – typically by establishing a trust or providing a letter of credit or via a funds withheld arrangement – in each case, subject to meeting certain regulatory requirements.

Credit for reinsurance

18. What are the regulatory requirements for cedents to obtain credit for reinsurance on their financial statements?

If the reinsurer is licensed or accredited, is domiciled in another US state, or has obtained reciprocal jurisdiction reinsurer in the state, the ceding company may take full credit for the reinsurance on its statutory financial statements. In addition, if the reinsurer has obtained certified reinsurer status in the state, it may post reduced collateral (with such reduction dependent on its ratings) without jeopardizing the cedent’s ability to take full credit on its financial statements for such reinsurance.

If the reinsurer does not hold any status described above, the reinsurer is required to post 100 percent collateral in order for the ceding company to obtain full credit for the reinsurance in its statutory financial statements. The most common means of providing collateral that satisfies the statutory credit for reinsurance requirements include a letter of credit meeting certain criteria; a trust funded with certain permitted assets in the aggregate amount of not less than 102 percent of the actual amount required to fund the reinsurer’s obligations under the reinsurance agreement; or funds withheld on the cedent’s balance sheet and composed of certain permitted assets.

Insolvent and financially troubled companies

19. What laws govern insolvent or financially troubled insurance and reinsurance companies?

The laws of the state in which an insurance company is domiciled are the primary source of law applicable to insolvent or financially troubled insurance companies. If the state insurance commissioner determines, through a review of a company’s financial information, that the company is unable to pay its outstanding lawful obligations, or the admitted assets of the company are less than the aggregate amount of its liabilities, the commissioner may order the company to eliminate the impairment or discontinue the issuance of any new policies, or both, while the impairment exists. Depending on the severity of the impairment, the insurance commissioner may also seek an order to rehabilitate or liquidate the financially impaired insurance or reinsurance company. Typically, the insurance commissioner in the insurance company’s domiciliary state serves as the receiver in any formal delinquency proceeding, subject to review by a supervising court. Also, an insurance commissioner may revoke or suspend the license of an insurance or reinsurance company deemed to be insolvent, regardless of whether it is domiciled in the state. States also have guarantee funds, capitalized through assessments on licensed insurers, to supplement payments to insureds in the event of the insolvency of an insurer.

Claim priority in insolvency

20. What is the priority of claims (insurance and otherwise) against an insurance or reinsurance company in an insolvency proceeding?

The priority of claims (insurance and otherwise) in an insolvency proceeding involving an insurance or reinsurance company is determined by the insurance laws in the insurance or reinsurance company’s domiciliary state. The classes of claims are typically listed in the domiciliary state’s insurance laws, with payment of administrative expenses of the estate paid first and payments to shareholders and other owners of the company paid last. Claims of policyholders for benefits under their insurance policies are invariably ahead of claims of general creditors (claims of counterparties under reinsurance contracts are considered general creditor claims and thus rank lower than policyholder claims). As claims are paid, the highest priority of claims is paid first, and every claim in each successive class must be paid in full before members of the next lower priority class receive any payment. If there are not sufficient assets to pay a particular class in full, the creditors of that class will share in any distribution on a pro rata basis based upon the assets available and the total amount of claims in that class.

Intermediaries

21. What are the licensing requirements for intermediaries representing insurance and reinsurance companies?

Insurance intermediaries such as insurance producers, agents and brokers are subject to licensing requirements in any state in which they are transacting business. Depending on the state, other intermediaries may also require special licensure to conduct business in the state, including managing general underwriters or agents, claims adjusters, third-party administrators and reinsurance intermediaries. To obtain a license, many states require individual agents to pass a minimum competency examination and be screened for past criminal conduct. Sanctions, including license suspensions and fines, are employed to punish unlawful conduct such as fraud.

INSURANCE CLAIMS AND COVERAGE

Third-party actions

22. Can a third party bring a direct action against an insurer for coverage?

As a general rule, such direct actions are not permitted in most states absent an unsatisfied judgment against the insured. A few states and US territories, however, generally allow a third party to bring a direct action against a liability insurer before a judgment has been entered against the insured tortfeasor. Louisiana (Louisiana Revised Statutes 22:1269) permits a direct action against liability insurers by injured persons (or their survivors or heirs) under several circumstances, including when:

• the insured is insolvent;
• a citation or other process cannot be made on the insured;
• the cause of action is for damages as a result of an offence between children and their parents or between married persons;
• the insurer is an uninsured motorist carrier; or
• the insured is deceased.

Many states, such as New York, allow a third-party claimant to bring a direct action against an insurer when a judgment against the insured is unsatisfied. New York Insurance Law 3420 New York by statute also allows direct actions in certain situations when an insurer denies coverage of a personal injury or wrongful death claim based on late notice, unless the insurer or the insured has commenced a declaratory judgment action within 60 days of the insurer’s denial of coverage and named the injured person or other claimant as a party to the action. Minnesota, by statute, permits direct actions by the state of Minnesota against an insurer for coverage of environmental response costs related to mixed municipal solid waste disposal facilities that are caused by the insured and covered by the insurer’s policy. Minnesota Statutes 115B.444.

Case law in the United States is split as to whether and when a settlement between the policyholder and insurer, according to which the insurer has been released from liability under the policy, can bar a subsequent direct action against the insurer by a third-party claimant. Compare Sales v US Underwriters Ins Co, 1995 WL 144783 (SDNY 3 Apr 1995) with Continental v Employers Ins Co, 60 AD3d 128 (1st Dept 2008).

A third party may also bring a direct action against an insurer if an insured assigns that right to the third party. Some policies require the insurer to consent to any assignment, although some states have public policies that provide that restrictions on assignment are unenforceable , or unenforceable once a loss has been incurred. See, for example, Oregon Revised Statutes 31.825 (allowing assignments of liability insurance); Jawad A Shah MDPC v State Farm Mut Auto Ins Co, 920 NW2d 148 (Mich App 2018).

Late notice of claim

23. Can an insurer deny coverage based on late notice of claim without demonstrating prejudice?

Whether an insurer can deny coverage based on late notice without a showing of prejudice depends on the language of the policy, the jurisdiction and the type of insurance policy involved. Some states, such as New York in certain instances, require that policies issued in the state contain provisions dealing with whether and to what extent prejudice is required to defeat coverage based on late notice.

Concerning occurrence-based policies, most states do not permit an insurer to deny coverage based on late notice unless the insurer has been prejudiced by the delay. Triyar Hosp Mgmt LLC v QBE Specialty Ins Co, 2023 WL 2372049 (CD Cal 17 Jan 2023) (applying California law). New York, which used to be known for its rule that late notice bars coverage regardless of prejudice, modified its common law rule as to certain types of liability policies issued or delivered in New York by amending section 3420 of the New York Insurance Law, effective from 17 January 2009, to prohibit an insurer from denying coverage under certain circumstances owing to late notice absent prejudice to the insurer. The statute also shifts the burden of showing prejudice depending upon the tardiness of the notice. Certain states, such as Georgia, do not require a showing of prejudice but permit a policyholder to rebut a late notice defense by showing that the failure to provide timely notice was justified under the circumstances. Foreshee v Employers Mut Cas Co, 711 SE2d 28 (Ga App 2011).

Courts are much more likely to deny coverage for late notice regardless of prejudice under a ‘claims made and reported’ policy, where notification of a claim within a certain time is an express part of the insuring agreement, rather than merely a contractual condition. See, for example, Pine Bluff School District v Ace American Insurance Company, 984 F3d 583 (8th Cir 2020) (applying Arkansas law).

Wrongful denial of claim

24. Is an insurer subject to extra-contractual exposure for wrongful denial of a claim?

Most jurisdictions allow an insured to recover some form of extra-contractual damages if an insurer acts in bad faith in certain circumstances, such as when it wrongfully fails to settle a case within policy limits and that failure results in a judgment against the insured in excess of policy limits, or when it is found to have wrongfully denied a defense or indemnity, and thereby breached its duty of good faith and fair dealing. Ellington v Cure Auto Insurance,2017 WL 3081717 (NJ App Div 20 July 2017) (failure to settle); Gray v Zurich Ins Co, 419P2d 168 (Cal 1966) (failure to defend). The standard of conduct as to what constitutes bad faith, however, varies by state, ranging from failure to act reasonably to gross disregard of an insured’s interests to willful misconduct. Pavia v State Farm Ins Co, 82 NY2d 445 (1993). In some states, various unlawful claims handling practices are identified by statute, but several of these statutes permit enforcement only by the state rather than by private action. For example, New York makes it an offence for insurers to engage in several listed prohibited practices. NY Insurance Law 2601.

Certain states, such as Florida, permit a cause of action for bad faith if the insurer does not take affirmative action to settle a case within policy limits, even absent a settlement demand from the underlying claimant, when liability is clear enough and damages serious enough that an excess judgment is probable. Fla Stat 624.155.

Depending on the jurisdiction, an insured may be able to recover punitive or consequential damages, or both, when the insurer has acted in bad faith. Some states, however, limit recovery of punitive damages to situations involving egregious conduct directed at the public at large. New York Univ v Continental Ins Co, 87 NY2d 308 (1995).

Defense of claim

25. What triggers a liability insurer’s duty to defend a claim?

Because the duty of an insurer to provide a defense is contractual, courts generally look to the wording of the insurance policy to determine whether and to what extent an insurer is obliged to defend a claim. Generally, the duty to defend is broader than the duty to indemnify.

Where the policy imposes a duty to defend certain claims, most courts determine the existence of a duty to defend a given claim based upon some form of the ‘four corners’ rule. Atlantic Mut Ins Co v Badger Medical Supply Co, 528 NW2d 486 (Wis 1995). Under this rule, an insurer’s defense obligation is determined by comparing the allegations of the claimant’s complaint to the policy provisions. If, accepting the complaint’s allegations as true, there is even a single claim that would require the insurer to indemnify the insured in the event of a judgment, an insurer is usually obliged to defend the entire action, although in some jurisdictions the insurer may be able to allocate the defense costs to particular claims if the costs incurred are severable. American and Foreign Ins Co v Jerry’s SportsCenter, Inc, 948 A2d 834 (Pa Super 2008). There may also be a duty to defend against certain claims that, if true, would fall within an exclusion when the insured denies the allegations. Wintermute v Kansas Bankers Sur Co, 630 F3d 1063 (8th Cir 2011).

In most jurisdictions, courts will also consider extrinsic evidence outside of the four corners of the complaint in determining whether the insurer has a duty to defend, at least in certain circumstances, such as where the extrinsic facts are relevant to the duty to defend but not the merits of the underlying action. In many of these cases, however, extrinsic evidence of actual facts has been used to impose the duty to defend rather than permit the insurer to defeat it. But see West Bend Mut Ins Co v US Fidelity and Guar Co, 598 F3d 918 (7th Cir 2010) (applying Indiana law, whose minority position holds that there is no duty to defend where extrinsic facts reveal a claim to be ‘patently outside’ a policy’s coverage).

Indemnity policies

26. For indemnity policies, what triggers the insurer’s payment obligations?

Under an indemnity policy, an insurer’s obligation to provide indemnification for defense costs and other loss is determined by a comparison of the scope of coverage afforded by the policy and the claim submitted for indemnity. If the claim falls within the coverage provided by the policy, the claim will be covered. A complaint may include both covered and uncovered claims, and only covered claims in a complaint are generally subject to indemnity. Estate of Bradley ex rel Sample v Royal Surplus Lines Ins Co, Inc, 647 F3d 524 (5th Cir 2011).

Where a policy places the duty to defend on the insured, and not the insurer, it will often require the insurer to advance legal fees as they are incurred, rather than holding them back until after the underlying dispute is resolved. If a claim is ultimately determined to be not covered, the insured will typically be required to pay advanced sums back to the insurer.

Incontestability

27. Is there a period beyond which a life insurer cannot contest coverage based on misrepresentation in the application?

For life insurance, state statutes generally require a one- or two-year contestability period beyond which a life insurer cannot contest coverage based on a misrepresentation in the application, although some jurisdictions permit contestation even after the general contestability period where the misstatement was made with intent to defraud. NY Insurance Law 3203. A contestability period allows an insurer a limited time in which to investigate statements made by the insured in its application to determine whether the statements were truthful. If the misrepresentation is discovered within the contestability period, the life insurer may deny coverage even if the fact misrepresented had nothing to do with the cause of the insured’s death. Precision Auto Accessories, Inc v Utica First Insurance Company, 52 AD3d 1198 (4th Dept 2008).

Punitive damages

28. Are punitive damages insurable?

Whether and to what extent punitive damages are insurable varies by jurisdiction. In some states, such as Arizona and Georgia, there is no public policy against insurance for punitive damages, and an insurance policy providing coverage for such damages will be enforced under its terms. Other states, however, have a public policy against insurability of punitive damages, at least when imposed to punish the wrongdoer, such as New York and California. Not all ‘punitive’ damages, however, are imposed as punishment, and when they are imposed under a state law that views the damages as compensatory, they may be viewed as insurable, even in a jurisdiction that generally bars coverage for punitive damages. Similarly, punitive damages imposed on account of vicarious liability for the acts of another may be viewed as insurable even by a state that generally bars punitive damages coverage, such as Florida.

Even where a policy contains an express choice-of-law provision (many policies do not), there are often significant choice of law questions when the public policy of the state in which a punitive damages judgment has been rendered differs from the public policy of the jurisdiction identified in the policy. In such a situation, the decision may depend on the forum in which the public policy issue is determined, as some courts hold that a strong public policy may override the parties’ choice of law. That said, the Supreme Court of the United States recently unanimously held that, in the context of marine insurance contracts, choice-of-law provisions are presumptively enforceable, with narrow exceptions. Great Lakes Ins SE v Raiders Retreat Realty Co, LLC, 144 S Ct 637 (2024). Some policies (especially certain directors’ and officers’ liability (D&O) policies) include a clause providing that insurability for punitive damages will be governed by the law of the jurisdiction that is the most favorable to the insured, so long as that jurisdiction has one of several specified relationships with the parties or the underlying claim against the insured. In some other policies, coverage disputes are resolved by arbitration, and the arbitrator is contractually directed to enforce coverage for punitive damages regardless of the law that might otherwise apply to the policy.

Excess insurer obligations

29. What is the obligation of an excess insurer to ‘drop down and defend’, and pay a claim, if the primary insurer is insolvent or its coverage is otherwise unavailable without full exhaustion of primary limits?

Whether an excess insurer is obliged to ‘drop down’ is generally a matter of contract. Courts usually look to the policy wording to determine whether and when an excess insurer is required to drop down. Certain insurance programs (particularly D&O liability insurance programs) include one or more excess policies that expressly provide for drop down coverage as a feature of the policy.

Absent an express drop down feature, there is a distinction between compelling an insurer to drop down so that it assumes the obligations of an underlying insurer when the limits of the underlying insurance have not been paid by anyone, and requiring the excess insurer to provide coverage when the insured, rather than the underlying insurer, has paid some or all of the amount of the underlying policy limit. In the latter situation – particularly if the excess policy merely requires exhaustion of the underlying insurer’s limits, without expressly requiring that such exhaustion is through full payment of limits by the underlying insurer – some courts refuse to excuse the excess insurer from its obligations. Sometimes this is because the courts, reluctant to provide the excess insurer with what the courts view as a windfall, construe the term ‘exhaustion’ to include cessation of the underlying insurer’s liability rather than full payment of its limits. Maremont Corporation v Ace Property & Casualty Insurance Company, 100 F Supp 3d 417 (D Del 2015). Such courts often enunciate a public policy rationale, noting that if the entire underlying limit has been paid by someone, the excess insurer has not been prejudiced. Similarly, where a failure of the underlying insurer to pay the full amount of its limits is because of a settlement between that insurer and the insured, some courts reason that to permit the excess insurer to avoid coverage because of the settlement would defeat the public policy in favor of settlement. GenCorp v AIU Ins Co, 297 F Supp 2d 995 (ND Ohio 2003). Many courts, however, will enforce the literal terms of an excess policy that require, as a condition of coverage, exhaustion of the underlying policy by full payment of limits by the underlying insurer. National Union Fire Ins Co of Pittsburgh, Penn v Travelers Ins Co, 214 F3d 1269 (11th Cir 2000).

Self-insurance default

30. What is an insurer’s obligation if the policy provides that the insured has a self-insured retention or deductible and is insolvent and unable to pay it?

Whether an insurer remains obliged to pay under a contract of insurance when the insured is incapable of satisfying a self-insured retention (SIR) owing to its insolvency varies by jurisdiction. There are two general schools of thought. The public policy approach provides that an insurer is responsible for the amount of covered loss in excess of the SIR notwithstanding that the SIR has not been paid. Phillips v Noetic Specialty Ins Co, 919F Supp 2d 1089 (SD Cal 2013). The strict contract interpretation approach construes the insurance contract strictly and finds that an insurer’s obligations under a policy with an SIR are not triggered until the insolvent insured has paid the SIR. Pak-Mor Mfg Co v Royal Surplus Lines Ins Co, 2005 WL 3487723 (WD Tex 3 November 2005). Neither of these schools of thought requires an insurer to drop down and pay the SIR for the insured in the event of the insured’s bankruptcy or insolvency.

Some states, like Illinois, that follow the public policy approach have enacted legislation requiring liability policies to include a provision that the insured’s bankruptcy will not relieve the insurer of its obligations under the policy. In those states, even if a policy expressly makes the payment of an SIR a condition precedent to coverage, the obligation of the insurer to pay covered amounts in excess of the SIR amount remains despite the insured’s inability to satisfy the SIR. States that follow the strict contract interpretation approach rely on the law of contracts and treat payment of the SIR as a strict condition of coverage even if the insured is insolvent.

If the insured’s policy contains a deductible amount that is included within the limits of a policy, rather than an SIR over which the policy limits apply, the inability of the insured to pay the deductible generally does not relieve the insurer from its obligation to pay covered claims and expenses. In general, the insurer would have the duty to pay without regard to the payment of the deductible by the insured and, in turn, would have to seek reimbursement for the amount of the deductible from the insured. In such cases, the insurer is generally considered a creditor of the insured concerning the amount of the deductible paid on the insured’s behalf.

Claim priority

31. What is the order of priority for payment when there are multiple claims under the same policy?

Certain types of policies contain provisions setting forth the priority of payments when there are multiple claims under the same policy or claims against multiple insureds. For example, D&O policies often include provisions indicating that the individual insured’s claims should be paid first before the insured organization is paid, or that in the event of an insolvency of the insured organization, pre-petition claims will be given priority over post-petition claims, or both. If not specified in the policy, jurisdictions look at different factors in determining priority of payment. Such factors include potential liability, excess exposure and ripeness for settlement.

Some courts have allowed an insurer, when faced with multiple claims against one insured, to exhaust its policy limits in settling one claim, even if that leaves another claim unsettled, where the settlement is reasonable. Pride Transp v Cont’l Cas Co, 511 Fed Appx 547 (5th Cir 2013). However, where there are multiple insureds under one policy, some jurisdictions have held insurers to be in violation of their duty of good faith if the settlement of one claim against one insured favors one insured over another. Many jurisdictions have not ruled on the specific issue of whether an insurer can enter into a settlement benefiting one insured to the detriment of others. In several instances, insurers facing uncertainty as to how a settlement on behalf of fewer than all insureds will be viewed have commenced interpleader actions, seeking a judicial determination of how the policy limits should be distributed. QBE Specialty Insurance Company v Uchiyama, 2023 WL 6796159 (D Haw 13 Oct 2023).

Allocation of payment

32. How are payments allocated among multiple policies triggered by the same claim?

Case law concerning allocation of coverage for a claim that triggers multiple policies in various years is complex and conflicting. Several different theories have evolved concerning policies that contain standardized terms that do not deal specifically with the allocation issue. Many of these theories were developed in connection with asbestos insurance coverage cases and then were subsequently used in pollution coverage cases, which many courts view as analogous.

While there are variations, the following theories are ones generally relied on by the courts:

• The ‘exposure’ theory: under which, the policies in effect at the time of the exposure to the hazardous substances are triggered. In personal injury product liability cases, the exposure period is the time during which the underlying claimant was exposed to the product. In pollution cases, the exposure period is the time during which hazardous substances were released or deposited at the site; Zurich Ins Co v Raymark Industries, Inc, 514 NE2d 150 (Ill 1987).
• The ‘manifestation’ theory: under which, the policies in effect at the time that the injury or damage becomes manifest provide coverage; Eagle-Picher Industries, Incv Liberty Mut Ins Co, 682 F2d 12 (1st Cir 1982).
• The ‘continuous trigger’ or ‘triple trigger’ theory: under which, the injury or damage is viewed as a continuous injurious process, so that all policies from initial exposure through manifestation are triggered; Westfield Insurance Company v Sisterville TankWorks, Inc, 895 SE2d 142 (West Virginia 2023).
• The ‘injury in fact’ theory: under which, a policy is triggered if injury, in fact, occurred during the policy period, even if the injury was, in and of itself, not compensable. Don’s Bldg Supply, Inc v OneBeacon Ins Co, 267 SW3d 20 (Tex 2008).

Where multiple years of coverage are involved, courts have split on:

• whether stacking of triggered policies is permitted; Great Lakes Dredge & Dock Co v City of Chicago, 260 F3d 789 (7th Cir 2001);
• whether a triggered policy is responsible up to policy limits for all sums owed to the underlying claimant or merely a pro rata share of the liability; Danaher Corporation v Travelers Indemnity Company, 414 F Supp 3d 436 (SDNY 2019);
• how and when excess coverage in a given year applies when fewer than all of the primary policies in triggered years have been exhausted; Ali v Federal Ins Co, 719F3d 83 (2d Cir 2013); and
• whether and to what extent an insured must bear responsibility for uninsured periods that would otherwise be triggered had appropriate coverage been obtained. Stonewall Ins Co v Asbestos Claims Management Corp,73 F3d 1178 (2d Cir 1995).

When multiple policies for the same policy period are triggered, most courts look to the language of the respective policies to determine whether one is meant to be primary to the other. When one policy is made excess to another by specific reference, courts generally follow that language. However, it is common for insurance policies to have general ‘other insurance’ provisions that state that any coverage provided is excess to all other valid and collectible insurance. When two policies have dueling other insurance provisions, courts will look to the language of the policies to determine whether the coverage should be split evenly between the two policies, proportionally to their respective limits of liability, or in some other fashion. Admiral Insurance Company v Anderson, 529 F. Supp. 3d 804 (ND Ill 2021).

Disgorgement or restitution

33. Are disgorgement or restitution claims insurable losses?

Courts disagree on whether and to what extent disgorgement or restitution claims are insurable. A decision of the United States Court of Appeals for the Seventh Circuit, which has been followed by several courts, held that a settlement of such claims was uninsurable as a matter of public policy, even though there had been no adjudication of wrongdoing. Level 3 Communications, Inc v Federal Ins Co, 272 F3d 908, 910–11 (7th Cir 2001). Other courts, however, have found that public policy does not bar coverage at least for defense and settlement of restitution or disgorgement claims and that any public policy concerns are satisfactorily addressed by the standard conduct exclusion in insurance policies. JP Morgan Securities Inc v Vigilant Insurance Company, 37 NY3d 552 (2021). Some courts have looked beyond the label of a payment as ‘restitution’ to find such payments insurable if they serve a compensatory goal from a substantive perspective. Due to the concern that uninsurability of disgorgement or restitution could deprive insureds of coverage for various US securities claims, thereby making D&O policies less marketable, many D&O policies now contain a provision whereby the insurer agrees not to contend that claims under sections 11 and 12 of the Securities Act of 1933 – and sometimes other securities laws provisions as well – are uninsurable.

Definition of occurrence

34. How do courts determine whether a single event resulting in multiple injuries or claims constitutes more than one occurrence under an insurance policy?

How the policy defines ‘occurrence’ can be determinative of whether a single event resulting in multiple injuries or claims will be considered one or multiple occurrences. In the absence of explicit policy language addressing the question, some courts have adopted a ‘cause’ test, while others have adopted an ‘unfortunate event’ test (and a minority of courts have applied other tests). Under the cause test, if there is a single cause of the injuries and claims, that cause will generally be viewed as constituting the occurrence. Cincinnati Ins Co v ACE INA Holdings, Inc, 886 NE2d 876 (Ohio App 2007). Under the unfortunate event test, however, which is applied in New York, each of the individual injuries or claims may be considered an unfortunate event that is itself a separate occurrence. Appalachian Insur Co v General Electric Co, 863 NE2d 994 (NY 2007).

Rescission based on misstatements

35. Under what circumstances can misstatements in the application be the basis for rescission?

For an insurer to rescind a policy based on misstatements in the application, courts generally require, at a minimum, that there be a material misstatement in the application upon which the insurer relied in issuing the policy. Jackson v Hartford Life and Annuity Ins Co, 201 F. Supp. 2d 506 (D Md 2002). In some states, an intent to defraud the insurer is also required.

Kiss Const NY, Inc v Rutgers Cas Ins Co, 61 AD3d 412 (1st Dept 2009). Ordinarily, a misrepresentation is considered material if the insurer would not, had it received accurate information, have provided the coverage at issue for the premium charged. It is ordinarily not required that the insurer show it would not have issued any policy at all.

Fidelity insurance applications, however, are often treated differently for rescission purposes than other types of coverage. This is because one of the purposes of fidelity insurance is to provide coverage for employee thefts or other losses caused by employee dishonesty that took place before the issuance of the policy but are discovered during the policy period. If the dishonest employee’s knowledge were imputed to the insured, the purpose of the coverage would be defeated. Thus, a failure to disclose in the application thefts known only to the dishonest employee or employees will generally not be considered a misrepresentation in the application. If, however, the dishonest employee is the person who actually signs the application, some courts will permit rescission, although other courts will not. National Credit Union Administration Board v CUMIS Insurance Society, Inc, 241 F. Supp. 3d 934 (D Minn 2017) (noting the different decisions and ultimately refusing rescission under Minnesota law).

REINSURANCE DISPUTES AND ARBITRATION

Reinsurance disputes

36. Are formal reinsurance disputes common, or do insurers and reinsurers tend to prefer business solutions for their disputes without formal proceedings?

While cedents and reinsurers usually attempt to resolve their disputes before commencing arbitration or litigation, the relationship between cedents and reinsurers has grown increasingly contentious since the 1980s, resulting in more formal proceedings.

Arbitration is generally the preferred mechanism to resolve such disputes, and many reinsurance contracts contain arbitration clauses. Arbitration provides the advantage of resolution by a panel of industry professionals, is often viewed as more cost-effective and efficient than litigation, and generally entails a level of confidentiality not always available through court proceedings. The Federal Arbitration Act (FAA) and case law interpreting it generally govern the procedural aspects of most reinsurance disputes arbitrated in the United States to the extent not otherwise provided by the contract.

Although some reinsurance contracts contain choice-of-law provisions that govern substantive issues, arbitration clauses often relieve the arbitrators from following strict rules of law and provide that their decisions should be made concerning the customs and practices of the reinsurance industry.

Notwithstanding the popularity of arbitration clauses for reinsurance disputes, many reinsurance disputes continue to be litigated, often in New York federal or state courts. When parties choose to resolve their dispute through litigation, courts tend to rely more heavily upon the language of the policy and less on industry custom and practice.

Common dispute issues

37. What are the most common issues that arise in reinsurance disputes?

Issues that commonly arise in reinsurance disputes include:

• liability of the reinsurer for defence costs in addition to the limit of liability stated in the reinsurance certificate;
• liability of the reinsurer for declaratory judgment action expenses incurred by the cedent in coverage litigation;
• whether and to what extent a reinsurer is bound by the methodology used by the cedent to allocate payments to particular years of coverage;
• whether arbitrators or courts should decide arbitrability, consolidation, joinder and collateral estoppel issues;
• the scope of a cedent’s duty of utmost good faith concerning disclosure of risks, handling of claims, timely notice, settlements and allocation issues;
• the right of a party to a reinsurance agreement to offset amounts owed under that agreement based on amounts allegedly owed under a different agreement with the same counterparty;
• whether reinsurance proceeds owed to an insolvent reinsured constitute a general asset of the reinsured’s insolvent estate or should be used for the benefit of the underlying claimant;
• whether and to what extent the McCarran-Ferguson Act, which generally leaves insurance regulation to the states, precludes pre-emption by the FAA of state insurance laws that relate to arbitration; and
• recently, as a result of the global pandemic, the extent to which reinsurers must indemnify cedents for payment of loss outside of the terms of the policy between the cedent and its policyholder, and the extent to which cedents may aggregate losses under excess of loss reinsurance treaties.

Arbitration awards

38. Do reinsurance arbitration awards typically include the reasoning for the decision?

The FAA does not impose an obligation on arbitrators to describe the reasoning for a decision, and arbitrators do not typically do so unless the reinsurance contract requires it or they agree, at the parties’ request, to do so. Reasons for this approach include confidentiality and finality. There is, however, an industry-wide debate as to whether arbitrators should issue reasoned awards more frequently.

Power of arbitrators

39. What powers do reinsurance arbitrators have over non-parties to the arbitration agreement?

Given that arbitration is a creature of contract, non-parties to an arbitration agreement generally cannot be joined as parties to an arbitration without their consent as well as the consent of the other parties to the arbitration. If the non-party is an alter ego of one of the contracting parties, however, it may be joined on the theory that it is the same entity as the one that signed the arbitration agreement.

Section 7 of the FAA provides arbitrators with the authority to compel non-parties to appear before them at a hearing to produce documents and provide testimony, but courts have split on whether and under what circumstances this provision authorizes pre-hearing discovery, as opposed to the production of documents or testimony at the arbitration hearing; whether ‘hearing’ can be defined to include non-substantive preliminary hearings held for discovery purposes; and whether a distinction should be drawn between the authority of an arbitrator to order production of documents, as opposed to testimony, from a non-party during the discovery phase of the arbitration. Compare In re Security Life Ins Co of Am, 228 F3d 865 (8th Cir 2000) (allowing pre-hearing third-party discovery) with Managed Care Advisory Group, LLC v CIGNA Healthcare, Inc, 939 F3d 1145 (11th Cir 2019) (agreeing with the majority view that such discovery is not allowed under the FAA).

While some courts have found that section 7 of the FAA empowers arbitrators to obtain discovery from non-parties anywhere in the United States, most have held that the jurisdictional reach of an arbitrator’s subpoena power under section 7 of the FAA is limited to 100 miles, just as the reach of a district court subpoena is limited to 100 miles from where the court sits. Legion Ins Co v John Hancock Mut Life Ins Co, 33 Fed Appx 26 (3d Cir 2002).

Appeal of arbitration awards

40. Can parties to reinsurance arbitrations seek to vacate, modify or confirm arbitration awards through the judicial system? What level of deference does the judiciary give to arbitral awards?

The primary authority for confirmation of an award is provided by section 9 of the FAA, which permits the contracting parties to agree that a court can issue a judgment confirming the award. The courts have also held that even if the contract does not expressly provide for confirmation by a court, section 9 of the FAA authorizes a court to confirm an arbitration award as long as the contract provides for ‘final and binding’ arbitration.

Section 11 of the FAA permits the court to modify an award, but only if:

• there is evidence of a material miscalculation of figures or a material mistake in a description of a person, thing or property referred to in the award;
• the arbitrators have awarded on a matter not submitted to them (unless the matter does not affect the merits); or
• there is an error in the form of the award not affecting the merits.

Under section 10(a) of the FAA, an award can be vacated only if:

• it was procured by corruption, fraud or undue means;
• there was evident partiality or corruption on the part of the arbitrators;
• the arbitrators were guilty of misconduct in refusing to postpone a hearing on sufficient cause shown, refusing to hear pertinent and material evidence, or engaging in other misbehaviour by which the rights of a party were prejudiced; or
• the arbitrators exceeded their powers or so imperfectly executed them that a mutual, final and definite award on the subject matter was not made.

Traditionally, an additional basis for vacating an award has been if the arbitrator’s award was in ‘manifest disregard of the law’. The continuing viability of that doctrine, however, was called into question by the US Supreme Court decision in Hall Street v Mattel, 552 United States 576 (2008). After Hall, some courts have declined to apply the doctrine or have cast serious doubt on its continuing validity, while some courts have continued to apply the doctrine, either as an independent basis for vacatur of an award or as a judicial gloss on the statutory ground concerning instances of the arbitrators exceeding their powers. Compare Telecom Business Solutions, LLC v Terra Towers Corp, 2024 WL 446016 (2d Cir 6 February 2024) (holding that the doctrine still exists as a gloss on the specific grounds set out in the FAA) with Dream Medical Group, LLC v Old South Trading Company, LLC, 2023 WL 2366982 (5th Cir 2023) (holding that the doctrine is not an independent ground). In Stolt-Nielsen SA v Animal Feeds International, 559 US 662 (2010), the US Supreme Court, in the course of vacating an award under section 10(a) of the FAA because the arbitrators exceeded their powers, again refused to rule on the viability of the manifest disregard of the law doctrine, but noted that that doctrine also would have required vacatur. The Supreme Court still has not yet resolved the circuit split.

REINSURANCE PRINCIPLES AND PRACTICES

Obligation to follow cedent

41. Does a reinsurer have an obligation to follow its cedent’s underwriting fortunes and claims payments or settlements in the absence of an express contractual provision? Where such an obligation exists, what is the scope of the obligation, and what defensesare available to a reinsurer?

Courts are split as to whether a reinsurer is bound to follow its cedent’s underwriting fortunes and claims payments or settlements absent an express contractual provision requiring it to do so. Requiring a reinsurer to follow its cedent is generally known as the ‘follow-the-fortunes’ doctrine. Some courts use this term interchangeably with the ‘follow-the-settlements’ doctrine.

Courts are also split as to whether the follow-the-fortunes doctrine applies even if the reinsurance contract does not contain a provision to that effect. Compare Public Risk Management of Florida v Munich Reinsurance America, Inc, 38 F4th 1298 (11th Cir 2022) (not applying the doctrine in the absence of an express provision) with International Surplus Lines Ins Co v Certain Underwriters and Underwriting Syndicates at Lloyd’s of London, 868 F Supp 917 (SD Ohio 1994) (applying the doctrine without a provision in the contract). Sometimes, resolution of the issue will turn on expert testimony regarding industry custom and practice. National American Ins Co of California v Certain Underwriters at Lloyd‘s of London, 93 F3d 529 (9th Cir 1996). In the absence of presentation and acceptance of such testimony, most courts are unlikely to imply a follow-the-fortunes obligation in a reinsurance contract that does not contain one or where the agreement’s terms are inconsistent with the doctrine.

When the follow-the-fortunes doctrine applies, either through an express provision or otherwise, it imposes on a reinsurer an obligation to indemnify a cedent for a claim payment reasonably or arguably within the terms of the cedent’s policy with its insured, even if not technically covered by that policy, provided that the payment is not fraudulent, collusive, in bad faith, or outside the terms, conditions and limits of the reinsurance contract at issue.

The New York Court of Appeals, in Glob Rein Cor of A v Century Indem Co, 30 NY3d 508, 519-20 (2017), recently held that ‘New York law does not impose either a rule, or a presumption, that a limitation on liability clause [in a reinsurance agreement] necessarily caps all obligations owed by a reinsurer, such as defense costs, without regard for the specific language employed therein.’ Rather, whether or not the reinsurer must reimburse such additional costs is a question of ordinary contract interpretation that must be decided in light of the terms of the reinsurance agreement read as an integrated whole. In light of this decision, the Second Circuit recently overturned two thirty-year-old decisions holding that the liability limitation in a reinsurance certificate necessarily caps all obligations owed by the reinsurer, including defence costs, without regard to the specific language employed therein. Global Reinsurance Corporation of America v Century Indemnity Company, 22 F4th 83 (2d Cir 2021), overruling Bellefonte Reinsurance Co v Aetna Casualty & Surety Co, 903 F2d 910 (2d Cir 1990) and Unigard Security Insurance Co v North River Insurance Co, 4 F 3d 1049 (2d Cir 1993).

Good faith

42. Is a duty of utmost good faith implied in reinsurance agreements? If so, please describe that duty in comparison to the duty of good faith applicable to other commercial agreements.

The relationship between the insurer and the reinsurer has been characterized as one of utmost good faith (sometimes referred to as uberrima fides). Matter of Liquidation of Union Indem Ins Co of New York, 89 NY 2d 94 (1996). Traditionally, the duty of utmost good faith has run from the cedent to the reinsurer. As a corollary, some courts hold that there is no cause of action for bad faith by a cedent against its reinsurer. Some jurisdictions, however, now treat the duty as reciprocal. Claims of breach of the duty of utmost good faith can be made concerning any element of the relationship between the cedent and the reinsurer, including the cedent’s disclosure of the risks, handling of underlying claims, allocation decisions and the timing of notices to reinsurers.

Courts are divided on the standard to be applied to this duty, with some defining it as a fiduciary duty, some as a quasi-fiduciary duty and some as no more than the duty of good faith implied in all commercial agreements. Concerning the duty of disclosure of relevant facts to a treaty reinsurer before the inception of the contract, courts have generally recognized an elevated duty of good faith beyond that applicable to most commercial agreements because the reinsurer is not able to select which risks it will accept, but instead automatically assumes the risks underwritten by the reinsured that are covered by the treaty. Compagnie de Reassurance d’Ile de France v New England Reinsurance Corp, 57 F3d 56 (1st Cir 1995).

Facultative reinsurance and treaty reinsurance

43. Is there a different set of laws for facultative reinsurance and treaty reinsurance?

Treaty reinsurance agreements are contracts between the cedent and reinsurer whereby the reinsurer agrees to accept the reinsurance risk as to an entire class or classes of the cedent’s insurance policies. Facultative reinsurance, on the other hand, is reinsurance of part or all of a specific insurance policy.

Generally, the same body of law applies to facultative and treaty reinsurance, although the duty of utmost good faith tends to be more stringently applied against a cedent in the treaty context because the reinsurer has less ability to make its own examination of the risks in the treaty context than in the facultative reinsurance context. Additionally, several courts have found that where a facultative reinsurance contract contains a follow-the-form provision, a presumption of concurrency exists between the terms of that reinsurance contract and the reinsured policy, subject only to any clear limitation to the contrary in the facultative certificates themselves. In such a situation, the facultative reinsurer may be bound by the terms of the underlying policy to the extent the language of the facultative certificate is not different.

Third-party action

44. Can a policyholder or non-signatory to a reinsurance agreement bring a direct action against a reinsurer for coverage?

Because of the lack of privity of contract, policyholders and other nonparties to a reinsurance contract generally cannot assert a direct action against a reinsurer absent an express provision in the reinsurance contract allowing them to do so. Jurupa Valley Spectrum, LLC v National Indem Co, 555 F3d 87 (2d Cir 2009). Such a provision is customarily referred to as a ‘cut-through’ clause. Some courts, however, have carved out a very limited fact-based exception to this rule to permit a policyholder or other non-signatory

to have direct access to reinsurance coverage if it can prove that a business relationship exists between it and the reinsurer such that it should be accorded the status of a third-party beneficiary of the reinsurance contract. Trans-Resources, Inc v Nausch Hogan & Murray, 298 AD2d 27 (1st Dept 2002). Moreover, some courts have also held that when a reinsurer agrees to assume the policies of the reinsured and exercises actual control of claims, the reinsurer may become directly liable to the insureds for whatever the reinsured is liable to pay. Cleveland v Commonwealth Nat Ins Co, 269 F Supp 2d 752 (SD Miss 2003).

Insolvent insurer

45. What is the obligation of a reinsurer to pay a policyholder’s claim where the insurer is insolvent and cannot pay?

Most states have statutes prohibiting ceding insurers from receiving statutory financial statement credit for liabilities ceded unless their reinsurance contracts contain ‘insolvency clauses’. These clauses require a reinsurer to pay the liquidator of an insolvent ceding insurer amounts on reinsurance claims regardless of whether the insolvent insurer has actually paid its insured for the underlying insurance claims. Since ceding insurers almost always wish to obtain that credit, insolvency clauses are generally included in reinsurance agreements so that, as a practical matter, reinsurers must pay otherwise valid claims under their contracts even when the cedent is insolvent and has not fulfilled its own payment obligations. The statutes requiring an insolvency clause to receive credit for reinsurance were enacted largely as a reaction to the US Supreme Court decision in Fidelity & Deposit Co v Pink, 302 US 224 (1937), which found that a reinsurer was not required to reimburse the liquidator of an insolvent ceding company for losses not actually paid by that insurer. This holding remains valid if there is no insolvency clause in the reinsurance agreement, the language of the reinsurance agreement requires actual payment by the cedent to trigger the reinsurer’s liability and state law does not forbid the result. Theriot v Colorado Ass’n of Soil Conservation Districts Medical Benefit Plan, 38 F Supp 2d 870 (D Colo 1999).

Notice and information

46. What type of notice and information must a cedent typically provide its reinsurer with respect to an underlying claim? If the cedent fails to provide timely or sufficient notice, what remedies are available to a reinsurer and how does the language of a reinsurance contract affect the availability of such remedies?

Many reinsurance contracts contain provisions that specify the type of notice and information that the cedent must provide to its reinsurer, as well as when such notice must be provided. A cedent is generally expected to provide a reinsurer with sufficient information to reserve properly, adjust premiums to reflect loss experience under the reinsurance contract and decide whether to exercise the option of associating with the reinsured in handling an underlying claim, to the extent the contract allows the reinsurer to do so.

Under US case law, the timeliness of a cedent’s notice to its reinsurer is judged under an objective standard and generally must be reasonable in light of the facts of the specific claim. The majority view is that late notice defeats reinsurance coverage only if the reinsurer has been prejudiced by the delay, the cedent was grossly negligent or the cedent acted in bad faith. Utica Mutual Insurance Company v Fireman’s Fund Insurance Company, 238 F Supp 3d 314 (NDNY 2017).

Allocation of underlying claim payments or settlements

47. Where an underlying loss or claim provides for payment under multiple underlying reinsured policies, how does the reinsured allocate its claims or settlement payments among those policies? Do the reinsured’s allocations to the underlying policies have to be mirrored in its allocations to the applicable reinsurance agreements?

There are a variety of different methodologies that may be employed when allocating loss payments to the policies triggered by an underlying lawsuit, depending on the facts surrounding a particular claim and the language of the policies involved. Courts have generally required deference by the reinsurer to the cedent’s allocation-related decisions. United States Fid & Guar Co v American Re-Ins Co, 20 NY3d 407 (2013). Thus, a reinsurer is ordinarily precluded from avoiding payment so long as the cedent’s allocation decisions were reasonable and in good faith, and the allocation is within the terms and conditions of the underlying policy or policies and reinsurance contract or contracts. New York’s highest court has ruled that the cedent’s allocation must be one that it would have, or reasonably could have, adopted if it had no reinsurance coverage. However, a reinsurer cannot be held accountable for an allocation that is contrary to express language in the reinsurance policy.

Review

48. What type of review does the governing law afford reinsurers with respect to a cedent’s claims handling, and settlement and allocation decisions?

The follow-the-fortunes and follow-the-settlements doctrines generally prevent a reinsurer from second-guessing the claims, settlement and allocation-related decisions of its cedent, so long as the liability is reasonably within the scope of the reinsurance, and the reinsured’s decisions were reasonable, made in good faith and would have, or reasonably could have, been adopted by the reinsured even if it had no reinsurance coverage. Utica Mutual Insurance Company v Fireman’s Fund Insurance Company, 957 F3d 337 (2d Cir 2020).

Reimbursement of commutation payments

49. What type of obligation does a reinsurer have to reimburse a cedent for commutation payments made to the cedent’s policyholders? Must a reinsurer indemnify its cedent for ‘incurred but not reported’ claims?

US case law does not specifically address a reinsurer’s obligation to follow a cedent’s commutation-related payment. However, as a commutation is a form of settlement, a reinsurer’s obligation to reimburse a cedent for a commutation payment is likely to be subject to the same standard as other settlements under the follow-the-fortunes and follow-the-settlements doctrines, so long as there have been sufficient claims under the policy to justify the commutation payment amount. For example, if there are claims valued at US$3 million and the cedent’s policy with its insured is only for US$1 million, the follow-the-fortunes and follow-the-settlements standards are likely to apply even if coverage of the claims under the cedent’s policy has been hotly contested.

Whether the follow-the-fortunes and follow-the-settlements doctrines extend to incurred but not reported (IBNR) claims, as opposed to actual claims payments, has also not specifically been addressed by US courts. The New Jersey Supreme Court, however, has held, in the context of a cedent’s insolvency, that IBNR claims could not share in the distribution of the assets of the estate because they were not ‘absolute’ as at the liquidator’s claim bar date. In re Liquidation of Integrity Ins Co, 193 NJ 86 (2007). In so holding, the Court noted that its decision was important to reinsurers, who otherwise faced the prospect of having to pay an enormous amount of money for claims that had not yet been brought. Depending upon the language of the reinsurance agreement, a court could similarly refuse to bind the reinsurer to coverage of a reinsured’s commutation of a policy with the original insured to the extent such commutation was based upon the mere possibility of claims being brought in the future.

Extracontractual obligations (ECOs)

50. What is the obligation of a reinsurer to reimburse a cedent for ECOs?

Generally, a reinsurer is required to indemnify a cedent only to the extent that the cedent’s payments or losses are reasonably or arguably within the scope of the cedent’s underlying insurance policy. A reinsurer will not be held liable for losses arising from the cedent’s bad faith unless the reinsurance contract is interpreted as covering that exposure. Moreover, some states, as a matter of public policy, preclude coverage for punitive damages, regardless of the language of the contract.

Where, however, the reinsurer has actively participated in the alleged bad faith conduct through its association in the defense or settlement of the claim, some courts have found that the reinsurer has taken the role of a co-insurer and is, therefore, also liable for losses caused by the bad faith conduct regardless of its policy limits. Midtown Hotel Grp LLC v Selective Ins Co of Am, 2023 US Dist LEXIS 90244 (D Ariz 23 May 2023).

UPDATES & TRENDS IN INSURANCE AND REINSURANCE IN USA

Key developments

51. Are there any emerging trends or hot topics in insurance and reinsurance regulation in your jurisdiction?

In light of recent political and social developments, the National Association of Insurance Commissioners (NAIC) and certain state insurance regulators have begun initiatives, or issued guidance, on race and insurance, diversity within the insurance industry, potential unfair discrimination or bias resulting from the use of artificial intelligence and big data by the insurance industry, and climate change. The NAIC has formed a Special Committee on Race and Insurance, which has held sessions to discuss the historical context of racial discrimination in the insurance sector and current practices within the insurance industry that can potentially disadvantage minority communities, and plans to increase inclusion and diversity within the insurance industry. In addition, in March 2021, the New York insurance regulator issued guidance to New York-licensed insurers with respect to the promotion of diversity, equity and inclusion in the insurance industry. As described below, the NAIC and certain state regulators have also issued or proposed guidance concerning a potentially unfairly discriminatory impact that may result from the use of AI, big data and predictive models by insurance companies and other licensees.

The NAIC is also currently undertaking a multi-faceted effort to address a variety of considerations related to the increasing trend of private equity firms acquiring US insurance companies and the increasingly complex asset classes in which US insurance companies invest. Among other things, this initiative is also intended to address the increasing use of offshore reinsurance arrangements by US insurance companies, regulatory considerations relating to pension risk transfer transactions, and investment management arrangements between US insurance companies and their affiliates or related parties.

The NAIC has also formed a Climate Risk and Resiliency Task Force, which will consider appropriate climate risk disclosures and evaluate regulatory approaches to climate risk. The NAIC had created a Climate Risk Disclosure Survey in 2010, designed to be an annual, publicly available insurer reporting mechanism to provide state insurance regulators a window into how insurers across all lines of insurance assess and manage climate-related risks.

The NAIC has recently taken steps to align its survey with the Financial Stability Board’s Task Force on Climate Related Financial Disclosures (TCFD) Survey, an annual questionnaire that provides a framework for public companies and other organizations to disclose climate-related risks and opportunities, which has become a global standard for the disclosure of climate-related risks.

More than 15 US states now require insurers to submit either the TCFD Survey or the NAIC Survey. In November 2021, the New York insurance regulator issued guidance addressing how New York domestic insurers should analyze and manage the financial risks of climate change, including with respect to board governance, risk appetite, the impact of climate risks on existing risk factors, reflection of climate risks in the own risk and solvency assessment, scenario analysis, and public disclosure. Similar guidance for Connecticut domestic insurers was issued by the Connecticut insurance regulator in September 2022. In addition, in March 2024, the US Securities Exchange Commission (SEC) adopted climate-related disclosure requirements that will require US public companies and certain foreign private issuers, including insurers, to dramatically expand the breadth, specificity and rigor of climate-related disclosures in their SEC periodic reports and registration statements. Finally, in March 2024, the NAIC announced that state insurance regulators intend to issue and coordinate a comprehensive, multi-state data call to collect zip code-level data from homeowner’s insurers for assessing climate-related exposures, and to provide the results to FIO for analysis.

The NAIC and state insurance regulators are also in the process of developing best practices, revisions to regulations, and other initiatives relating to innovation and technology in the insurance sector, including with respect to AI, big data, blockchain technology, data privacy and data security. Technology-enabled innovators in the insurance industry, or InsurTech, continue to gain momentum and market share in the US insurance market.

The NAIC has formed an Innovation and Technology Task Force to track key InsurTech developments and consider how state insurance laws and regulations may need to be revised, and in some cases relaxed, in order to accommodate InsurTech innovations, while at the same time ensuring policyholders and consumers are protected. Certain state insurance regulators are experimenting with a ‘regulatory sandbox’ approach, whereby the regulator encourages experimentation through some degree of flexibility by means of safe harbors or other variances, while continuing to focus on maintaining consumer protection and risk mitigation.

Certain US states and the NAIC have also issued, or are developing, guidance relating to the use of artificial intelligence (AI) and big data in the business of insurance. This guidance addresses a variety of concerns, including that the use of AI and big data by insurance industry participants may result in unfair discrimination or bias or in questionable underwriting decisions, and a potential lack of transparency into decisions made by insurance industry participants through the use of AI and big data.

In addition, certain states have adopted, or are developing, regulations or guidance to establish, among other things, internal governance and risk management framework requirements for insurers that use AI algorithms and predictive models or external consumer data and information sources in their operations.

Finally, the NAIC is also reviewing gaps in existing laws and regulations relating to privacy. In July 2023, the NAIC released an updated draft of a model law that, among other things, is intended to establish standards for the collection, processing, retaining and sharing of consumers’ personal information by insurance licensees. California enacted the California Consumer Privacy Act in 2018, which imposes several requirements on businesses that collect the personal information of California consumers, including requirements to provide individuals with certain rights to their personal information and make mandatory disclosures regarding how businesses use and disclose consumers’ personal information. Other states have also passed or proposed comprehensive privacy laws, and other states may take similar actions in the future.

* The information in this chapter was accurate as of April 2024.

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