The US Department of the Treasury (Treasury) has finalized a long overdue update to federal rules governing the Federal surety bond program (Program). The Final Rule (Rule) adds two new classes of reinsurers, including Reciprocal Jurisdiction Reinsurers, that will be recognized for purposes of providing credit for reinsurance to Treasury-authorized companies and protecting risks in excess of the Program’s 10% underwriting limit. The Rule also permits Treasury to accept letters of credit for purposes of protecting risks in excess of the 10% underwriting limit and codifies other existing Treasury practices. The Rule will become effective on August 9, 2024.
I. Background
Insurers with authority to write Federal surety bond obligations (Certified or T-Listed Companies) are required to comply with Program requirements administered by Treasury’s Bureau of Fiscal Service (BFS). These requirements are codified in federal law (31 U.S.C. 9304-9308) and federal regulations (31 CFR part 223). BFS also publishes interpretive guidance in the form of annual letters (Annual Letters) to T-Listed Companies and Admitted Reinsurers (defined below). One of the most notable requirements for Certified Companies is known as the “10% Underwriting Limit,” which provides that no Certified Company may underwrite any risk on any bond or policy (including federal surety bonds and all other business) that is greater than 10% of the insurer’s paid-up capital and surplus, as calculated under Treasury rules. Risks in excess of the 10% Underwriting Limit are commonly referred to as “Excess Risks.”
The 10% Underwriting Limit is similar to state “single risk” limits, but it differs in the reinsurance that an insurer can use to satisfy the cap. Under state insurance laws, insurers are allowed credit for any reinsurance arrangement that is recognized under state law (e.g., reinsurance that is assumed by a reinsurer that is licensed, accredited or approved as a Certified or Reciprocal Jurisdiction Reinsurer in the cedent’s state of domicile, or that maintains collateral for the benefit of the cedent in the form and amount specified by state law). In contrast, for purposes of Treasury’s 10% Underwriting Limit, T-Listed Companies are currently only allowed credit for reinsurance as follows:
- With respect to Excess Risks running to the US government (i.e., Federal bonds), reinsurance ceded to another T-Listed Company;
- With respect to Excess Risks not running to the US government, reinsurance ceded to insurers approved by Treasury to provide reinsurance within the Program, including (a) other T-Listed Companies, and (b) reinsurers recognized by Treasury to provide reinsurance to T-Listed Companies (Admitted Reinsurers and together with T-Listed Companies, Treasury Authorized Reinsurers); and
- With respect all other Excess Risks except bonds required to be furnished to the US government by the Miller Act (40 U.S.C. 3131, as amended), by posting Treasury-approved collateral for the benefit of the cedent.
Treasury rules governing a T-Listed Company’s financial condition are more restrictive than states’ rules in other respects. First, in addition to (and distinct from) the 10% Underwriting Limit described above, Treasury credit for reinsurance rules only permit Certified Companies and Admitted Reinsurers to take credit for reinsurance (1) ceded to other Treasury Authorized Reinsurers, or (2) supported by Treasury-approved collateral. This can result in a “Schedule F penalty” for unauthorized reinsurance ceded by Treasury Authorized Reinsurers that is greater than the Schedule F penalty reflected in the insurer’s statutory financial statements. Second, Treasury’s rules governing admitted asset treatment for T-Listed Companies can be more restrictive than applicable state law.
Historically, only certain US-domiciled reinsurers and alien reinsurers with a US branch were eligible for recognition by Treasury as a Treasury Authorized Reinsurer. This limited the pool of Treasury Authorized Reinsurers and could require Certified Companies’ assuming reinsurers to post significant collateral to satisfy the Excess Risk requirements or otherwise provide credit for reinsurance.
II. New Categories of Treasury Authorized Reinsurers
The Rule adds two new categories of reinsurers that are eligible for Treasury Authorized Reinsurer status for purposes of reinsuring Excess Risks (except Excess Risks on federal bonds) and obtaining credit for reinsurance more generally. The first category, “Complementary Reinsurers,” includes reinsurers that are: (1) domiciled and licensed to write reinsurance in a non-US jurisdiction that is subject to an in-force Covered Agreement (currently the European Union and United Kingdom); and (2) recognized by at least one state as a Reciprocal Jurisdiction Reinsurer. Certified Companies ceding risk to companies recognized as Complementary Reinsurers receive financial statement credit for the reinsurance without the reinsure posting any collateral. For more information on Reciprocal Jurisdiction Reinsurers, see our client alert.
The second category, “Alien Reinsurers,” includes reinsurers that are: (1) domiciled and licensed to write reinsurance in a jurisdiction that is recognized by any state as a Qualified Jurisdiction (currently, Bermuda, France, Germany, Ireland, Japan, Switzerland, and the United Kingdom) or a non-Covered Agreement Reciprocal Jurisdiction (currently, Bermuda, Switzerland and Japan); and (2) recognized by at least one state as an “Accredited Reinsurer,” “Certified Reinsurer,” or “Reciprocal Jurisdiction Reinsurer” (as each such term is defined by the applicable state’s credit for reinsurance rules based on the NAIC Credit for Reinsurance Model Law (#785) and Model Regulation (#786)). Certified Companies ceding risk to companies recognized as Alien Reinsurers are eligible to receive credit for the reinsurance to the extent allowed by the cedent’s state of domicile (which generally results in reduced or zero collateral). Treasury also retains the authority to require an Alien Reinsurer to post additional collateral if it determines that either the cedent or the Alien Reinsurer may be unable to carry out its obligations.
Both Complementary Reinsurers and Alien Reinsurers must be approved by BFS, must renew their status with BFS annually, and must comply with all capital and surplus, solvency and market conduct requirements under the applicable state law for continued eligibility as an Accredited, Certified or Reciprocal Jurisdiction Reinsurer (as applicable). A company is not eligible for recognition as a Complementary Reinsurer or Alien Reinsurer if it only insures or reinsures risks of its parent, affiliated, or controlled unaffiliated business, or is deemed by Treasury to be primarily engaged in self-insurance.
III. Other Changes
The Rule provides that Treasury may, on a case-by-case basis, consider a letter of credit to be adequate collateral to protect Excess Risks if Treasury can verify that the assets referenced in the letter are pledged exclusively to secure the Excess Risk, and if the letter of credit meets other requirements Treasury might prescribe. The Rule also codifies various BFS requirements reflected in the Annual Letters and other BFS reporting instructions, including:
- Rules governing admitted asset treatment for Treasury purposes are generally limited to investments in cash, cash equivalents, investment grade, readily marketable securities, mortgage loans (with certain limits), and real property necessary for the conduct of a company’s business.
- For purposes of the 10% Underwriting Limit, a “single risk” is defined as the total risk under one bond or policy regardless of the number of individual risks under that bond or policy.
- A Certified Company may not cede to a Treasury Authorized Reinsurer any Excess Risk that exceeds 10% of the reinsurer’s paid-up capital and surplus.
- Collateral used to protect Excess Risks cannot also be used to obtain credit for reinsurance for Treasury Schedule F purposes.
- Certified Companies and Admitted Reinsurers must notify Treasury of certain changes that could have a significant impact on their financial statements or solvency, such as changes in capital levels, changes in the owners of 5% or more of any class of the company’s stock, mergers and other material restructuring and amendments to governing documents.
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