The U.S. Department of Treasury Bureau of the Fiscal Service has taken an important first step to modernize the regulations pertaining to its assessment and evaluation of sureties writing bonds to the U.S. Federal government.  In a Federal Register Notice dated December 30, 2019, the Fiscal Service announced that it was considering “modernizing and improving the program” and sought input from sureties and other stakeholders to support the effort.  One focus of the revisions appears to be a harmonization with analytical approaches used by State insurance regulators in assessing reinsurance and providing credit for reinsurance.  At present, State regulation recognizes the reality that reinsurance is a global enterprise, while the Fiscal Service regulations do not.  In its Federal Register Notice, the Fiscal Service stated, “A number of changes in the regulation of the insurance industry that have an indirect effect on the program … have taken place in the years since the Fiscal Service last significantly updated the program’s regulatory requirements and its financial analysis methodology.” 

A harmonized approach with State regulation will affect the Fiscal Service’s computation of a surety’s surplus and capital.  Briefly, an insurer may take credit for reinsurance on its financial statement if the reinsurance is acceptable.  Otherwise, the insurer is required to post collateral to take statutory credit.  Under Fiscal Service regulations, Treasury does not recognize reinsurance ceded to reinsurers that are not admitted in a State or are certified by Treasury.  The Fiscal Service lags behind the States in its analytical approach when it comes to reinsurance.  Under the NAIC Credit for Reinsurance Model Law, the insurer receives credit for reinsurance from a reinsurer that is not licensed in the state, but is domiciled in a “Qualified Jurisdiction” (i.e an alien insurer).  In addition, the Department of Treasury’s Federal Insurance Office and U.S. Trade Representative negotiated covered agreements with the European Union and United Kingdom that allow for credit for reinsurance by a U.S. insurer for reinsurers in EU member states and the U.K.  The NAIC has incorporated the provisions of the covered agreement into its model laws.

A modernized approach in determining whether a reinsurer is acceptable also could affect the mechanisms a surety uses to exceed its Treasury Limit.  As background, under 31 CFR 223.10, a surety may not underwrite a bond that is greater than 10% of the paid-up capital and surplus, “as determined by the Secretary of Treasury”.  This amount is known as the Treasury Limit.  A surety may exceed its Treasury Limit if it employs certain risk mitigation mechanisms.  31 CFR 223.11 sets forth ways in which the underwriting limitation may be exceeded. 

1. Reinsurance – For bonds on which the United States is the obligee, the excess of the underwriting limitation may be reinsured by a company holding a certificate of authority from Treasury.  The reinsurance may not be in excess of the underwriting limitation of the reinsuring company.  (Thus, the aggregate underwriting limitation is the combination of the limitations of the primary company and the underwriting company.)  The primary company must furnish to the Federal agency accepting the bond a reinsurance agreement from the reinsurance company on the appropriate form
   
   For bonds or policies not running to the United States, the excess liability must be covered by: (i) a company holding a certificate of authority from Treasury; (ii) an admitted reinsurer (see below); or (iii) a pool composed of companies in (i) or (ii).
   
   
2. Co-surety - -The regulations permit two or more sureties to write a bond that does not exceed the aggregate of their underwriting limitations.

An analytical approach harmonized with the States may avail the surety to use many otherwise qualified and well-capitalized reinsurers that are not located in the United States to exceed its Treasury Limit. 

The Federal Register Notice asks seven questions:

1. Should the Fiscal Service consider changing the approach or methodology it uses to value assets and liabilities of a company applying to be certified as an insurer?
2. What different methodologies should the Fiscal Service consider using when evaluating companies that are part of an insurance group’s pooling arrangement?
3. Should the Fiscal Service consider changing the methodology it uses to determine the credit allowed for reinsurance?
4. Should the Fiscal Service consider changing any aspects of the methodology it uses to determine recognition of a company as an admitted reinsurer?
5. Should the Fiscal Service consider changing the permissible methods for limiting risk in excess of its Treasury Limit?
6. Should the Fiscal Service consider changing the schedule and documentation required for issuing and renewing certificates of authority?
7. What other revisions should be made?

This first step in revising the Fiscal Service regulations marks a recognition that the risk mitigation approaches used by insurers has changed significantly since the regulation were last revised, including use of global providers of reinsurance.  Stay tuned for further developments.