The office of General Counsel issued the following informal opinion on October 26, 2000, representing the position of the New York State Insurance Department.
RE: Non-Admitted Reinsurance/Letters of Credit, Insurance Department Reg. No. 133 (11 NYCRR 79)
In the absence of written notice from the issuing bank to the ceding insurer, would a letter of credit automatically be renewed?
2) May a reinsurer, having obtained the issuance of an "acceptable" letter of credit to a ceding insurer as part of a reinsurance transaction, unilaterally instruct the issuing bank to cancel or non-renew the instrument?
The inquiry was from a representative of a foreign unauthorized insurer, which is not an accredited reinsurer, that offers reinsurance to New York licensed insurers. As security for satisfaction of its obligations under the reinsurance treaties, the reinsurer often obtains letters of credit for the ceding insurers from qualified banks. In instances where the reinsurance is cancelled or non-renewed, the reinsurer has approached the bank to request cancellation of the letter of credit. The bank has refused to cancel the letter of credit, citing the requirements of the "evergreen clause", a provision in the letter of credit.
Reinsurance is a vehicle which permits a licensed insurer to reduce its loss exposure on either an individual risk or a large number of risks by selling (ceding) a portion of its liability to another insurance company (the reinsurer), Dictionary of Insurance Terms 397 (3rd ed. 1995). N.Y. Ins. Law §1301 (McKinney 2000) establishes the criteria whereby the ceding insurer may take credit for reinsurance as an admitted asset on its financial statement. N.Y. Ins. Law §1301(a)(14) (McKinney 2000) authorizes the insurer to take admitted asset credit for reinsurance that satisfies the following criteria:
Reinsurance recoverable by a ceding insurer: (i) from an insurer authorized to transact such business in this state, except from a captive insurance company licensed pursuant to the provisions of article seventy of this chapter, in the full amount thereof; (ii) from an accredited reinsurer, as defined in subsection (a) of section one hundred seven of this chapter, to the extent allowed by the superintendent on the basis of the insurers compliance with the conditions of any applicable regulation; or (iii) from an insurer not so authorized or accredited or from a captive insurance company licensed pursuant to the provisions of article seventy of this chapter, in an amount not exceeding the liabilities carried by the ceding insurer for amounts held under a reinsurance treaty with such unauthorized insurer or from a captive insurance company licensed pursuant to the provisions of article seventy of this chapter as security for the payment of obligations thereunder if such funds are held subject to withdrawal by, and under the control of, the ceding insurer. Notwithstanding any other provision of this chapter, the superintendent may by regulation prescribe the conditions under which a ceding insurer may be allowed credit, as an asset or as a deduction from loss and unearned premium reserves, for reinsurance recoverable from an accredited reinsurer, an insurer not authorized in this state or a captive insurance company licensed pursuant to the provisions of article seventy of this chapter.
For reinsurance ceded to an unauthorized insurer, which is not an accredited reinsurer, the ceding insurer may only take admitted asset credit for amounts withheld subject to withdrawal by, and under the control of, the ceding insurer. N.Y. Comp. Codes R & Regs. tit. 11 §125.6 (1995) (Regulations 17, 20 and 20-A). A letter of credit complying with the provisions of Regulation 133 would qualify for treatment as an admitted asset. N.Y. Comp. Codes R & Regs. tit. 11§125.6(b)(2) (1995).
N.Y. Comp. Codes R & Regs. tit. 11 §79 (1994) (Regulation 133) establishes requirements relating to letters of credit. Section 79.1 establishes definitions applicable to the remainder of the section. The reinsurer is the "applicant", requesting the bank to issue the letter of credit in favor of the "beneficiary", the ceding insurer. An "Evergreen clause" is a provision in a letter of credit which prevents its expiration without due written notice to the beneficiary from the issuing or confirming bank or trust company.
N.Y. Comp. Codes R & Regs. tit. 11 §79.2 (1994) establishes required conditions for acceptable letters of credit, which may be treated as an asset by the ceding insurer. One requirement is that the letter must "have a term of at least one year and contain an evergreen clause which provides at least 30 days" written notice to the beneficiary prior to expiry date for nonrenewal; ." N.Y. Comp. Codes R & Regs. tit. 11 §79.2(h) (1994).
The letter of credit is obtained to ensure that the reinsurer will fulfill its contractual obligations to the ceding insurer. Although it is the reinsurer that applies for the letter of credit and makes payment to the bank, the obligations under the instrument flow from the issuing bank to the ceding insurer (the beneficiary).
The letter of credit automatically renews unless the issuing bank elects not to renew and gives 30 days written notice of that intention to the ceding insurer. N.Y. Comp. Codes R & Regs. tit. 11 §79.9(a) (1994). Once the issuing bank has served written notice on the ceding insurer of its intent not to renew the letter of credit, the ceding insurer may chose to protect itself by withdrawing funds, as per the terms of the agreement, or may simply allow the letter of credit to be nonrenewed.
The inquiry focused on the operation of such a clause in a situation where the reinsurance treaty is nonrenewed but the letter of credit is automatically renewed because the ceding insurer does not receive the required written notice from the bank.
The evergreen clause is intended to protect the interest of the ceding insurer. The sample form found in N.Y. Comp. Codes R & Regs. tit. 11 §79.9(a) (1994) clearly expresses the fact that it is the ceding insurer (as beneficiary) and not the reinsurer which has enforceable rights. Even if the reinsurance treaty has been terminated, it does not necessarily follow that the letter of credit should be non-renewed. There may still be potential exposure under the terms of the expired reinsurance treaty.
By requiring the issuing bank to notify the ceding insurer in writing of its intent to nonrenew the letter of credit, the ceding insurer, as beneficiary of the letter of credit, is afforded the opportunity to act to protect its rights.
In addition, the banks inclusion of the evergreen clause in a letter of credit makes it "acceptable", which allows the ceding insurer to take credit for the reinsurance coverage ensured by the letter of credit as an asset. N.Y. Ins. Law §1301(a)(14) (McKinney 2000).
A situation could develop where a ceding insurer, after notification by the issuing bank of its intention to nonrenew a letter of credit, draws funds to which it is not entitled, thereby acting to the prejudice of the rights of the reinsurer. In that instance the ceding insurer might be subject to a legal action by the reinsurer. Such an action, however, would not be pursuant to any Insurance Law or Regulation.
For further information you may contact Associate Attorney Sam Wachtel at the New York City Office.