OGC Op. No. 08-06-14
The Office of General Counsel issued the following opinion on June 18, 2008 representing the position of the New York State Insurance Department.
RE: Proposed Collateral Program
Does any provision of the New York Insurance Law prohibit a New York authorized ceding insurer from taking credit for reinsurance in cases where the reinsurer has funded the “Regulation 114 Trust” with the below-described Collateral Notes?
No, nothing in the New York Insurance Law prohibits a New York authorized ceding insurer from taking credit for reinsurance in cases where the reinsurer has funded the “Regulation 114 Trust” with the below-described Collateral Notes.
The Insurance Department reviewed a proposed program (the “Program”) that will involve the raising of funds from the capital markets. Funds raised from the capital markets will be deposited in a trust (the “Qualifying Collateral Trust”) formed under Delaware law, and invested solely in government and corporate obligations of the kinds qualifying as permitted investments under 11 NYCRR § 126 (Regulation 114). Collateral Notes backed by those assets (the Collateral Notes”) will be issued by the Qualifying Collateral Trust and deposited in trusts established by reinsurers for the benefit of ceding insurers. Each such trust will be a single beneficiary trust that satisfies all the requirements of Regulation 114. Further details about the Program follow.
The parties to the Program will be the participating reinsurers that reinsure risks ceded by New York-licensed cedents; K Capital Limited (“K Capital”), a corporation wholly owned by K Management (Bermuda) Limited that will raise funds in the capital markets; a collateral trustee to hold qualifying assets in the Qualifying Collateral Trust and issue Collateral Notes; and the New York-licensed cedents.
Use of Funds
K Capital will deposit funds raised in capital market transactions into the Qualifying Collateral Trust, which will be a statutory trust formed in Delaware. The trustee of the Qualifying Collateral Trust (the “Collateral Trustee”) will be a U.S. bank. Funds held in the Qualifying Collateral Trust will be invested in government and corporate obligations that are permitted investments under Regulation 114. The trust agreement governing the Qualifying Collateral Trust will limit the use of the assets held in trust to the terms of the Program, and the assets held in the Qualifying Collateral Trust will be pledged to secure the payment of the outstanding Collateral Notes. To help ensure that the market value of the assets held in the Qualifying Collateral Trust equal or exceed the amount of the outstanding Collateral Notes, the Collateral Trustee will enter into derivative transactions in the capital markets pursuant to which highly rated financial institutions will assume the risk of declines in the market value of the trust assets.
The Collateral Notes will be of varying denominations and, once issued, will be perpetual in duration until surrendered by the holder thereof, subject to the right of the Qualifying Collateral Trust to redeem the Collateral Notes if they remain outstanding 12 months after being withdrawn from a Regulation 114 Trust. Each Collateral Note will entitle the holder thereof to receive, upon demand, either assets held in the Qualifying Collateral Trust or cash, up to the amount of the note. Collateral Notes will be issued only to trustees of credit for reinsurance trusts, for deposit in the trust accounts created thereunder.
Operation of the Program
The Program is designed to provide participating reinsurers with an alternative to letters of credit or the deposit of their own assets in a credit for reinsurance trust. Under the Program, participating reinsurers will establish credit for reinsurance trusts for the benefit of ceding insurers. The participating reinsurers will be the grantors of the trusts, and the cedents will be the beneficiaries. For New York-licensed cedents, the terms and conditions of the trust will comply with each of the additional requirements under Regulation 114. At the request of participating reinsurers, K Capital will instruct the Collateral Trustee to issue Collateral Notes for deposit in the trust accounts established to secure the payment obligations of participating reinsurers to New York-licensed cedents.
In the event that a cedent decides to make a draw on a Regulation 114 Trust, the cedent would have multiple choices regarding the Collateral Notes held in such trust:
(1) The cedent could withdraw the Collateral Notes from the Regulation 114 Trust and either hold them as an investment or demand payment from the Qualifying Collateral Trust of the value of the Collateral Notes; or
(2) The cedent could direct the trustee of the Regulation 114 Trust to demand payment from the Qualifying Collateral Trust of the value of the Collateral Notes and distribute the proceeds to the cedent.
In the event of such a draw on the assets in the Qualifying Collateral Trust, the applicable participating reinsurer will be required to reimburse the Qualifying Collateral Trust for the amount so withdrawn. It is stated that the capital market investors will ultimately bear the credit risk in the event that a participating reinsurer defaults on its reimbursement obligations.
In the event that a credit for reinsurance trust becomes overfunded, the amount of the Collateral Note held in the trust account will be reduced as part of the normal quarterly true-up process of such trust. In addition, if there has been a previous draw on the assets in the Qualifying Collateral Trust, any assets subsequently released from the trust account to the reinsurer in the ordinary course will be distributed directly to the Collateral Trustee to the extent that the participating reinsurer has not previously reimbursed the Qualifying Collateral Trust.
At issue is whether, under the New York Insurance Law, the Collateral Notes could qualify for use in connection with reinsurance transactions. One of the methods by which a ceding insurer may claim credit for reinsurance placed with an unauthorized reinsurer is when sufficient assets are placed into trust for the benefit of the ceding insurer. See 11 NYCRR § 125 (Regulation 20) at §§125.5(b)(2) and 125.6(b)(3). The terms of such a trust are set forth by Regulation 114, 11 NYCRR § 126.1 et seq.
A relevant requirement outlined in Regulation 114 is the character of assets that qualify for deposit. Specifically, 11 NYCRR § 126.5(a)(2) provides:
[A]ssets deposited in the trust account … shall consist only of cash (United States legal tender), certificates of deposit (issued by a United States bank and payable in United States legal tender), and investments of the types specified in paragraphs (1),(2),(3),(8) and (10) of subsection (a) of section 1404 of the New York Insurance Law provided that such investments are issued by an institution that is not the parent, subsidiary or affiliate of either the grantor or the beneficiary.
The types of assets described in the above-cited provisions of Insurance Law §1404(a) are enumerated in the statute in relevant part as follows:
1. Government obligations. Obligations which are not in default as to principal or interest, which are valid and legally authorized, and which are issued, assumed, guaranteed or insured by:
(A) the United States or by any agency or instrumentality thereof,
(B) any state of the United States,
(C) any territory or possession of the United States, or
(D) any other governmental unit in the United States, or any agency or instrumentality of any governmental unit referred to in subparagraphs (B) and (C) of this paragraph …
2. Obligations of American institutions.
(A) Obligations which are issued by any solvent American institution or which are assumed or guaranteed by any solvent American institution (other than an insurance company) and which are not in default as to principal or interest provided such obligations: (i) are adequately secured by collateral security having a market value not less than the principal amount thereof and have investment qualities and characteristics wherein the speculative elements are not predominant, or (ii) are rated A or higher (or the equivalent thereto) by a securities rating agency recognized by the superintendent, or if not so rated, are similar in structure and in all material respects to other obligations of the same institution which are so rated, or (iii) are insured by one or more authorized insurance companies (other than the investing insurer or any parent, subsidiary or affiliate of such insurer) who are licensed to insure obligations in this state and, after considering such insurance, are rated Aaa (or the equivalent thereto) by a securities rating agency recognized by the superintendent, or (iv) have been given the highest quality designation by the Securities Valuation Office of the National Association of Insurance Commissioners….
3. Preferred or guaranteed shares of American institutions. …
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8. Equity interests. (A) Investments in common shares or partnership
interests of any solvent American institution, if
(i) all its obligations and preferred shares, if any, are eligible as investments under this subsection and
(ii) such equity interests of any such institution except an insurance company are registered on a national securities exchange … and … price quotations therefor are furnished through a nationwide automated quotations system approved by the National Association of Securities Dealers… .
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10. Investment companies. Securities of any investment company registered pursuant to the federal Investment Company Act of 1940… .
Of the various permissible categories set forth above, the Collateral Notes are best characterized as “obligations of American institutions”. See Insurance Law § 1404(a)(2). The term “obligation” is defined under Insurance Law § 107(a)(33) to include “bonds, debentures, notes and other evidences of indebtedness … as well as participation interests in any of the foregoing.” Similarly, Insurance Law § 107(a)(6) defines the term “American institution” as “an institution created under the laws of the United States of America or any state, district or territory thereof.” In addition, a trust constitutes one of the kinds of entities included in the definition of “institution” in Insurance Law § 107(a)(24).
The Collateral Trust, the issuer of the Collateral Notes, is a trust formed pursuant to the Delaware Statutory Trust Act. As such, it is an institution formed under the laws of one of the United States, and thus qualifies as an “American institution” within the meaning of the Insurance Law.
Based on the information provided, the Department is of the view that the Collateral Notes are represented as meeting the requirements set forth in Section 1404(a)(2)(A). Specifically, the Collateral Notes will be adequately secured by collateral security having a market value not less than their principal amount. In addition, they will be rated “A” or higher by a nationally recognized statistical rating organization (NRSRO). Accordingly, the Collateral Notes are “obligations of an American institution” within the meaning of Insurance Law § 1404.
Regulation 114 requires the reinsurer to be the grantor of the Regulation 114 Trust established for the benefit of the ceding insurer, but Regulation 114 does not expressly mandate that the assets deposited in the Regulation 114 Trust be assets owned by the reinsurer. What is required is that the ceding insurer have unfettered access to the contributed assets. See 11 NYCRR § 126.3(f).
In sum, in view of the representations made to the Department, nothing in the New York Insurance Law prohibits a New York authorized ceding insurer from taking credit for reinsurance where the reinsurer has funded the Regulation 114 Trust with Collateral Notes. However, if the facts presented were to differ in any material way, the Department might alter its conclusion.
For further information you may contact Supervising Attorney Michael Campanelli at the New York City Office.