1. (a) Purpose.

   1. (1) The Texas Department of Insurance recognizes that licensed insurers routinely enter into reinsurance agreements that yield legitimate relief to the ceding insurer from strain to surplus.

   2. (2) The Texas Department of Insurance, however, has become aware that some insurers, in the capacity of ceding insurer, have at times entered into reinsurance agreements primarily as financing arrangements which have the principal purpose of producing increased surplus for the ceding insurer, typically on a temporary basis, but which provide little or no indemnification of insurance risks by the reinsurer. The purpose of this section is to provide for the regulation of the accounting for reinsurance agreements and agreements represented to be, or styled as, reinsurance, when such latter arrangements, despite their legal form, are in substance and effect financing arrangements. The terms of such latter agreements do not comply in essence with the requirements of subsection (d) of this section and violate one or more of the following:

      1. (A) the Insurance Code, Articles 1.10, 1.32, 6.04, 6.05, 6.11, 6.12, 8.07, 15.13, 15.15, 16.18, 16.20, 17.11, 17.25, 18.08, 18.12, 19.06, 19.08, 20.02, and 21.21, concerning the financial condition of insurers, thus resulting in distorted financial statements which do not properly reflect the financial condition of the ceding insurers;
      2. (B) the Insurance Code, Article 5.75-1, concerning reinsurance reserve credits, thus resulting in a ceding insurer improperly reducing liabilities or establishing assets for reinsurance ceded; and
      3. (C) the Insurance Code, Articles 1.32 and 21.28-A, concerning creating a situation that may be hazardous to policyholders of this state.
2. (b) Scope. This section applies to all insurers writing all forms of insurance regulated by the Insurance Code, Chapter 5, including, but not limited to, property and casualty insurance, fire insurance, auto insurance, fidelity, guaranty and surety bonds, and workers' compensation insurance in this state, including all insurers authorized to do the business of insurance in this state under the Insurance Code, Chapters 2, 5, 6, 8, 15-19, and 21. The provisions of this section shall not apply to ceding insurers domiciled in another state that regulates the accounting for reinsurance agreements by property and casualty insurers under law, rule, or bulletin substantially similar in substance and effect to Texas law and rules. To pursue this exception the ceding insurer shall provide, upon request, to the commissioner of insurance evidence of similarity in the form of statutes, regulations, and interpretation of the standards utilized by the state of domicile. The provisions of this section are supplementary to and cumulative of existing statutes and rules of the Texas Department of Insurance. In the case of an ambiguity or contradiction between any of the provisions in this section and any statute, the provisions of the statute control.

3. (c) Definitions. The following words and terms, when used in this section, shall have the following meanings, unless the context clearly indicates otherwise.

   1. (1) Commutation--A transaction which results in the recapture by the ceding insurer of risks previously reinsured with an assuming insurer which provides payment and complete discharge of all present and future obligations between the parties arising from the reinsurance agreement.
   2. (2) Insurance risk--Uncertainty as to the ultimate amount of any claim payments (underwriting risk) and the timing of those payments (timing risk).

   3. (3) Obligations--As pertains to reinsurance agreements:

      1. (A) losses and loss adjustment expenses paid by the ceding insurer, but not recovered from the assuming insurer;
      2. (B) reserves for losses reported and outstanding;
      3. (C) reserves for losses incurred but not reported;
      4. (D) reserves for loss adjustment expenses related to losses reported and outstanding and to losses incurred but not reported;
      5. (E) reserves for unearned premiums; and
      6. (F) any other balances due under the reinsurance agreement.

4. (d) Accounting and other requirements.

   1. (1) Reinsurance agreements often cap or limit the reinsurer's maximum liability for assumed obligations under the contract. The credit taken by an insurer for reinsurance ceded to an assuming insurer under an agreement shall be exclusive of all deductibles and retentions and may not exceed the reinsurer's liability for obligations as capped or limited actually transferred under the agreement.
   2. (2) For purposes of determining whether credit for reinsurance will be allowed under an agreement, the ceding insurer has the responsibility to satisfactorily explain all provisions of an agreement to the Texas Department of Insurance. The Texas Department of Insurance may require such explanations to be in writing and include both cash flow projections and mathematical models using various interest rate and other assumptions.
   3. (3) Credit for unearned premiums ceded shall not be allowed a ceding insurer under reinsurance agreements written on a pro-rata or proportional basis which provide for the settlement of premiums as the premiums are earned or for the automatic recapture of premiums as the premiums are earned. Credit for unearned premiums ceded shall not be allowed a ceding insurer under a series of reinsurance agreements written on a pro-rata or proportional basis which provide for initial settlement of premiums as the premiums are written and the subsequent retrocession to the original insurer of premiums as the premiums are earned.
   4. (4) Credit for unearned premium ceded under reinsurance agreements written on an excess or nonproportional basis shall not be allowed for minimum and fully earned reinsurance premiums.
   5. (5) Reinsurance agreements must contain both components of insurance risk (underwriting and timing) for credit for reinsurance to be allowed in financial statements filed with the Texas Department of Insurance.

   6. (6) A ceding insurer shall reflect reinsurance recoverable on paid losses and loss adjustment expenses which is more than 90 days overdue as a liability in financial statements filed with the Texas Department of Insurance, provided that the Texas Department of Insurance may waive the application of this subsection if the department determines that good faith efforts are being made by both parties to resolve the claim(s) or disputes arising therefrom as soon as practicable after consideration by the department of the following factors:

      1. (A) the nature of the business giving rise to the losses;
      2. (B) the number of years of coverage involved in the claim(s);
      3. (C) the number of assuming insurers involved in the claim(s);
      4. (D) the payment history between the ceding insurer and assuming insurer(s);
      5. (E) the level of communication with respect to the claim(s);
      6. (F) any other evidence of efforts to resolve the claim(s) as expeditiously as possible; and
      7. (G) any other factor deemed relevant by the department.

   7. (7) In addition to the requirements of paragraphs (1)-(6) of this subsection, no insurer subject to this section shall, for reinsurance ceded, reduce any liability or establish any asset in any financial statement filed with the Texas Department of Insurance if the contract or agreement is not in compliance with the Insurance Code, or with the rules or regulations, including actuarial interpretations or standards, adopted by the State Board of Insurance.

      1. (A) The following descriptions of treaty provisions are provided as guidance to examiners to determine if reserve credits are proper and in no way limit the department's authority:

         1. (i) the reserve credit taken by the ceding insurer is greater than the underlying reserve of the ceding insurer supporting the policy obligations transferred under the contract;

         2. (ii) the ceding insurer is required to reimburse the reinsurer for adverse experience under the contract in an amount greater than 5.0% of the net written premium to any extent, except that:

            1. (I) any provision for subsequent adjustment on the basis of actual experience in excess of 5.0% of net written premium is allowable so long as a reserve is established at the inception of the agreement equal to the full amount of the potential adjustment in excess of 5.0% and that reserve is maintained until such time as the subsequent adjustments are due and payable, pursuant to the terms of the agreement;
            2. (II) commission adjustments which provide that adverse experience may be carried forward and offset against future commission adjustments will not be considered a reimbursement to the reinsurer for adverse experience;
         3. (iii) the ceding insurer must, at specific points in time, terminate or automatically recapture all or part of the reinsurance ceded in a manner which deprives the ceding insurer of surplus;
         4. (iv) the consideration to be paid by the ceding insurer is not reasonable in relation to the amount of insurance risk transferred under the agreement;
         5. (v) any language which allows termination of the agreement automatically, except upon termination of the underlying policy, or at the sole option of the reinsurer on less than 30 days prior written notice;
         6. (vi) any language that specifies the amounts to be reimbursed to the ceding insurer at fixed or determinable future dates, or includes predetermined payment schedules, delayed payment clauses, or formulas that, in substance, delay reimbursement to the ceding insurer; or
         7. (vii) no cash payment is due from the reinsurer throughout the lifetime of the contract with all settlements prior to the termination date of the agreement made only in a reinsurance account.

      2. (B) The following descriptions of treaty provisions are prohibited provisions which, if included in substance or effect in a contract shall, for reinsurance ceded, result in disallowance of credit for reinsurance:

         1. (i) the agreement provides for adjustments that allow the assuming insurer's gain or loss to be determinable in advance;
         2. (ii) the ceding insurer can be deprived of surplus at the reinsurer's option or automatically upon the occurrence of some event, such as the insolvency of the ceding insurer; except that termination of the contract for nonpayment of reinsurance premiums shall not be considered to be such a deprivation of surplus;
         3. (iii) the entry of an order of rehabilitation including the appointment of a supervisor, conservator, or receiver of the ceding insurer shall constitute either an anticipatory breach of any contracts of the ceding insurer; grounds for retroactive commutation or retroactive cancellation; or grounds for retroactive revocation of any contracts of the ceding insurer; or
         4. (iv) any language which allows cancellation regarding obligations reinsured prior to the date of termination of the agreement, except that nothing contained herein would preclude a subsequent commutation of reinsurance coverage upon terms mutually agreeable to the parties to the agreement. This paragraph is not intended to limit the actions of the supervisor, conservator, rehabilitator, liquidator, or receiver of the ceding company.
   8. (8) Notwithstanding paragraphs (1)-(7) inclusive, of this subsection, a ceding insurer subject to this section may, with the prior written approval of the commissioner of the Texas Department of Insurance, reduce its liability or establish an asset in an amount as the commissioner may allow. All its financial statements thereafter shall, by footnote, identify such reduced liability or increased asset established on the financial statement and shall reference the commissioner's prior written approval.

5. (e) Written contracts.

   1. (1) No reinsurance contract or amendment to any such contract may be used to reduce liability or to establish any asset in any quarterly or annual financial statement filed with the Texas Department of Insurance, unless the contract or amendment thereto or a letter of intent has been duly executed by both parties, except for facultative certificates duly executed by the reinsurer or its duly appointed agent, no later than the "as of" date of the quarterly or annual financial statement. A letter of intent may consist of a cover note or placement slip signed by the assuming insurer or its designated agent and accepted in writing by the ceding insurer.
   2. (2) In the case of a letter of intent, a contract or amendment to a contract must be executed within a reasonable period of time, not exceeding 90 days from the execution date of the letter of intent, in order for credit to be granted for the reinsurance ceded. This provision shall govern unless it is explained to the satisfaction of the Texas Department of Insurance why such contract has not been executed within 90 days. The Texas Department of Insurance may, at its discretion, allow an additional period of time for execution not to exceed an additional 90 days (for a total of 180 days) from the execution date of the letter of intent.

6. (f) Existing contracts. Insurers subject to this section may continue to reduce liabilities or establish assets in financial statements filed with the State Board of Insurance for reinsurance ceded under the types of reinsurance contracts described in subsection (a)(2) of this section and in subsection (d) of this section, provided:

   1. (1) the reinsurance contracts were executed and in force prior to December 31, 1991;
   2. (2) no new business is ceded under the contract after the effective date of this section;
   3. (3) the reduction of the liability or the asset established for the reinsurance ceded is reduced to zero by December 31, 1993, or such later date approved by the commissioner of the Texas Department of Insurance as a result of an application made by the ceding insurer within 120 days of the adoption date of this section;
   4. (4) the reduction of the liability or the establishment of the asset is otherwise permissible under all other applicable provisions of the Insurance Code or rules or regulations, including actuarial interpretations or standards, adopted by the Texas Department of Insurance; and
   5. (5) the Reinsurance Activity of the Texas Department of Insurance is notified, within 90 days following the effective date of this section, of the existence of such contracts and all corresponding credit for reinsurance taken in the ceding insurer's December 31, 1991, financial statement and all subsequent financial statements.
7. (g) Effective date. This section becomes effective December 31, 1991.
8. (h) Severability. If any provision of this section or the application thereof to any person or circumstance is held invalid for any reason, the invalidity shall not effect the other provisions of this section which can be given effect without the invalid provisions or application. To this end, all provisions of this section are declared to be severable.

Source Note:The provisions of this §7.615 adopted to be effective December 27, 1991, 16 TexReg 7196.