Sec. 31.05.07.05. Circumstances Under Which Reduction of Liability and Establishment of Asset Prohibited

A. In general. An insurer may not, for reinsurance ceded, reduce any liability or establish any asset in any financial statement filed with the Commissioner if, by the terms of the reinsurance agreement, in substance or effect:

(1) Renewal expense allowances provided or to be provided to the ceding insurer by the reinsurer in any accounting period are not sufficient to cover anticipated allocable renewal expenses of the ceding insurer on the portion of the business reinsured, unless a liability is established for the present value of the shortfall using assumptions equal to the applicable statutory reserve basis on the business reinsured;

(2) The ceding insurer can be deprived of surplus or assets:

(a) At the reinsurer's option, or

(b) Automatically on the occurrence of some event, such as the insolvency of the ceding insurer;

(3) The ceding insurer is required to reimburse the reinsurer for negative experience;

(4) The ceding insurer is required, at specific points in time scheduled in the agreement, to terminate or automatically recapture all or part of the reinsurance ceded;

(5) The reinsurance agreement involves the possible payment by the ceding insurer to the reinsurer of amounts other than from income realized from the reinsured policies, such as reinsurance premiums or other fees or charges to a reinsurer that are greater than the direct premiums collected by the ceding company;

(6) All of the significant risk inherent in the business being reinsured is not transferred;

(7) The credit quality risk, reinvestment risk, or disintermediation risk is significant for the business reinsured and except as provided in Regulation .06B of this chapter, the ceding company does not:

(a) Transfer the underlying assets to the reinsurer, or

(b) Legally segregate the underlying assets in a trust or escrow account or otherwise establish a mechanism satisfactory to the Commissioner that legally segregates, by contract, the underlying assets;

(8) Settlements are made less frequently than quarterly or payments due from the reinsurer are not made in cash within 90 days after the settlement date;

(9) The ceding insurer is required to make representations or warranties:

(a) Not reasonably related to the business being reinsured, or

(b) About future performance of the business being reinsured; or

(10) The reinsurance agreement is entered into for the principal purpose of producing significant surplus aid for the ceding insurer, typically on a temporary basis, while not transferring all of the significant risks inherent in the business reinsured and, in substance or effect, the expected potential liability to the ceding insurer remains basically unchanged.

B. Acts Not Prohibited.

(1) Section A(2) of this regulation does not prohibit a reinsurer from terminating the reinsurance agreement for nonpayment of:

(a) Reinsurance premiums; or

(b) Other amounts due, such as modified coinsurance reserve adjustments, interest and adjustments on funds withheld, and tax reimbursements.

(2) Section A(3) of this regulation does not prohibit:

(a) Offsetting experience refunds against current and prior years' losses under the agreement; or

(b) Payment by the ceding insurer of an amount equal to the current and prior years' losses under the agreement on voluntary termination of in force reinsurance by the ceding insurer.

(3) Voluntary termination under §B(2)(b) of this regulation does not include termination because of unreasonable provisions that allow the reinsurer to reduce its risk under the agreement, such as a provision that gives the reinsurer the right to increase reinsurance premiums or risk and expense charges to excessive levels forcing the ceding company to prematurely terminate the reinsurance agreement.