As Solvency II draws closer to taking effect in Europe, insurance industry participants are learning more about how it may affect parties outside Europe. A big question has been which other regulatory frameworks will be deemed “equivalent” to Solvency II.
On Friday June 5, the European Commission announced the first set of equivalence decisions. These grant provisional equivalence to the group capital regulatory regimes in six non-E.U. countries:
- United States
Separately, Switzerland was granted full equivalence for all three areas considered by Solvency II: reinsurance, group capital, and group supervision.
To understand these announcements, let’s recap the three separate areas that Solvency II considers for equivalence:
Reinsurance (Article 172)
If the foreign regulatory system is deemed to be equivalent with regard to reinsurance, reinsurance contracts between E.U. insurers and foreign reinsurers will receive the same treatment under Solvency II as contracts between E.U. insurers and E.U. reinsurers. A major consideration here is whether reinsurers are required to collateralize unearned premiums and unpaid claims.
Calculation of group capital (Article 227)
Is a foreign company owned by an E.U. insurer subject to a solvency regime equivalent to Solvency II? If so, the E.U. owner may take into account the Solvency Capital Requirement (SCR) and own funds of the foreign subsidiary when calculating group capital.
Supervision of groups (Article 260)
Does the foreign regulator supervise groups in a matter equivalent to Solvency II? If so, E.U. insurers with a foreign parent will rely on the group supervision exercised by the parent’s regulator.
For E.U. companies with foreign parents or subsidiaries, failure to establish equivalence could have created substantial headaches. Effectively, such companies might have had to separately establish compliance with both regimes. And lack of equivalence could have severely hampered the market for reinsurance transactions between E.U. insurers and foreign reinsurers. The U.S. has been a particular concern because its risk-based solvency standard – while long established – differs fundamentally in approach from Solvency II.
With the June 6 announcements, the European Commission has made the following determinations of equivalence:
|Calculation of group capital|
|Supervision of groups|
5 years, non-renewable
10 years, renewable
5 years, non-renewable
The next step is for these decisions to be scrutinized by the European Parliament and the Council. Successful completion of this scrutiny process will lead to publication in the E.U. Official Journal, with equivalence taking effect as of January 1, 2016.
The European Commission’s press release states that “Further Solvency II equivalence decisions are envisaged by the Commission in future.”
The US didn’t enter a formal equivalence application which had prompted a great deal of concern that an agreement may not be reached. Perhaps the most notable example was the announcement by Prudential in 2012 that it may consider exiting the UK if an equivalence agreement weren’t reached, given the potential additional capital requirements that may have caused. The decision to grant US provisional equivalence is clearly important and will be well received.
In its 5th June press release the European Commission noted that an important part of its decision to grant the US provisional equivalence was the EU-US Dialogue project which aims to achieve ‘improved mutual understanding of the respective insurance regulatory and supervisory regimes’. The provisional equivalence lasts for 10 years for the solvency calculation (article 227 above) and is renewable at that stage. However, provisional equivalence for group supervision and reinsurance (articles 260 and 172) last for 5 years and is non-renewable. The continuation of this dialogue will therefore be important.
While U.S. regulators are unlikely to change the basic underpinnings of their risk-based capital standard, they are implementing a Solvency Modernization Initiative (SMI) that began in 2008. One of the outcomes of the SMI is the requirement for insurers over a certain size to provide an Own Risk and Solvency Assessment (ORSA). It remains to be seen exactly how the SMI may affect group supervision by U.S. regulators.