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Going global: as EU nations prepare for the upcoming Solvency II--implementation deadline, several other nations are taking their own approaches to solvency requirements.

The insurance industry is abuzz with talk of Solvency II, the risk-based regulatory regime for European carriers.

Some European Union countries are ahead of the game in adoption of the rule that some have called the biggest regulatory change ever; others lag behind. But one thing is certain: the long-anticipated, already delayed start of the regulatory overhaul date is now within arm's reach and it will have a significant impact on insurance companies that seek to do business globally.

Are insurers ready? Most European insurers seem to be, according to EY's 2014 European Solvency II survey. Nearly 80% said they expect to fully meet all requirements before the rule is adopted by the European Parliament as part of an omnibus legislative package in January 2016. However, considerable variability in the level of preparedness exists in each of the European Union's member countries.

Carriers in the United Kingdom, the Netherlands and Nordic countries are most confident in meeting the requirements, while French, German, Greek and Eastern European insurers are less optimistic, the survey shows. Most European insurers reveal a high state of readiness to implement all components of a Pillar 1 balance sheet and fulfill most Pillar 2 requirements; Pillar 3, however, still presents a major challenge. (Solvency II is divided into three areas, or pillars.)

While the EU anxiously awaits the looming deadline, a handful of other countries outside the EU have already or soon expect to adopt components of rules broadly based on the European model.

Take Mexico, for instance. Recently, the country implemented the second and third pillars of its new Solvency II equivalency standards. Pillars 2 and 3 relate to corporate governance and market transparency, respectively, and include the requirement to have a national scale rating provided by a rating agency that is approved by the local regulator. Mexico has pushed back implementation of Pillar 1 to January 2016.

China also is taking steps of its own. Reports indicate this year the world's most populous country expects to put into effect a new risk-oriented and internationally comparable solvency regulatory system that meets the needs of China's insurance market.

Other countries, like the United States and Canada, are leaning in a different direction.

While the journey to regulatory harmonization is unique for each nation, the end goal remains the same.

Going Equivalent

Some countries are eyeing equivalence as a way to develop a consistent, risk-based solvency regime and reporting requirements for the insurance sector.

The concept of equivalence within Solvency II is judged on the ability of a third country (that is, a country outside the EU) to offer a similar level of policyholder protection as Solvency II, said Ed Barron, a director for PwC in London. "This will be judged by reviewing the regime's capital adequacy assessments, risk management processes, governance and reporting and disclosure.

"Equivalence is a concept within Solvency II that provides relief for European groups with business outside of the EU," Barron said.

"One of the overriding factors of Solvency II is the need to supervise an insurance group at the group level. Equivalence has encouraged some countries to decide if they should update their current regulatory framework and become equivalent by introducing comparable provisions to the Solvency II directive."

In 2009, the Committee of European Insurance and Occupational Pensions Supervisors issued a consultation paper on the technical criteria for assessing third-country equivalence.

Equivalence benefits are available in three areas: reinsurance, group solvency calculation and group supervision, said David Sherwood, a senior manager in Deloitte's governance, regulatory and risk practice.

Today, three countries--Bermuda, Japan and Switzerland--are attempting to go through the process of equivalence, Sherwood said. "Switzerland for group solvency, Bermuda is pursuing group equivalence and Japan is seeking equivalence for reinsurance," he said. In 2011, the European Insurance and Occupational Pensions Authority found each of the three nations met the equivalence criteria but with certain caveats.

In March, the pensions authority published final reports on third-country equivalence assessments for the three nations under Solvency II. The pensions authority's Board of Supervisors adopted the reports, which then were submitted to the European Commission. The pensions authority expects the commission to decide sometime this year whether the regimes are equivalent for the purpose of Solvency II.

PwC's Barron said a handful of nations are venturing down a slightly different path and seeking temporary equivalence.

"That's a group of countries that is not in a formal equivalence process but has expressed interest in being equivalent, partly because of the large number of European businesses that operate within their market," he said.

Third countries that fall within the transitional regime either have a risk-based regime similar to Solvency II or are willing and committed to move toward such a regime over a pre-defined period (five years in the initial proposal), according to global legal practice Norton Rose Fulbright.

South Africa has expressed interest in temporary equivalence, said David Kirk, a Milliman principal based in Cape Town, South Africa. "Solvency II is a large, complex set of regulations. Given South Africa's financial services history and similarities to the U.K., our country has decided to embark on a project aiming for third-country equivalence to the directive and compliant with the requirements of the IAIS Insurance Core Principles."

The International Association of Insurance Supervisors developed the Insurance Core Principles to provide a globally accepted framework for insurance regulation and supervision.

Some other nations seeking temporary equivalence include Australia, Chile, Hong Kong, Israel, Japan, Mexico, Singapore, Brazil, China and Turkey.

Notably missing from that list are the United States and Canada, said Carl Groth, managing director in KPMG's actuarial and insurance risk practice.

"Neither country has thrown its hat in the ring to go through the equivalence process," he said.

Why? "There's a level of satisfaction with the current regulatory regime in the U.S., and plans for its own solvency modernization initiative are generally considered sound for companies that operate there," Groth said. "Both the U.S. and Canada, however, are eligible for provisional equivalence, but the timing and outcomes are quite doubtful given the lengthy process. To add to the complexity, there are many points of contention between U.S. and European regulators on certain technical aspects of how capital should be calculated."

The two North American nations aren't alone. Guernsey, for instance, is another country that's opted not to seek equivalence under the rule.

Reports say regulators in the island nation fear insurers would be burdened with added costs, and equivalence could make captive business plans uneconomic.

In November 2014, A.M. Best issued a Special Report, Solvency II Progresses, but Significant Challenges in Store for Insurers, a section of which addressed equivalence: "The Solvency II approach might place European insurers at a competitive disadvantage to local insurers in some third countries because of a requirement to hold, and service, more capital than local insurers not subject to Solvency II at the group level. For this reason, 'equivalence,' meaning the ability within Solvency II to incorporate local solvency requirements of third countries as a component of the SCR, has been an issue. Important territories appear to have been categorized as provisionally equivalent. At this writing, some uncertainty persists over the treatment of provisional equivalence under Solvency II and the position it will place European insurers in when facing local competition. A.M. Best will continue to monitor the effect of equivalence, and management's reactions to developments, on rated insurers' competitive positions."

Eyeing ICPs

When looking at what non-EU nations are doing around globally consistent supervisory standards and capital requirements, "it's important to draw a distinction between Solvency II and Insurance Core Principles, or ICPs," said Barron.

Currently, more than 100 countries and jurisdictions have agreed to the core principles established by the IAIS, Barron said. The internationally developed principles and standards are "very similar guidelines to Solvency II," he added. In 2011, the IAIS issued a revised set of core principles, which for the first time integrated a number of separate standards and guidance into the core principles, Barron said. The core principles cover various areas such as cross-border cooperation, licensing, risk management, groupwide supervision and reinsurance.

"When individual countries decide how they want to establish their supervisory environment, they need to look at three things: What do they want for their local market in terms of supervisory standards for insurers to operate in a jurisdiction; what have they signed up for under the Insurance Core Principles and international standards; and what do other regulatory jurisdictions require of them if companies were to do business in those nations," Sherwood said.

Making the Case

Just what is the allure of Solvency II or equivalence by those outside the EU not obligated to adopt the rule? Barron said nations may receive a number of benefits in exchange for aligning their supervisory system with Solvency II, namely a competitive edge. "EU insurers may prefer to do business with third countries who they know meet equivalence standards," Barron said.

"Equivalence encourages supervisors of those countries to reflect on whether they feel their current supervisory framework is sufficient and would achieve the same degree of protection for policyholders of the insurer within that country," Barron said. "When asking that question, in many instances the answer has been 'no.' So it's encouraging nations to change their supervisory framework and introduce something that at times looks a lot like Solvency II."

Since the start of the financial crisis in 2007, "regulations have come to the fore and every country is being driven by what happened at that time," Sherwood said.

"New international standards are being developed and new demands are being put on regulators and supervisors that haven't before experienced that level of oversight from local governments," he said.

"So it's not uncommon for countries to now be reviewing their current supervisory frameworks for sufficiency," he said. "Some look to Solvency II as potentially being a leading practice that their regimes should look like or have flavors of. For instance, Mexico and Australia have elements of a Solvency II regime. Others, however, look at other frameworks. The U.S. is also an influencer to what good regulations look like."

Questions continue to swirl. "You have the U.S. industry pondering whether equivalence will hamper its competitiveness in the global market." said Howard Mills, a global insurance regulatory leader at Deloitte.

"It really behooves each individual firm to be able to operate in a seamless fashion. It raises many concerns about the nature of the world's market around equivalence going forward."

Time constraint issues also present some challenges, Groth said.

"Even for countries like Bermuda and Switzerland that have very robust regulatory regimes, the EIOPA has found caveats in some of the equivalence testing," Groth said. "So it's a long, rigorous assessment and consultation process for nations to endure."

The Time Has Come

What should companies now be doing to ready themselves for what many call "the most significant change ever to insurance and reinsurance regulations?"

Organizations should now be focusing on putting into practice recently built frameworks for Solvency II, Barron said.

"Over the last two years, companies within the EU have had a dry run, almost like a dress rehearsal getting things ready," Barron said. "Now it's about learning from the things that didn't go well and improving on efficiencies within those rehearsals to go live in 2016.

The time for lobbying around Solvency II has passed; effort now is about getting into position so you can convert solvency compliance into business-as-usual with minimal impact to your firm."

The big question now is where companies fit within that process, said Sherwood.

"Each company that's operating in different countries around the world will have to look at processes like equivalence and ask what that means for them: 'If we get equivalence, what is the impact on our business model? If we don't, what is that impact and how do we respond?' It's classic things around planning, organizing, understanding the regulatory environment and making business-based decisions on the back of that," Sherwood said.

Sherwood suggests companies conduct global assessments to determine how to best organize themselves around the various countries in which they operate.

"Even though global harmonization is trying to occur, individual countries still have their own legislative requirements that have to be met," Sherwood said. "So you get an attempt at harmonization but there are still local flavors and standards that you need to be compliant with. The key challenge is determining how to manage the complexity and diversity."

"One thing we've been urging clients to do as they get ready for Solvency II and requirements like ORSA [the Own Risk and Solvency Assessment] is to ensure they're getting leverage across all the different regulatory jurisdictions," Groth said.

"So instead of looking at these requirements separately, we urge clients to make sure they can actually leverage capabilities across regulatory jurisdictions to reduce expense and streamline information.

"It's going to be a journey and an exciting time as we enter into a new era, at least from the U.S. perspective where we will see a lot more regulatory-driven requirements than ever before," Groth said. "It's just a fact of life and the way the world is moving today."

Key Points

Leading Up: European nations are gearing up for the fast-approaching 2016 Solvency II implementation deadline.

Current Events: Several countries outside Europe are developing standards of their own, some that are broadly based on the Solvency II directive.

Taking Action: A number of nations are seeking equivalence, temporary equivalence or provisional equivalence.

Positive Outcomes

Shelby Weldon, director of licensing and authorization of the Bermuda Monetary Authority, said island regulators are cautiously optimistic they can be designated an equivalent regulatory system by the European Union and the European Insurance and Occupational Authority in late 2015.

He spoke with [sup.A.M.] BestTV at the Risk and Insurance Management Society 2015 Annual Conference & Exhibition in New Orleans.

The following is an edited transcript of the interview.

Could you give us an update on Solvency II? It's scheduled to finally be in place January 2016. How are you faring with equivalency?

It has been a long journey for Bermuda but we continue to be engaged with EIOPA (the European Insurance and Occupational Pensions Authority), the European agency that is charged with doing the assessments of countries like Bermuda. We're in the final stages of amendments to our legislation in preparation for the Jan. 1, 2016, launch date.

We have just issued a consultation paper at the beginning of April, which allows the market to consult on those final changes. They include aspects of our regime, like the economic balance sheet that brings into play a fair value approach to assets and liabilities.

It defines the requirements and expectations of the Authority with respect to outsourcing of services and then has some amendments to the requirements to hold head office directly in Bermuda. That process is well-advanced. We remain cautiously optimistic that the EU Parliament and EIOPA would confirm Bermuda's equivalency toward the end of this year.

Are you still looking at a two-tier system where commercial insurers may be judged differently than the captive industry?

Yes, without a doubt. Early on in the process, we determined that we wanted to seek what we call "bifurcated equivalence," which would allow our commercial insurers to avail themselves of the more stringent regime but keep our captives outside of a Solvency II-equivalent type of regime.

That decision was made based on our own assessment that the regime that we had in place for captives was appropriate for the risk profile of those companies registered in our Class I, Class II and Class III sectors. Also recognizing that the chief trading partner or source of that captive business was the U.S., who was quite comfortable with the way Bermuda was going about supervising and regulating captives. We remain, again, very optimistic that EIOPA would confirm bifurcated equivalence once they make that final decision.

Bermuda's been home to a lot of this alternative capital that's entered the market, either through new commercial insurers or captives or insurance-linked securities. Have you seen that continue so far this year?

Without a doubt. Insurance-linked securities continue to be the flavor of the day in Bermuda. We have seen tremendous growth in that area over the last three years. It has represented in excess of 50% of our new incorporations over that three-year period. We are seeing that trend continuing through 2015.

It's also supported by the Bermuda Stock Exchange, which is the home of at least 40% of global listings in that space. Bermuda once again has shown itself as the jurisdiction for these sorts of alternative risk transfer products.

You've also seen new companies forming?

We had 18 new captives form last year, 20 new commercial insurers. It's interesting. Those commercial insurers were dominated by companies looking to conduct long-term business. It was great to see renewed interest in that space.

I believe that is a consequence of Bermuda's being granted qualified jurisdictional status by the U.S. NAIC, which then reduces the collateral requirements for non-admitted insurers looking to place reinsurance business into the United States.

From a captive perspective, we continue to see a broad spectrum of interest but there has been a move to attract business from both Canada and Latin America.

Twenty-five percent of our new captives represented formations from those two regions. While we understand there is increasing competition, Bermuda continues to hold its own in both the commercial and captive and ILS space.

Could you speak to what you're seeing in terms of premium volume?

In the commercial space we are seeing increased premiums, even in a period of a continuing soft market.

We had $130 billion of premiums written in our commercial space during 2013 and some $23 billion written in 2013 in the captive space.

Many of these debates around comparisons of domiciles are normally focused on incorporation numbers and register's numbers, but it's my belief that premium volume is probably a better statistic as to the robustness of any particular market.

Bermuda continues to be the world's risk capital and the home of many of the large reinsurance companies and continues to be the premier captive domicile globally.

We are in a good place.

--Meg Green

Lori Chordas is a senior associate editor. She can be reached at lori.chordas@ambest.com.
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Title Annotation:The Web: Solvency II
Author:Chordas, Lori
Publication:Best's Review
Geographic Code:5BERM
Date:Jun 1, 2015
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