February 3rd, 2016

Solvency Regimes: Third-Country Equivalence

Posted at 1:00 AM ET

Current capital requirements in the United States are set at a legal-entity level. Yet there are currently no global requirements for companies that operate in more than one country, and calculation formulas for capital requirements typically vary in each jurisdiction. Solvency II is the closest to mandating a group standard. Solvency II uses the concept of “equivalence” to deal with differing capital regimes between the European Union and the rest of the world including the United States, instead of forcing Solvency II standards on a third country.

In June 2015, the European Commission confirmed “provisional” equivalence for a period of 10 years for six countries - Australia, Bermuda, Brazil, Canada, Mexico and the United States. Only Switzerland was granted “full and permanent” equivalence status. To calculate the group solvency position, European insurance groups are permitted to use the local capital requirement rules of the corresponding country for subsidiaries within these seven countries. But there is still a lot of uncertainty around the extent to which the different risk-based capital ratios should be used.

For subsidiaries in other countries, European insurance groups are still in the dark as to which capital requirement rules should apply. The same is true for possible group supervisory requirements for European subsidiaries of overseas groups and the requirements for reinsurance contracts bought from reinsurers outside Europe. A second round of equivalence decisions by the European Commission is expected in the autumn of 2015. It is believed that other countries, such as China, Hong Kong and Singapore are also interested in “provisional” equivalence status.

The Japanese Financial Services Agency is seeking to achieve equivalence only for domestic reinsurance companies writing business in Europe. This will allow Japan-domiciled reinsurers to assume business in Europe without collateral requirements for unearned premium or reinsurance recoverables. In a 2015 report by the European Insurance and Occupational Pension Authority (EIOPA), Japan was listed as equivalent or largely equivalent in five out of six considered categories, so it is believed that Japan will be granted “full and permanent” equivalence for reinsurance business.

U.S. insurance regulators have historically required non-U.S. reinsurers to hold 100 percent collateral within the United States for the risks they assume from U.S. insurers. As reinsurers are ultimately providing insurance to other insurance companies that are directly protecting U.S. policyholders, requiring collateral in the United States is intended to ensure claims-paying capital is available and reachable by U.S. firms and regulators should it be needed, particularly in the wake of a natural disaster. Foreign reinsurers’ regulators and politicians have objected to this requirement in part because this capital is not available for investment in other opportunities.

State regulators understand and recognize that the potential for variation across states makes planning for collateral liability more uncertain and thus potentially more expensive. State regulators have been working together through the National Association of Insurance Commissioners (NAIC) to reduce collateral requirements in a consistent manner commensurate with the financial strength of the reinsurer and the quality of the regulatory regime that oversees it.

Recently, the NAIC passed amendments that reduce the financial strain on foreign reinsurers. Foreign insurers may post less than 100 percent collateral for U.S. claims, provided the reinsurer is evaluated. The NAIC established a number of new processes and procedures for evaluating and overseeing foreign reinsurers in addition to making amendments to the “Credit for Reinsurance Models.”

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