Will Solvency II give full recognition to third-country supervisory systems? What are the implications for insurers? Author Dr. Kathleen Ehrlich Contact solvency-solutions@munichre.com You wish to receive regular information about Solvency II? You can find our Knowledge Series at www.munichre.com September 2011 1 Cf. Consultation Papers 3, 4 and 5. Available online at: https://eiopa.europa.eu/consultations/consultation-papers/index.html. The ability to set up branches and freedom of services are important principles for the European single market. They make it more difficult for insurance companies from third countries to gain access to the European Economic Area (EEA). Supervisory authorities in third countries can, however, apply for full recognition of their system, which facilitates access to the markets in EEA member states for the companies they regulate hence its considerable importance for the insurance industry. Recognition makes it clear how insurance contracts with insurance companies from third countries are to be treated. The main aim of Europe s equivalence assessment is to ensure that a third country s supervisory system guarantees the same protection for policyholders as under the Solvency II regime. The European Insurance and Occupational Pensions Authority (EIOPA) has initially assessed the equivalence of the supervisory systems in Switzerland, Japan and Bermuda and published the results in three draft reports, on which comments can be submitted until the end of September in the context of the consultation process. 1 The assessment will focus on whether the third country s supervisory system uses a risk-based approach, considering the following factors: Reinsurers domiciled in non-eea countries (reinsurance supervision in accordance with Article 172): recognition of equivalence will mean that contracts with reinsurers in the third countries concerned will be treated in the same way as contracts with EEA reinsurers, so that reinsurance protection for an insurer will be fully recognised for supervisory purposes. The recognition of a third-country supervisory system is important for the group solvency calculation (Article 227), as it means that the group may take account of the third country s solvency capital requirement and the capital eligible to meet that requirement in the calculation of group solvency. Supervision of EEA insurers that belong to a group based in a third country (group supervision in accordance with Article 260): recognition of equivalence would mean that the EEA supervisors would rely on group supervision by the third-country regulator. The examination of a third country s supervisory system can encompass either all of the three articles in the Solvency II Directive relating to the recognition of third-country supervisors, as was the case for the current assessment of the Swiss and Bermuda systems, or only specific areas, as with Japan. The applicable assessment criteria were defined in
Seite 2/6 Principles Bermuda Japan Switzerland Art. 172 Art. 227 Art. 260 Art. 172 Art. 172 Art. 227 Art. 260 Largely for classes 3, 3A, 3B and 4 Partly for classes 1 and 2 Largely for classes 3, 3A and 4 Partly for classes 1 and 2 1 Powers and responsibilities 2 Professional secrecy, exchange of information and promotion of supervisory convergence 3 Licensing conditions for the taking-up of insurance business partly largely 4 System of governance and public disclosure Partly for classes 3B and 4, in some areas also for 3A largely partly Not for classes 1 to 3, in some areas also for class 3A 5 Changes in business, management and qualifying holdings not largely 6 Solvency assessment Largely for classes 3A, 3B and 4 largely 7 Solvency assessment Largely for classes 3A, 3B and 4 8 Scope of group supervision 9 Cooperation and exchange of information between supervisory authorities 10 System of governance and public disclosure Equivalent, though scope of supervision still at development stage partly partly 11 Changes in business, management and qualifying holdings not partly 12 Solvency assessment Largely for classes 3A, 3B and 4 Table 1
Seite 3/6 2 Available online at: https://eiopa.europa.eu/ consultations/consultation-papers/2010-2009-closed-consultations/september-2010/ consultation-paper-no-82/index.html 3 Cf. EIOPA Draft Report Equivalence assessment of the Bermudan supervisory system: no assessment was made for insurers with longterm business as the category was only introduced earlier this year. Consultation Paper no. 82. 2 Each criterion is assessed and given one of the following five ratings:, largely, partly, not or not applicable. EIOPA will submit one of the following overall assessments to the European Commission for each supervisory system examined: Country A satisfies the criteria set by the European Commission, Country A satisfies the criteria set by the European Commission subject to certain caveats, or Country A must make changes in order to satisfy the criteria set by the European Commission for recognition of equivalence. The result of the equivalence assessment (Table 1) is of particular importance for companies from third countries conducting reinsurance business in member states and insurance groups with subsidiaries in an EEA member state. Japan Japan is the second-largest insurance market in the world after the USA. The result of the equivalence assessment will affect Japanese reinsurers covering risks in European member states. Consequently, only reinsurance supervision was covered in the assessment of the Japanese supervisory system, which substantially meets the equivalence criteria. Changes are required to the conditions for licensing insurance companies, the governance and disclosure requirements, and the calculation of capital requirements. EIOPA has also requested the Japanese supervisory authority to adjust the existing requirement criteria to ensure that potential risks that might endanger the stability of the capital markets can be identified at an early stage. Switzerland The Swiss supervisory system was assessed in all three areas defined in the Solvency II Directive for the recognition of third-country supervision. EIOPA has concluded that the Swiss supervisory system largely meets the equivalence criteria set by the European Commission. Amendments are required only to the governance and disclosure requirements. Bermuda Bermuda plays a significant role in the global and European insurance markets, with more than 1,000 insurers being regulated by the BMA at the end of 2009. The BMA divided the insurers into eight classes: three for captives, three for traditional insurance companies, one for special purpose insurers, and one for insurers with long-term business, which is in turn divided into six sub-classes (Table 2). 3 The Bermudan supervision system was also assessed in all three areas defined in the Solvency II Directive for the recognition of third-country supervision. For a number of criteria the system was considered to be not, or only partly,. One criticism of the system was that in Bermuda there are no uniform requirements for all classes of insurance, so that, for example, the supervision criteria for captives do not comply with Solvency II requirements. As the regulatory system for long-term insurers is still at the development stage, a definitive assessment is not possible at present. As a result, EIOPA concludes in its report that the Bermudan supervisory system is currently only to the Solvency II regime in some areas relating to the supervision of traditional insurers in classes 3A, 3B and 4. Other parts of Bermuda s supervisory system can be expected to be considered subject to certain caveats.
Seite 4/6 Company class Class 1 Class 2 Class 3 Single-owner captives insuring only the risks of their owners or of affiliates of their owners Single or multi-owner captives deriving up to 20% of their net premiums from unconnected entities ( unrelated parties ) Captives deriving up to 50% of their net premiums from unrelated parties Where are improvements required according to EIOPA? The assessment highlighted the following deviations from the European supervisory system: The degree of discretion on the licensing requirements for insurance companies deviates too much from the Solvency II requirements. Class 3A Class 3B Class 4 Class 5 Class 6 Insurers deriving 50% or more of their net premiums from unrelated parties, where total net premiums from business with unrelated parties are less than $50m Insurers deriving 50% or more of their net premiums from unrelated parties, where total net premiums from business with unrelated parties are US$50m or more Insurers with capital and surplus of $100m or more, or writing catastrophe business Special-purpose insurers Insurers writing life insurance or long-term business: Class A: Single-owner captives insuring only the risks of their owners or of affiliates of the owners Class B: Single or multi-owner captives deriving up to 20% of their net premiums from unrelated parties Class C: Insurers with total assets of less than $250m Class D: Insurers with total assets of $250m and over, but less than $500m Class E: Insurers with total assets of $500m and over There is no legal requirement stipulating that an insurer must have its head office in the same country as its registered office. 4 Solvency II stipulates that insurance companies may not conduct non-insurance business, 5 but there is no such rule in Bermuda. It is therefore possible for a company to conduct both insurance and noninsurance business, which would create additional risks. For some classes of insurance, the governance and disclosure requirements differ from those under Solvency II, for example requirements for key positions, the independence of internal audit and outsourcing. Though compliance with the code of conduct is mandatory for all insurers, the Bermudan supervisory authority has introduced varying application procedures for different classes of insurance. Insurers writing a combination of long-term (or life) business and non-life business Table 2: Insurance company classes There are insufficient mandatory criteria to enable future changes in the economic situation to be identified. EIOPA requires stricter rules defining the process for outsourcing key functions. EIOPA requires that more information be publicly accessible. 4 Cf. Article 20 of the Solvency II framework directive. Available online at: http://ec.europa. eu/internal_market/insurance/solvency/ index_en.htm#oj 5 Cf. Article 18 (1) of the Solvency II framework directive.
Seite 5/6 The BMA applies varying risk-capital measurement criteria for different classes of insurance. Contrary to Solvency II requirements, in some areas a risk-based approach is not prescribed and as a result capital requirements are frequently below Solvency II levels. As regards Article 227, the assessment found deviations from the European supervisory system, particularly in the calculation of risk capital. As Bermuda is expected to introduce its system for group supervision at the end of 2011, the assessment is based only on the proposed system for group supervision. Changes are required notably in the area of cooperation and exchange of information between supervisory authorities, for example cooperation between supervisory authorities where there is no college of supervisors ; cooperation between supervisory authorities in crisis situations; establishment and composition of colleges ; mediation procedures; cooperation between supervisory authorities on approvals of internal group risk models. Amendments to the governance and disclosure requirements are also required. EIOPA has identified the following areas that the BMA would need to strengthen for them to be considered : The independence of internal audit The outsourcing process Disclosure requirements Moreover, the BMA s requirements relating to the identification of risks that could have an adverse impact on a company s financial situation deviate too much from the Solvency II rules. EIOPA requires the BMA to lay down mandatory standards to achieve equivalence. EIOPA also requires minor amendments to the powers and responsibilities of the BMA, in particular uniform application for all classes of insurance. What are the implications for insurers? Solvency II is intended to prevent distortions in competition and uneven playing fields and it is important for comparable standards also to apply to third countries, even if they are not subject to the jurisdiction of the European competition authorities. Europe therefore welcomes signs that third countries are committed to introducing similar standards. All insurers based in third countries that operate in the European Economic Area are affected by the future Solvency II regulations. If supervisory systems converge worldwide, consultation and cooperation between national supervisory authorities can also be expected to improve. This will provide better conditions for competition and reduce opportunities for regulatory arbitrage. In the long term, it will also mean that similar risks will in principle be treated in the same way. For insurance companies with affiliated companies in a third country, recognition of equivalence will mean that the group may take account of the third country s solvency capital requirement and the capital eligible to meet that requirement in the calculation of group solvency. 6 Affiliated companies in the third country will not initially be directly affected by recognition, as the Solvency II Directive only applies
Seite 6/6 in member states. However, the results have shown that third-country systems need to be adapted in some areas. Third-country insurers will have to contend with the adjustments their regulators will need to make to achieve recognition of equivalence. Existing structures and processes will have to be reviewed depending on the current requirements and conditions, though the additional work involved will bring considerable gains in the area of risk assessment. Insurers with affiliated companies in third countries and those based in third countries with affiliated companies operating in member states will therefore have to take account of any changes in future decisions on location. Solvency Consulting for your company Munich Re assists its clients in all areas of Solvency II. Solvency Consulting has already amassed a wealth of experience in dealing with the standard formula, the development and use of internal stochastic risk models and their relevance to valuebased portfolio management. Munich Re also plays an active role in industry committees looking at regulation and specialist issues and ensures that knowledge and expertise are transferred and translated into practical recommendations for action on the ground. We are thus able to offer our clients real and ongoing help in preparing for Solvency II. 2011 Münchener Rückversicherungs-Gesellschaft Königinstrasse 107, 80802 München, Germany Order number 302-07152 6 If the deduction and aggregation method is used in accordance with Article 233 of the Solvency II framework directive.