Solvency II raises barriers for US reinsurers to underwrite risk in Europe

Some US reinsurers could be in for a nasty surprise in the upcoming renewals as they discover unexpected barriers that could prevent them writing business in Europe because of rule changes that have been introduced by European countries in conjunction with the implementation of Solvency II.

The situation could lead to a migration of business to Solvency II-equivalent jurisdictions and, potentially, retaliation measures, according to some commentators.

Solvency II is the legislative programme implemented by EU member states this year. It has introduced a new, harmonised, EU-wide insurance regulatory regime, replacing 14 EU insurance directives.

When regulators of many European countries changed their own regimes to give Solvency II precedent, they also—sometimes inadvertently—made things much harder for reinsurers based in non-Solvency II-compliant countries to do business there, according to Brad Kading, president of the Association of Bermuda Insurers and Reinsurers (ABIR).

Germany, Poland and the Netherlands are just three countries where specific rules are now in place that make it very difficult for reinsurers outside Solvency II to trade with insurers in those countries, he notes.

“There are now some clear impediments for reinsurers wishing to do business in some European countries, which could become a big problem for US reinsurers,” Kading suggests. “Negotiations around a EU-US regulatory deal are underway but the final implementation process could take years and it looks unlikely that a solution will be in place by the January 1 renewals.”

NO EASY SOLUTION

Many companies aware of a potential problem might have assumed that any issues could be overcome by posting collateral. But that may not be enough to resolve the problems, Kading says.

Solvency II gives freedom to EU member states to apply additional measures to reinsurers from countries that are not Solvency II-equivalent, and some jurisdictions decided to exercise this right. Some imposed additional requirements for players from non-Solvency II-equivalent jurisdictions, some of which refer to local presence and reporting.

“The approach of Solvency II to third country reinsurers doing business in a particular country’s territory is broad-based rather than specific,” says James Smith, executive director at accounting firm EY.

“The Solvency II directive basically says that member state countries shall not apply provisions to third country reinsurance undertakings taking up or pursuing reinsurance activity in its territory, which result in a more favourable treatment than that granted to reinsurance undertakings which have their head office in that member state,” he explains.

“There are different approaches to the interpretation of the term ‘taking up or pursuing reinsurance activity in the country’, and there are different sets of regulations which arguably are all compliant with Solvency II requirements,” he adds.

The German regulator, for example, has decided this means that a company that wants to reinsure German insurance companies must either be authorised in Germany (which means getting a branch office and having to comply with various local governance requirements including local capital requirements), or have a head office in a regime that the European Commission has decided is equivalent to Solvency II for the purposes of reinsurance, Smith says.

THE LUCKY FEW

The European Commission has given three jurisdictions the status of equivalence to Solvency II standards in this particular aspect of the EU directive: Bermuda, Switzerland and Japan.

As a result, reinsurers that do not have a subsidiary either in the EU or in one of the Solvency II-equivalent jurisdictions may not be allowed to trade in some EU countries.

“As an example, looking at a recent communication from the German regulator, it seems that a reinsurer wanting to underwrite from say the US into Germany would not be able to solicit business from German insurers unless it obtains authorisation in Germany,” Smith explains.

An exemption could be that a German insurance company contracts a US reinsurer to cede some business, but it does not work the other way around.

“It’s a quite restrictive situation,” he notes.

If the German regulator decides that a reinsurer has been doing business in Germany without authorisation and without a finding of equivalence, the reinsurance contract is unlikely to be invalidated but the regulator could be able to order the reinsurance company to cease what it’s doing and to put the business into run-off.

While reinsurance contracts which were in force before Solvency II will remain valid, problems are likely to become visible in the renewal as this creates a new contract.

Some businesses might not be affected for some years if they have signed multi-year reinsurance contracts, but in the case of annual renewals, “one can see that as quite a difficult issue,” Smith says.

“I wouldn’t be at all surprised to see some of these areas of Solvency II made the subject of an interpretative communication by the EC or guidelines from the European Insurance and Occupational Pensions Authority,” Smith notes, but that could be a slow process.

In order to resolve this issue, concerned parties could lobby the European authorities, point to the grey areas and inconsistencies in the laws and request them to tighten this up as it is disadvantaging companies, Smith suggests.

“It is in Europe’s interest to avoid undue disadvantage, as otherwise there is a possibility that the governments of the jurisdictions whose reinsurers are disadvantaged by this might take retaliatory action,” he notes.

There is, however, another disadvantage for reinsurers from non-Solvency II jurisdictions which may affect their ability to underwrite risk in Europe during the upcoming renewals season.

European insurers incur a higher charge on reinsurance recoveries if the reinsurer is not based in the EU or in a Solvency II-equivalent territory, says Barney Wanstall, director, advisory at auditing and consulting firm PwC.

“Because the insurer will suffer a higher capital charge by placing reinsurance with a reinsurer of a non-equivalent jurisdiction, it is more likely to place it with a reinsurer based in a Solvency II-equivalent jurisdiction,” Wanstall says.

NEGOTIATIONS CONTINUE

There is a continuous debate between Europe and the US about how the re/insurance trade works between the two and what are and aren’t the appropriate requirements each jurisdiction can place on companies in each location, Wanstall notes.

The insurance regulatory and supervisory dialogue between the US and EU is important to both sides, given the size of the jurisdictions’ bilateral trade in re/insurance, The American Council of Life Insurers, Insurance Europe, the Reinsurance Association of America and the American Insurance Association said in a joint September 21 statement ahead of upcoming negotiations.

“The dialogue between authorities in the EU and the US may help getting to a situation where the EU is comfortable with the US and vice versa, and could result in an agreement that gives US reinsurers easier access to the EU area,” Smith says.

Meanwhile, reinsurers which are not located in Solvency II regimes should look into their portfolios and check whether they are still able to do business in the European country where the cedant is located, Smith suggests.

“If not, such a reinsurer is unlikely to be able to fix the problem before the upcoming renewals season. Gaining authorisation usually takes a minimum of six months,” he says.

“But they can at least start to take steps to bring themselves into compliance. Some groups may have a reinsurer based in Bermuda and could conduct the business from there.

“The most secure way for a third country reinsurer to ensure that it can do business in Europe is by creating a subsidiary unit in an EU country—a branch would not be sufficient as it would allow the reinsurer only to do business in the country where the branch is located,” Smith explains.

“Another option could be creating a reinsurance subsidiary or affiliate company in Bermuda, Switzerland or Japan. Bermuda could, therefore benefit from the fact that it’s been judged to be equivalent for the purposes of this particular aspect of the directive,” he concludes.