In a previous Sidley update (click here), we commented on the equivalence regime under Solvency II1, outlining its scope and the effect that a determination of equivalence achieves with respect to insurance groups headquartered outside the European Economic Area (EEA) i.e. “third countries”, which have operations in the EEA and, on EEA insurance groups that have third country subsidiaries. On June 5, 2015, the European Commission adopted its first third country equivalence decisions under Solvency II, which concern, among others, the U.S. and Bermuda.
What is “equivalence”?
The Solvency II Directive sets out three distinct areas for equivalence determination of third countries:
- Reinsurance (Article 172) – this relates to reinsurance activities of firms located in third countries. Where the solvency regime of a third country is deemed to be equivalent to Solvency II, reinsurance contracts between EEA insurers and reinsurers in that third country will be treated in the same way as reinsurance contracts concluded between EEA firms.
- Group Solvency (Article 227) – this applies to EEA groups with third country subsidiaries. If a determination of equivalence is made, EEA groups will be allowed to apply the local calculation of capital requirements in respect of their third country subsidiaries, instead of applying a Solvency II calculation.
- Group Supervision (Article 260) – where a parent company of a group of EEA firms is in a third country, a determination of equivalence would mean that the EEA supervisors would rely on the group supervision of that third country.
For each of these three areas, equivalence can be granted for either an unlimited or limited duration. If equivalence is for an unlimited period, “full” equivalence is deemed to have been determined. This determination essentially means that a third country’s regulatory regime is considered to be fully equivalent to that established by Solvency II because it complies with requirements which provide a comparable level of policyholder and beneficiary protection. If equivalence is for a fixed term, equivalence will, under the transitional regime set out in the Omnibus II directive2 (the directive which amends Solvency II), be either “temporary” or “provisional.” Temporary equivalence applies to reinsurance and group supervision and is granted for five years with a possible extension of one year. Provisional equivalence, on the other hand, only applies to group solvency and will be granted for an initial period of ten years, with the option to renew for further ten year periods. For both temporary and provisional equivalence, inclusion in these transitional measures will only occur where the third country’s regime meets the necessary criteria.
The European Commission’s announcements of its first third country equivalence decisions on June 5, 2015, concern the U.S., Switzerland, Australia, Bermuda, Brazil, Canada and Mexico. Other than in respect of Switzerland, the European Commission’s decisions all relate to provisional equivalence in respect of group solvency. Provisional equivalence will be granted where a third country may not meet all the conditions for full equivalence, but is likely to adopt a fully equivalent solvency regime in the foreseeable future.
The issue of group solvency relates to the way in which third country “related undertakings” (i.e. subsidiaries or other undertakings in which a “participation”3 is held by an insurer) are integrated into the calculation of the group solvency capital requirement of an EEA parent. Solvency II provides for two methods for calculating group solvency – the first is the accounting consolidation-based method set out in Article 230, which is based on the consolidated accounts of the group (the “default method”), and the second is the deduction and aggregation method set out in Article 233, which calculates group solvency as the difference between the sum of the aggregate own funds in the group and the aggregated solvency capital requirements in the group (the “alternative method”).
A positive equivalence determination will allow EEA insurance groups, which are permitted by their group supervisor to use the alternative method, to use the local rules with respect to their own funds and capital requirements rather than the Solvency II rules, for their related undertakings in the relevant third country. Where the third country is not found to be equivalent, the related undertaking’s own funds and capital requirements would have to be recalculated according to the rules under Solvency II. This could potentially impose more stringent capital requirements on the third country entity than would be the case under local rules and therefore place the group at a competitive disadvantage to equivalent insurers in that third country which would be holding capital pursuant to local rules.
The inclusion of the U.S. in this “first package” of equivalence decisions has been welcomed by the insurance industry. Group solvency is one area where the Commission has the ability to make such a determination without a country expressly seeking it.
In its decision, the European Commission commented that a key part of the information for the assessment was obtained through the EU-U.S. Dialogue Project (the “Dialogue”). This is an initiative that began in 2012 with the objective of achieving mutual understanding of the respective insurance regulatory and supervisory regimes in the EU and the U.S. The participants in the Dialogue are the U.S. National Association of Insurance Commissioners, the U.S. Federal Insurance Office, the European Commission, the European Insurance and Occupational Pensions Authority (EIOPA), and certain supervisors of EU Member States. Recent information gathered in the framework of the Dialogue has provided the basis for the Commission’s present assessment on the U.S.
Which other countries are affected?
Switzerland, Bermuda and Japan had sought full equivalence, although in Japan’s case for reinsurance only. Having assessed the regulatory regimes in each of these countries, EIOPA published its final reports in March this year for the Commission, essentially providing that the regimes in these countries met the criteria in EIOPA’s methodology for equivalence assessment under Solvency II, subject to certain caveats.
Of the three, Switzerland has received a determination of full equivalence in all three areas of Solvency II: group solvency, group supervision and reinsurance. Bermuda, on the other hand, has initially been granted provisional equivalence in respect of group solvency only, although it had originally sought full equivalence in all three areas of Solvency II in the same way as Switzerland. The Bermuda Monetary Authority (BMA) has stated that it is still committed to achieving full equivalence and that its inclusion in the provisional regime is a “timing issue”. According to the BMA, its submission for full equivalence is currently being reviewed and it anticipates a decision between Q3 2015 and Q1 2016.
Japan, however, has not been included in this first wave of decisions. Similarly, a number of other countries which, in 2012, expressed an interest in being part of a transitional regime have also not been included in these initial equivalence decisions. These are: Chile, Hong Kong, Israel, Singapore and South Africa. Brazil, China and Turkey engaged with the Commission slightly later in the process with respect to inclusion in a transitional regime and, of these three, only Brazil has, at this stage, received a determination of provisional equivalence.
What happens next?
The European Commission’s equivalence decisions now need to pass to the European Parliament and the Council for scrutiny and ratification, for which the time limit is three months, although the Parliament and Council have the power to extend this period by a further three months.
The European Commission has confirmed that further Solvency II equivalence decisions are envisaged in the future, but without giving any indication as to when these might be expected. In the interim, there remains considerable uncertainty and the international reinsurance market will be keenly awaiting clarification as to whether the Bermudian, Japanese and U.S. markets, in particular, will be treated as equivalent for reinsurance activities under Article 172.