Solvency II fundamentally rewrites the prudential rules for insurers, reinsurers and (re)insurance groups. The new rules will improve regulatory consistency across the European Economic Area (EEA). They will also improve policyholder protection and reduce the risk that a (re)insurer will fail. However, the new rules are complicated, especially if the (re)insurer has a parent or subsidiary outside the EEA.
The EEA (re)insurer
Solvency II will require:
- Each EEA (re)insurer to hold eligible own funds to cover its solvency capital requirement (SCR).
- Each EEA member state to supervise the (re)insurers headquartered on its territory using "home member state supervision".
An EEA (re)insurer with a branch office
If an EEA (re)insurer (A) opens a branch office in another member state, it will still be a single legal entity; so home member state supervision still applies.
An EEA (re)insurer with a subsidiary inside the EEA
If A acquires a 20% interest in the capital or voting rights of another EEA (re)insurer (B):
- A and B will still be required to hold eligible own funds to cover their own SCRs;
- A and B will still be supervised by their home member states;
- A will be required to ensure there are eligible own funds available in the group to meet the group SCR; and
- A's home member state will supervise the group using a College to inform supervision.
Group solvency will be calculated using the "default method", which relies on consolidated data and accounts. Under this method, A's group solvency will be the difference between the own funds eligible to cover the SCR and the SCR at group level.
The group may be able to use the "alternative method" (deduction and aggregation), or a combination of methods, but only if:
- The exclusive use of the default method is not appropriate; and
- The group supervisor has agreed the change with B's supervisor and with A.
If the alternative method is used, A's group solvency will be the difference between:
- The sum of (i) A's SCR eligible own funds; and (ii) A's proportional share of B's SCR eligible own funds; and
- The value of B in A, plus A's SCR, and A's proportional share of B's SCR.
Double counting is not permitted and the proportional shares taken into account must reflect the control A actually has in B, rather than the control it appears to have in B. The result is that, after consulting the supervisory College, the group supervisor may decide that A's group solvency calculation should include:
- A proportional share of a third group company (C), even if A doesn't hold any shares or voting rights in C.
- A greater proportional share of a fourth group company (D) if A exercises a dominant influence over D even though it only has a small percentage of D's voting rights or capital.
An EEA (re)insurer with a subsidiary outside the EEA
If an EEA (re)insurer (A) acquires a 20% interest in the capital or voting rights of a (re)insurer based outside the EEA (E), the same basic principles apply.
However, if group solvency is calculated using the alternative method, an equivalence issue arises. If E's home state has a solvency regime that is equivalent to Solvency II, group solvency can be calculated using E's local rules to assess E's SCR and eligible own funds. If E's home state does not have an equivalent regime, Solvency II rules must be used to calculate E's SCR and eligible own funds instead.
An EEA (re)insurer owned by a third-country group
If the EEA (re)insurance group (A, B, C, D and E) is owned by a third-country (re)insurer (F), some additional issues arise.
A's supervisor will be required to assess whether F is subject to group supervision that is equivalent to Solvency II. A's supervisor:
- May carry out the equivalence assessment on its own initiative or at A's request.
- Must consult B's supervisor and the European Insurance and Occupational Pensions Authority (EIOPA) before making an equivalence decision.
If the third-country group supervision is equivalent, the EEA supervisors must rely on the third country to supervise the group. In these circumstances, the EEA supervisors will form a supervisory college with the third-country supervisor to inform group supervision.
If the third-country group supervision is not equivalent, the EEA supervisors will need to decide how to supervise the group. This might mean supervising the whole group through the EEA parent company (A) or restricting supervision to the EEA sub-group instead.
Solvency II also gives member states the power to use "other methods" to ensure appropriate group supervision. "Other methods" are not explained but:
- They must be agreed by the group supervisor, after consultation with the other supervisory authorities.
- They may include requiring the group to establish an EEA (re)insurance holding company to enable EEA sub-group supervision.
Equivalence assessments and transitional arrangements
The European Commission (the Commission) has the power to carry out equivalence assessments for group solvency and group supervisory purposes. These are distinct decisions: a third-country might be equivalent for one purpose, and not the other.
The Commission has asked EIOPA for detailed equivalence advice on Switzerland and Bermuda by September 2011 so that it can make equivalence decisions for those countries by July 2012.
The Commission is unlikely to make equivalence decisions on any other third countries before (re)insurers are required to comply with Solvency II (from 1 January 2013).
In the absence of a Commission equivalence decision, member states can make their own equivalence decisions. However, they are unlikely to do so for a number of reasons:
- Assessing equivalence is time and resource intensive (EIOPA will take almost a year to prepare its advice on Switzerland and Bermuda, and the Commission will need almost another year to make its equivalence decisions).
- A member state cannot make an equivalence decision until it has consulted the other member states and EIOPA.
- The member states and EIOPA are devoting so much time and resource to Solvency II implementation they are unlikely to be able to carry out equivalence assessments as well.
- EIOPA will be keen to ensure consistency between one equivalence assessment and the next, and to develop a consistent view across the EEA before each equivalence decision is taken. These (quite reasonable) objectives will slow the decision-making process down.
- The Commission can make transitional arrangements that will require member states to treat third-countries that are not equivalent as if they are. This power may act as a disincentive to member states that are considering whether to make equivalence decisions of their own.
Correspondence between the Commission and EIOPA suggests that, if the Commission is unable (for technical reasons) to make a positive equivalence assessment for Switzerland and Bermuda, it may use its transitional powers for both. It may also introduce transitional arrangements for the United States (for group solvency and group supervision) and (perhaps) Canada, Japan and Australia (for group supervision). But that is all.
Although it would be wrong to read too much into EIOPA's Report on the fifth Quantitative Impact Study (QIS5) for Solvency II , it does tend to suggest that (if end of 2009 figures are used):
- European (re)insurer's surplus assets will be 12% lower under Solvency II than Solvency I.
- Overall group surplus will be 43% lower under Solvency II than Solvency I, if the standard formula SCR and accounting consolidation are used. And lower still if deduction and aggregation is used instead.
- The overall impact of using local rules for non-EEA subsidiaries under the deduction and aggregation method will be about €45 billion "justifying a transitional measure with review clause for a few third countries that have not yet met the equivalence test".
The Financial Services Authority's UK Country Report on QIS5 adds that:
- "The use of local rules for non-EEA firms when using the deduction and aggregation method...has a large capital impact for a number of international groups. Without the ability to transition out of using local rules in an orderly manner, or the introduction of appropriate equivalence regimes, there would be a large increase in group solvency requirements..."
What does this mean? See our action points on what (re)insurance groups should consider in order to reduce the potential impact of Solvency II.