On 13 January 2017, the US Department of the Treasury (the Treasury) and the Office of the US Trade Representative (the USTR) notified Congress that they had negotiated a bilateral trade agreement with the European Union (EU), known as a ‘covered agreement’ (the Agreement). The Treasury and the USTR are authorised to negotiate covered agreements under the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank).
In the EU, the Solvency II Directive recognises the fact that the insurance industry is a global industry and, to avoid unnecessary duplication of regulation, the European Commission may determine that a third country’s solvency and prudential regime is equivalent to Solvency II. Equivalence between third country jurisdictions and the EU can be mutually beneficial to EU (re)insurers and third country (re)insurers: (re)insurers can use local rules in equivalent jurisdictions to report on their operations in third countries; (re)insurers based in an equivalent jurisdiction can be treated in the same way as EU (re)insurers for solvency purposes; and EU supervisors can rely on the group supervision of an equivalent third country.
For the past few years, the US and the EU have been considering the application of Solvency II and whether or not the US would seek to be recognised as an ‘equivalent’ jurisdiction under the Solvency II Directive, for the purposes of ‘group solvency’ (see below). Temporary equivalence was granted to the US in 2015 until 1 January 2026. It is important to note that the Agreement does not recognise the US as a fully equivalent jurisdiction but rather establishes a system of mutual recognition between the EU and the US. For the moment at least, there are no indications that the US will consider seeking full Solvency II equivalence.
The Agreement addresses three areas of insurance regulation: reinsurance, group supervision and the exchange of information between insurance supervisors. The Treasury and the USTR submitted a copy of the final legal text of the Agreement following private negotiations with the EU.
Overview of the Agreement
The reinsurance provisions in the Agreement aim to ensure that a foreign reinsurer is not disadvantaged relative to a locally domiciled reinsurer. The Agreement eliminates collateral and local presence requirements for US reinsurers operating in the EU and, vice versa, for EU reinsurers operating in the US.
However, these collateral or local presence provisions only apply if the (re)insurer satisfies certain conditions and standards. These include, minimum capital and risk-based capital (RBC) (please see table below); confirmation of financial condition by the reinsurer’s domestic regulator; claims payment standards; and consent in writing to pay all final judgments obtained by a ceding insurer in the courts where the judgment was obtained.
Collateral requirements under the Agreement
Own funds or capital and surplus when dealing with a US cedant
Own funds or capital and surplus when dealing with an EU cedant
Minimum solvency / RBC ratio
300% Authorised Control Level / solvency ratio of 100% solvency capital requirement (SCR) under Solvency II
In addition, the assuming (re)insurer must also provide certain information to the host supervisory authority if requested. The provision does not purport to have retrospective effect for collateral requirements already in place.
The US has 5 years to implement the reinsurance provisions and has agreed:
- that each year after the Agreement comes into effect, to reduce the amount of collateral required by 20%; and implement the relevant US state credit for reinsurance laws and regulations consistent with the Agreement.
- 42 months after the signing of the Agreement, the US will evaluate a potential preemption determination with respect to any US State insurance measure that is inconsistent with the terms of the Agreement. This determination must be completed within 60 months.
Further, the EU must implement provisions with respect to the restrictions on local presence requirements for reinsurance within 24 months of the date of signing of the Agreement.
Reinsurance equivalence under Article 172 of the Solvency II Directive is relevant for reinsurers from third countries. If the third country’s rules are deemed equivalent, such reinsurers must be treated by EU supervisors in the same way as the EU reinsurers for solvency purposes. This has the effect of increasing the attractiveness for EU insurers of entering into reinsurance arrangements with reinsurers from equivalent third countries. Insurers under Solvency II must comply with rules relating to risk mitigation techniques and reinsurance and cedants may only take credit for reinsurance from non-EU reinsurers if they either are based in an equivalent jurisdiction or if they are rated at least BBB and collateralise the reinsurance. As the Agreement eliminates future collateral and local presence requirements for US reinsurers operating in the EU insurance market, and eliminates similar future requirements for EU reinsurers operating in the US insurance market (subject to the conditions outlined above), the Agreement has a substantially similar effect to the equivalence provisions under the Solvency II Directive.
The Agreement provides that, subject to various exceptions, an EU or US headquartered (re)insurance group is subject to worldwide prudential insurance group supervision (including worldwide group governance, solvency, capital and reporting requirements) only by the supervisory authorities of the jurisdiction where the worldwide parent of the group is domiciled or headquartered. So a US headquartered insurance group with an EU presence will not be subject to worldwide supervision under Solvency II. However, its EU subsidiary insurance group will continue to be supervised as a group under Solvency II as before. With respect to risks from outside their territories that threaten operations and activities within their territories, supervisors in both the US and the EU can request information relating to insurance groups supervised on a worldwide basis by supervisors in each other’s territories, and take appropriate action within their territory to protect policyholders and financial stability.
The group supervision practices described in the Agreement apply only to US and EU insurance groups operating in both territories. The key issues in relation to group supervision are set out below.
1. Supervision The Agreement addresses group supervision and provides in Article 4(a) that an EU or US home party (re)insurance group is subject only to worldwide prudential insurance group supervision including worldwide group governance, solvency and capital, and reporting, as applicable, by its home supervisory authorities, and is not subject to group supervision at the level of the worldwide parent undertaking of the insurance or reinsurance group by any host supervisory authority.
Under the Solvency II Directive, equivalence in respect of group supervision under Article 260 relates to group supervision of EU insurers with the ultimate parent outside the EU. Where equivalence exists EU supervisors should rely on the group supervision of that third country. As with the Solvency II provisions, under the Agreement, the host supervisory authority may exercise group supervision, where appropriate, with regard to a home party (re)insurance group at the level of the top parent undertaking within its territory, but worldwide group supervision is reserved by the territory where the ultimate parent company of the insurance group is based (provided this is in the same country as a (re)insurer in the group).
2. Group supervisor US insurance groups operating in the EU will be supervised at the worldwide group level only by the relevant US insurance supervisors and EU insurers operating in the US will be supervised at the worldwide group level only by the relevant EU insurance supervisors.
The group will have a single supervisor who is responsible for the co-ordination and exercise of group supervision. This supervisor will be designated from among the supervisory authorities of all Member States in which the group has subsidiaries. The group supervisor and all other supervisors are required to co-operate in accordance with the provisions set out in the Agreement. This also mirrors the effect of the Solvency II rules under which a group subject to Solvency II will have a single supervisor who is responsible for co-ordination and exercise of group supervision. This supervisor is designated from among the supervisory authorities of all Member States in which the group has subsidiaries in accordance with the rules for determining the group supervisor in the Solvency II Directive. The group supervisor and all other supervisors are required to co-operate in accordance with the provisions set out in the Directive.
3. Supervision of the system of governance The system of governance rules set out in Title I, Chapter IV, Section 2 of the Solvency II Directive apply at the level of the group and require that:
- all persons who effectively run the insurer (or insurance holding company) or have other key functions are ‘fit’ and ‘proper’. Such persons are required to be notified to the EU group supervisor;
- to the extent Member States require ‘proof of good repute’, this is provided;
- the insurer has in place an effective risk management system;
- an own risk and solvency assessment (ORSA) is carried out and the results are provided to the EU group supervisor;
- the group has in place an effective internal control system;
- the group has in place an effective internal audit system;
- the group has in place an effective internal actuarial function; and
- outsourcing of critical or important operation functions is undertaken in accordance with the provisions of the Directive.
This level of detail is not provided for in the Agreement. The Agreement does not expressly require the EU / US (re)insurers subject to the Agreement to have in place the system of governance requirements set out in Title I, Chapter IV, Section 2 of the Directive.
However, the Agreement envisages sharing the worldwide ORSA to the extent that such worldwide ORSA is required. Where no worldwide ORSA is required, under the Agreement it is sufficient for equivalent documentation to be shared with host supervisory authorities (if they are members of the supervisory college) and supervisory authorities of significant subsidiaries or branches of that group in the host party (at their request). The ORSA must include:
- a description of the insurance or reinsurance group’s risk management framework;
- an assessment of the insurance or reinsurance group’s risk exposure; and
- a group assessment of risk capital and a prospective solvency assessment.
Under the Agreement, host supervisors have the ability to request and obtain a summary of the worldwide group ORSA and may impose ‘preventive, corrective, or otherwise responsive measures’ where the summary of the worldwide group ORSA ‘exposes any serious threat to policyholder protection or financial stability’ in their territory.
Under the Agreement, US insurance groups operating in the EU will not have to meet EU global group capital, reporting, or governance requirements (subject to the ORSA requirements set out above and information that is deemed necessary as described below). This is potentially less onerous than the requirement under Solvency II where a report must be provided to the EU group supervisor setting out the solvency and financial condition of the group. The report must include, for example, descriptions of business and performance, risk exposures, capital management and any non-compliance.
Article 4(f) of the Agreement states that prudential insurance group supervision reporting requirements do not apply at the level of the worldwide parent undertaking of the (re)insurance group unless they directly relate to the risk of a serious impact on the ability of undertakings within the (re)insurance group to pay claims in the host territory.
However the host supervisor has the right to request and obtain information that is deemed necessary to protect against serious harm to policyholders or serious threat to financial stability or has a serious impact on the ability of a (re)insurer to pay its claims in the host supervisory authority territory.
In terms of timing, the EU will provisionally apply the group supervision provisions until the date of entry into force of the Agreement and then apply the group supervision provisions by ensuring that supervisory authorities follow the practices in the Agreement.
For 60 months after the date of provisional application of the Agreement, supervisory authorities in the EU cannot impose a group capital requirement at the level of the worldwide parent with regard to a US insurance group with operations in the EU. After the end of such 60-month period, however, EU insurance supervisors would be able to impose a group level capital assessment or requirement at the level of the US worldwide parent if state insurance laws applicable to US insurance groups are not then viewed as sufficient to include the authority to impose a group capital assessment and requirement.
The Agreement provides that the US and EU shall encourage, in a non-binding manner, their respective supervisory authorities to cooperate in exchanging information. To support such information exchange, an annex to the Agreement includes model provisions for a memorandum of understanding on information exchange that insurance supervisors are encouraged to adopt.
The Agreement does not address group solvency as this was addressed in June 2015 under a Commission Delegated Regulation on the provisional equivalence of the solvency regime in force in the US and applicable to (re)insurers with a head office in the US. The Commission granted the US provisional equivalence with regard to group solvency until 1 January 2026 (this may be renewed).
Solvency II provides for two methods for calculating group solvency:
- 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 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’).
With respect to Article 227, there is no need to assess equivalence where group solvency of an EU insurer with non-EU subsidiaries is calculated under the default method under Solvency II. However, if the group uses the alternative method then equivalence becomes an issue. Under Solvency II, the temporary positive equivalence finding for the US in respect of Article 227 allows EU insurance groups to use US rules with respect to the own funds and capital requirements (rather than the Solvency II rules) for a US subsidiary.
The UK will very likely no longer benefit from the Agreement following Brexit but we might expect the UK and the US to work towards putting in place a bilateral agreement on similar terms, possibly as part of a wider trade deal between the UK and the US.