On 5 June 2015, the European Commission adopted its first third country equivalence decisions under Solvency II, granting Switzerland, Australia, Bermuda, Brazil, Canada, Mexico and the USA full or partial equivalence.

The decisions are delegated acts and are subject to scrutiny by the European Parliament and Council before they can take effect, which is expected to be within three months.

What is equivalence?

Solvency II permits the European Commission to determine that a third country’s insurance regulatory regime is equivalent to Solvency II in three areas:

  1. Reinsurance (article 172): if a third country’s rules are deemed equivalent under this article, Solvency II firms and regulators must treat reinsurance contracts with reinsurers established in that country in the same way as reinsurance contracts with EU reinsurers.
  2. Group Solvency Calculation (article 227): this is relevant where a group which is supervised in the European Economic Area (EEA) has sister companies or subsidiaries in a third country. If the third country’s rules are deemed equivalent under this article and the EEA group uses the deduction and aggregation method of consolidation for group solvency purposes, the EEA group can use the third country’s rules (rather than the Solvency II rules) in order to calculate the capital requirements and own funds of the third country company for group solvency purposes. Where the third country’s rules have not been deemed equivalent, the company in the third country would need to recalculate, using the Solvency II rules, its capital requirements and own funds for use in the EEA group’s calculations.
  3. Group Supervision (article 260): this is relevant where a UK (or EEA) firm has a parent in a third country. Where the third country’s rules are deemed equivalent under this article, the EEA supervisor of the Solvency II firm must rely on the group supervision regime of the third country, which will be the Group Supervisor.

Following advice received from the European Insurance and Occupational Pensions Authority (EIOPA), the European Commission has determined that Switzerland’s regime is fully equivalent to Solvency II. It has decided that Switzerland is to be given full equivalence in all three of the above areas, such equivalence to be granted indefinitely from 1 January 2016.

Six other countries – Australia, Bermuda, Brazil, Canada, Mexico and the USA – have been determined to be provisionally equivalent in respect of solvency calculations under article 227. Provisional equivalence is granted where the country may not satisfy all of the criteria for full equivalence, but progress is being made towards equivalence and it is expected that an equivalent regime will be adopted. The EIOPA reports highlight the areas where such regimes are not yet fully equivalent. This decision on article 227 equivalence allows the relevant countries to be treated as equivalent for the purposes of article 227, but only for 10 years from 1 January 2016. At the end of this period, the European Commission will need to reassess the developments in each country’s regime and determine whether to grant full equivalence or a further period of temporary equivalence in respect of each.

Implications of equivalence for firms with connections to Switzerland, Australia, Bermuda, Brazil, Canada, Mexico or the USA.

For UK firms which have Swiss holding companies or sister companies or reinsurance contracts with Swiss authorised counterparties:

  1. Reinsurance with Swiss-regulated counterparties is to be treated in the same way as reinsurance with EU counterparties.
  2. There is no requirement to convert the Swiss capital requirements and capital resource calculations into Solvency II calculations.
  3. If the group supervisor is the Swiss regulator (FINMA) then the Prudential Regulation Authority (PRA) must rely on the group supervision by FINMA rather than conducting group supervision itself.

In summary, this full equivalence decision means that navigating the interaction of Swiss and EU regulatory regimes is likely to be significantly easier than in other third country jurisdictions.

For a UK firm which has a sister firm regulated in any of the six provisionally equivalent jurisdictions (Australia, Bermuda, Brazil, Canada, Mexico or the USA), the decision extends only to the calculation of group capital requirements and capital resources (note that captives regulated in Bermuda are excluded from the equivalency decision). The European Commission’s decision is helpful as it removes the requirement to run capital resource and capital requirement calculations in accordance with two separate regulatory regimes (one for Solvency II requirements and one for the relevant third country requirement) which would otherwise apply. We expect this to be of wide-ranging benefit to industry as the solvency calculation equivalence is, of the three types of equivalence, perhaps of most importance to international insurance groups – cutting down on reporting requirements and potentially reducing the level of group capital required (as the capital requirements calculated on a Solvency II basis are likely to be higher than those calculated on a local basis).

However, the six provisionally equivalent jurisdictions have not yet been deemed equivalent in relation to reinsurance. This means that any reinsurance with a provisionally equivalent counterparty (or any other third country regulated counterparty) may attract additional collateral requirements or otherwise not operate effectively to reduce the UK firm’s capital requirements in the way it would for reinsurance with an EU counterparty. The position in relation to reinsurance is currently under negotiation between the EU and the USA, where industry and regulators consider this issue to be particularly significant.

The six provisionally equivalent jurisdictions have also not yet been deemed equivalent in relation to group supervision. This means that any UK firm within a group supervised by one of the provisionally equivalent jurisdictions (or any other third country group supervisor) may still be subject to dual group-wide supervision, at least in theory. However, in the absence of a European Commission decision, unlike reinsurance equivalency, article 260 allows the acting group supervisor (assisted by EIOPA and in consultation with the other supervisory authorities concerned) to assess third country equivalence for the purposes of group supervision. Therefore, the PRA may determine that the relevant third country is equivalent for the purposes of group supervision. It is not yet clear how the PRA intends to approach this determination but this is likely to depend on the current relationship with the third country regulator and the potential risks posed to the UK in reliance on the third country group supervision.

There is a further pragmatic solution available to the PRA where neither the European Commission or the PRA have determined a third country to be equivalent for the purposes of group supervision. The Solvency II directive explicitly envisages that the PRA may apply “other methods” to group supervision instead of supervising the worldwide group as well (which would effectively be overlaying the third country group-wide supervision with a second layer of Solvency II compliance oversight by the PRA). As set out in PRA Supervisory Statement SS12/15, the PRA expects to apply these “other methods” to firms on a case by case basis and firms should apply for such “other methods” by way of a waiver application form in the usual manner.

This is potentially particularly helpful in the case of jurisdictions such as the USA where the regulatory regime and group-wide supervision is far more developed in certain states compared to others. Firms which are currently part of a group subject to third country group supervision may feel that it is worth submitting a waiver application to the PRA in advance of Solvency II coming into force, in order to start the dialogue with the regulator about what “other methods” the PRA will apply to the group in the absence of jurisdiction-wide equivalence being granted.

What’s next?

Decisions on other jurisdictions and on other types of equivalency will follow. In particular, Japan, which was the subject of an EIOPA report on reinsurance equivalence in March, is expected to be granted full or provisional equivalence and we watch the USA-EU negotiations on reinsurance equivalency with interest.

Copies of the European Commission’s decisions can be found here: http://ec.europa.eu/finance/insurance/docs/solvency/international/delegated-act-c-2015-3754_en.pdf

and here: http://ec.europa.eu/finance/insurance/docs/solvency/international/delegated-act-c-2015-3740_en.pdf.

The EIOPA reports on Bermuda, Japan and Switzerland are available here:https://eiopa.europa.eu/Pages/News/EIOPA-publishes-the-Final-Reports-on-full-equivalence-assessments-of-Bermuda-Japan-and-Switzerland.aspx.