Best’s Managing Director-Europe: Solvency II is Coming to an Insurer near You

By | October 24, 2011

Stefan Holzberger, A.M. Best’s managing director-analytics, recently moved to London from the U.S. He is well placed to analyze the impact of the European Union’s Solvency II regulations, not only on the Europeans, who are directly affected, but also on insurers outside the EU, who will have to adapt to a changed regulatory environment.

Before throwing up your hands at yet another Solvency II article, consider this: SII’s three pillars will affect capital requirements, corporate governance and mandate transparency; i.e. public disclosure of information regulators consider important. Everyone in the insurance industry, who does business in an EU country, or hopes to, will have to deal with those rules.

After his presentation at Best’s 2011 Insurance Market briefing in London on October 19, Holzberger took some time to talk with the IJ, and to explain some of the ramifications SII will have on “non-EU” insurers, particularly the impact they have on the U.S. market.

“The implications for U.S. insurers with regard to Solvency II have the potential for a direct exposure as well as an indirect (one),” he said. From an indirect perspective he pointed out that “a lot of U.S. companies cede significant portions of their book of business, whether it be property or casualty, to London-based reinsurers, as well as the ‘big four’ global reinsurers located in Europe.”

As a result, under SII, “we may find certain classes of business become more price sensitive in that the capital charges to write, or to maintain, these businesses on the books will become more expensive for European companies.”

SII is now scheduled to go into effect at the beginning of 2014; however, a number of exceptions have been made to enable the more complex – and hotly debated regulations – to be phased in at later dates.

Holzberger said: “Although the final rules have yet to be worked out, there’s a good chance that capacity could change for certain classes of business that are deemed to be excessively capital intensive, and require too high a rate of return to write that business.” Companies that do cede a good portion of their business should therefore be aware of this potential impact.

In terms of “a more direct effect,” he noted that steps taken by the U.S. regulator, notably the “solvency modernization initiative undertaken by the NAIC, partially to achieve ‘equivalence’ [i.e. regulatory requirements similar to SII] is going to impose new rules directly on insurers and reinsurers operating in the U.S.” This could have an impact on the profit and loss statements of “small to midsize companies.” It might also require “duplication of reporting to the regulator.”

Holzberger said that “on the life side annuity business with guaranteed returns is expected to be quite capital intensive.” It could affect companies that are “not well diversified.” As far as P&C, or non-life, is concerned, “even catastrophe exposed business, with the catastrophe module integrated into Pillar One,” will be affected – “particularly perils outside of the European Union. Those could also carry very high capital charges,” which will directly affect rates in Florida, the Caribbean, the U.S. East and Gulf Coast, as well as earthquake coverage in California.

As far as Bermuda’s reinsurers are concerned, Holzberger pointed out that many of them “are operating now with multiple platforms, several have a London market presence [which includes the Lloyd’s market] where some of this business is written, as well as Ireland or Zurich.” As Bermuda’s reinsurers write more business using these platforms it becomes more important to understand and comply with the SII regulations.

In addition Holzberger explained that “to the extent that Bermuda receives equivalency, there will be pressure on the Bermudian Monetary Authority to step up and improve or increase their capital requirements – risk-based capital requirements – to achieve Solvency II equivalency.”

Bermuda’s situation is – relatively speaking – uncomplicated, as it can, and is, in the process of acquiring equivalency status from the European Commission. For the U.S., with is 50 different state regulators, plus the federal government, the situation is far more complicated. Although no one expects a mass adaptation of SII’s fundamental regulations any time soon, there are some indications that steps will be taken to align some U.S. insurance regulations with those of the EU.

“You have the NAIC, sitting above all of the individual state regulators,” Holzberger said. Even though it can’t “directly impose rules on states’ supervisors, it does have the ability to “advise and guide.” As a result he notes that there is “a mounting consensus within the U.S. regulatory environment that certain elements of their regulatory platform(s) do need to be modernized.”

He singled out “risk management and reporting” as areas where state regulators and the NAIC jointly recognize that changes are needed. “They [regulators] are looking to ramp up, and make some modernizations” in these areas, but “less so with the capital requirements of Pillar I.

“I think that’s kind of a touchy point with the NAIC and the U.S. regulatory bodies, and that from their perspective RBC has held up quite well through some difficult economic times.” As a result “they’re not quite ready to make a wholesale change to risk-based capital in favor of a Solvency II approach – Pillar I – which hasn’t been tested quite yet.”

Nonetheless, Holzberger observed that regardless of whether SII may have a direct or an indirect impact on their business insurers “should be thinking about what it means for their business. To the extent that there’s a direct impact – by that I mean the organization has either a parent company or a subsidiary organization within the EU – they should be planning today, and probably are a little bit late, if they’re just coming to the dance at this point.”

However, in the case of companies that are “really U.S. focused, one would expect a transition period before it is determined whether the U.S. would receive equivalency, or not, under Solvency II.”

The EU’s constant changes in the implementation date for SII and the exact regulatory requirements have made it more difficult for both European and non-European insurers to decide what to do, and when to do it. Holzberger diplomatically characterized this as “unfortunate” [‘maddening’ might be more appropriate].

None theless he said “whether it’s one year, three years, five years, the point is that this is something that U.S. insurers should be thinking about.”

How will SII, when it finally arrives have the potential to require action, regardless of whether there’s U.S. equivalency, or not? Is the essential question. How it will affect “their business partners operating out of European organizations – out of European countries – how will that affect their business? I would say now is the time to giving that serious consideration.”

In conclusion he indicated that “those companies that take the risk management approach, and take the new regulatory hurdles seriously, may find that they can develop a competitive advantage against the companies that find themselves late to the game” – words of wisdom from an expert.

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