EC clears the way for ‘transitional regime’ approach to equivalence for Solv II

It has singled out the US as a prime candidate to qualify through this more relaxed approach that will see countries allowed to write insurance business in the European Union without undertaking the full equivalence assessment that the the first wave countries- Switzerland, Bermuda and Japan-will go through.

“Full equivalence assessments are likely to be time consuming and resource intensive. As such it is not reasonable to ask CEIOPS to assess a greater number of third countries than those identified in the letter,” Chantal Hughes, Spokesperson for Michel Barnier, European Commission Internal Market and Services Commissioner, explained to Commercial Risk Europe the reasoning behind the move.

“In the case of other third countries for which an equivalence finding may nonetheless be relevant the European Commission is currently discussing with Member States in the Solvency Expert Group the possibility of introducing a transitional regime,” she explained.

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Third countries who qualify for the transitional regime will have to satisfy ‘certain criteria’ and ‘commit to converging towards a solvency regime capable of meeting the equivalence assessment criteria’ by the end of what will be a limited transitional period, the EC said in its letter.

Experts believe that this is potentially good news for European insurance buyers who will more likely continue to have access to the full international market.

Insurers based in countries outside of the EU not granted equivalence to Solvency II that wanted to trade in Europe would face a potentially considerable competitive disadvantage. They would have to set up separate European operations to underwrite the business, which would likely restrict their ability to underwrite business and could effect pricing.

And should the US, for example, gain equivalence under this regime, insurers, and in turn their customers, will also benefit from the fact that European companies with US-based subsidiaries will not be subject to capital additions, experts agreed.

All of which may help to avert the capacity crunch much feared under Solvency II and any market disruption that would cause harm to EU and non-EU industry interests.

The letter from the EC to Gabriel Bernardino also confirms that the deadline for CEIOPS assessment of third countries and recommendations thereafter to the EC has been moved back to September 2011 from June of that year. Which will still allow the EC to publish decisions on equivalence by July 2012, it said.

There are obvious concerns about how the transitional regime would work in practice and whether it will place as much scrutiny on jurisdictions as the full equivalence assessment.

“The details of what the transitional regime may look like are still being developed. In developing a transitional regime, the Commission will have regard to precedents for similar transitional regimes in the area of equivalence,” said Miss Hughes

The screening process is likely to be ‘less intensive’ than for the other ‘first wave’ jurisdictions, noted Guy Soussan, Partner with Brussels law firm Steptoe & Johnson LLP told Commercial Risk Europe.

“In fact, in its letter to CEIOPS, the Commission already expects that CEIOPS will not need to undertake a full equivalence assessment in respect of later applicants,” Mr Soussan explained.

Bradley Kading, President and Executive Director of the Association of Bermuda Insurers and Reinsurers (ABIR), agreed that the proposed system will differ greatly from what was previously .

“It looks like the key criteria for the countries in the transition category are that they have to have substantive risk based regulation in place and being committed to moving towards a system that is equivalent to Solvency II. It looks to be a fundamentally different review than an equivalency assessment,” he explained.

Despite this apparent relaxing of the criteria Mr Soussan warned that the chances of a commitment from the US to engage in a convergence programme remain ‘slim’. “Particularly if some US stakeholders remain convinced that Solvency II cannot become an international standard until it has been successfully tested within Europe.”

“A number of jurisdictions may be reluctant to claim the benefit of the transitional regime. For example, some jurisdictions have built up a flexible and pragmatic environment for their captive business which they want to protect – at least until they have a better understanding of the effect of the principle of proportionality for the EU captive industry,” he continued.

The transitional measures would be time limited, the EC said in its letter. Those third countries included in the transitional regime would need to be in a position to fully satisfy all of the equivalence criteria at the end of the transitional period, in order for a permanent equivalence to be granted.

On the whole experts appear to welcome the new proposals from the EC on equivalence, but there are definite concerns.

“The transitional regime is a proper response for the countries that have been identified by CEIOPS as being of economic importance but which could not be included in a first wave assessment. However, it could cause problems if, following an initial assumption of equivalence, those jurisdictions fail to meet the equivalence test and therefore prolong a situation of legal uncertainty for EU and non-EU industry,” warned Mr Soussan.

Mr Kading described the transition regime as a ‘hold harmless’ provision.

Ultimately the EU hopes to see Solvency II become the global international standard and the transitional measures can only help to smooth the process and rally additional jurisdictions to the idea of equivalence, experts said.

In particular the US has been identified by European insurers, buyers and now the EC, as a critical jurisdiction for the success of Solvency II.

“The European insurance industry has stressed the importance of finding a solution in relation to the US (who have not been included in the list of countries for CEIOPS to assess). This is why they have been specifically mentioned in the letter, although the Commission is aware of other third countries for which a transitional regime may also be relevant,” said Miss Hughes.

One considerable block to the US meeting Solvency II requirements is the lack of a federal legal framework that allows negotiation with a single authoritative US regulator.

The three year transition period proposed by the EC will give the US more time to see if the Dodd Frank provisions on ‘covered agreements’ can be used to address this issue, explained Mr Kading.

“The EU has emphasized that equivalence will not require uniformity of standards, but a similar level of policyholder and beneficiary protection. If so, there is a fair chance that the convergence programme could encourage further modernisation of the current system of state-based insurance regulation and a more risk-based solvency regime. Otherwise, the EU and the US will have missed an opportunity, leaving Solvency II as a benchmark that is not replicated by other major insurance markets,”

 said Mr Soussan.