Questions over equivalence under Solvency II could have important implications for how your business is structured, where it is domiciled and decisions over reinsurance and acquisitions. Paul Clarke (Global Solvency II leader) and Jim Bichard (UK Insurance Regulatory leader) discuss.
Paul Clarke: So equivalence. It’s one of those themes that’s getting a lot of airtime in the press at the moment, a lot of our clients are very interested in it, and understandably so because clearly, for territories which are deemed to be equivalent, the basis on which capital will be included in group supervision for Solvency II purposes shifts materially between, if you like, a lift and drop approach based on the local rules, to a position where you might have to re-state to the Solvency II requirements. So, two speeds of progress down the equivalence assessment route. And obviously the authorities have already been through some discussions around formal equivalence with Bermuda, Switzerland and Japan, and there is also this concept of transitional equivalence which, at the moment, the territories included in that include Australia, South Africa, Hong Kong and Singapore. One or two names that you might expect to see in that list are not there at the moment. Certainly it’s interesting that Canada is not part of that process and I believe they have made a decision not to participate at this stage. There are also possibilities, at least, that Brazil, China and Turkey might join that at a future date. But the other name that’s obviously not there in a formal sense is the US. Jim, what do you think the consequences for that are?
Jim Bichard: Well, obviously it’s a huge part of the global market so there’s a lot of focus on where the US is going to be. It may not be a formal part even of that second tranche that you described, but we all know there’s a lot of discussion happening between senior European officials and both the federal and state regulatory bodies in the US. That’s been going on for quite a while. I think there’s a huge amount of appetite from the global insurance market for those discussions to continue. One of the reasons I think it’s going to take some time is because it’s such a difficult fit; you’ve got a state-based regime, 50 states, trying to pull that together against what’s much more sort of a harmonised federal approach. So, that is going to take some time but, as I said, there’s a lot of interest in that. I think if I consider why that’s important, certain products, as we’ve seen in the press, look very different under the two bases. So some companies are feeling that very, you know, significantly for their own operations. But also the US is such a big player for the UK market. So not just on the life side but also in the London market the US is a huge investor. And just talking about the London market, you know Bermuda is also a very important part of that. Being quite well placed in the front of the sort of wave of equivalence is very good for the London market, because the idea of being able to apply pretty much the same regime across all global operations is very attractive. And I think that’s sort of pointing towards what we’re seeing as a start of globalisation of solvency regimes.
Paul Clarke: I think that plays very squarely onto the agenda of the International Association of Insurance Supervisors, who clearly have a work programme that’s intending to develop a common framework for the regulation of internationally active insurance companies picking up the concepts of risk-based supervision, group supervision, and instruments like the ORSA, the Own Risk and Solvency Assessment. So all of that tends to suggest that there will be more convergence around the piece internationally. More broadly, why that’s relevant and how companies should respond to it?
Jim Bichard: Yes, I think there’re several implications particularly for global groups. One of them is around just the structure within the territories where they currently operate. So we’re still seeing a lot of big international groups looking at moving more to a sort of hub and spokes approach, single carrier with branches, much better for capital flexibility and fungibility. Secondly, we’ve seen comments in the press about moving domicile. And that’s whether that’s more attractive for that regulator, it’s more aligned to the strategy, or perhaps just avoids traps from a non-equivalence perspective. And thirdly, it’s use of reinsurance. So, you know, buying reinsurance from a reinsurer in a non-equivalent territory might impact capital charges, so that is going to potentially have an impact on the global reinsurance market. And finally, M&A is always something that comes up. We continue to think that’s going to impact activity in that sector because the source of capital, where it’s coming from in terms of investment, could well be impacted by the status of equivalence.
Paul Clarke: So, the equivalence agenda then something that international groups should be monitoring pretty closely. The formal establishment of which territories will finally be part of that equivalence conclusion won’t be known until 2013, but plenty to think about between now and then.
Equivalence is a key focus for multinational insurance groups. The status of equivalence of a particular country will affect whether your business will have to restate local capital requirements according to Solvency II rules, which may in turn affect the pricing of certain products.
Bermuda, Switzerland and Japan are seeking equivalence in the first wave. A second tier of countries, which currently includes Australia, Singapore, Hong Kong and South Africa, are set to join a transitional tier, which will confer equivalence for a specified period while their solvency rules move towards Solvency II. The US is yet to formally join this group. Its inclusion is clearly crucial to many UK insurers, given the size of the US market and its importance to their businesses. Discussions between EU and US regulators are continuing. One of the challenges is dealing with the regulation of insurance by different state jurisdictions within the US.
Equivalence is one important consideration in structuring decisions. Separately a number of groups are looking to move to a branch structure to ease movement of capital around the business. Some are also reviewing their domicile as they seek a base where regulation is aligned to their strategy and avoid the potential traps from non-equivalence. Further considerations include buying reinsurance from non-equivalent jurisdictions and how equivalence will affect acquisition decisions.
Looking ahead, equivalence will provide a further catalyst for regulatory harmonisation worldwide, which may eventually allow groups to apply similar capital rules across all their operating territories. Key areas of focus on the IAIS convergence agenda include group supervision and the own risk and solvency assessment (ORSA).