25 May 2012

Insurance Insight: Solvency II - Equivalence versus non-equivalence

Across the insurance industry there has been one issue in particular that has received more attention than any other in the past couple of years: Solvency II. Jurisdictions which are not part of the EU, such as Guernsey, are not required to adopt the regime, and these so-called ‘third countries' can choose whether or not to seek equivalence under Solvency II. The uncertainty surrounding Solvency II's final form, the practical implications and the timing of its introduction has been causing some angst around Europe, and it has also hampered the decision-making process for third countries. Guernsey opted for certainty when, in January 2011, the Island's government and the financial services regulator, the Guernsey Financial Services Commission, issued a joint statement announcing that there were no plans to seek equivalence under Solvency II.

Guernsey's announcement provided current and potential clients with certainty, and it was primarily based on the understanding that, unless there were significant amendments to the regulation's terms and conditions, seeking equivalence was not in the best interests of Guernsey's insurance industry. Under the current proposals, Solvency II is set to impose a number of inflexible requirements. It is for this reason, and not because captives are inherently risky, that 30 per cent of European captives are failing to meet the Solvency Capital Requirements published in May 2011.

Karel van Hulle, head of unit, insurance and pensions for DG Internal Market and Services, and the architect of Solvency II, has been quoted as stating that the special nature of captives will be accounted for in the final rules, and that the Commission will make sure they receive proportional treatment when the Directive is finally introduced in January 2014. However, it is unclear what this means or whether any action will be taken at all. The European Insurance and Occupational Pensions Authority, which advises the EU on the detailed implementation plans for Solvency II, has been rather reluctant to bring any meaningful proportionality to the table for captives.

Guernsey believes that applying the regulation as it is currently constructed would burden insurers in the island with additional costs, and render currently effective captive business plans uneconomic. Only by remaining outside the regime can Guernsey ensure that it is able to continue to offer a viable set of captive products and services.

Other non-EU jurisdictions, such as Bermuda and Switzerland, are adopting a different stance. These countries were in the first wave of equivalence applications. They were not seeking equivalence for their captives, but to protect their international commercial reinsurance industries. Bermuda, in particular, is seeking to mitigate the impact on its captive insurance business.

However, if Bermuda does not achieve equivalence without including its captives in the equation this will place an unnecessary burden on its US owned captives, for which Solvency II is not relevant. It will also mean that European owners of captives will suffer the additional capital requirements but without the passporting rights that EU captives enjoy. Third countries have to consider that not seeking equivalence will mean that ‘fronting' insurers will continue to be required to access EU markets.

At the time of writing, there is still a degree of uncertainty surrounding equivalence and what it means for third countries. Officials in Guernsey understand that the finalisation of the transitional provisions may depend on the actions of the European Parliament and the European Council.

Until their position is understood, a degree of uncertainty will remain about the equivalence process and how it will progress. On this basis, Guernsey remains committed to the policy outlined in January 2011 that it is not currently seeking equivalence under Solvency II.

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