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Allies Across the Atlantic?

Posted February 22, 2017

By David Worsfold

There is a rising sense of nervousness among European insurers and their regulators about the impact of the Trump administration’s ‘America First’ policy on global regulation of the insurance sector.

In particular, the gradual movement towards a consensus on International Capital Standards looks vulnerable, especially after President Trump’s executive order on financial regulation of 3 February. Its declarations about decreasing the regulatory burden on financial institutions and promoting US interests are almost certain to prompt a review of the current proposals which are closer to the very prescriptive European Solvency II regime that a lot of US insurers would like. There has been some sharp criticism of this in the US, especially from the National Association of Insurance Commissioners (NAIC) which seems likely to feel empowered by the President’s stance to press its opposition.

US insurers have only recently started moving towards a principles-based reserving regime and many have made it very clear that they are not happy at being pushed down that road too far or too fast.

The International Association of Insurance Supervisors (IAIS) has pushed its proposed capital standards aggressively but has increasingly run into opposition, exposing the differences in approach between Europe and the United States. In the US, the concern is that the IAIS proposals are too close to the Solvency II model and will require significant adjustments in capital structure, investment strategies and product portfolios if implemented.

The prospect of the Americans pressing for a less prescriptive regime may not be entirely unwelcome in the boardrooms of Europe’s major insurers. Their pan-European trade body, Insurance Europe, has recently turned up the volume on its complaints that Solvency II is being treated in too conservative and restrictive a manner by regulators, especially the European Insurance and Occupational Pensions Authority (EIOPA).

This drive for greater uniformity in the regulation of insurance firms across different jurisdictions has been progressing rapidly, especially in the area of capital standards.

The IAIS has an ambitious timetable and wants regulators to adopt its reporting framework by the middle of 2017 with the full regime due for implementation sometime in 2019. It is driven by the fear that another financial crisis could see major insurers falling between regulatory cracks, especially if they write business multi-nationally.

Global regulators are haunted by the fear of a major failure on their watch, as are the politicians who know there will be savage public condemnation and a renewed populist backlash if another Lehman Brothers happens.

Solvency II and the IAIS proposals are a response to those fears, and regulators remain determined to close the gaps between the regulatory approaches in major jurisdictions.

The IAIS may not have powers to enforce adoption of it preferred regime but with the ultimate backing of the Financial Stability Board, itself established by the G20 finance ministers, it will be hard to ignore. However, the election of President Trump and his declaration that when it comes to financial regulation the US will continue to participate in international discussions but will be “stronger and defend US interests” threatens the IAIS’s ambitious timetable.

European insurers might find this creates an opportunity for them to press home their own concerns about the rigidly conservative interpretation of Solvency II.

Olav Jones, deputy director general of Insurance Europe, recently set out their complaints: “As demonstrated by the results of the recent EIOPA stress tests, Europe’s insurers have done a great job of implementing Solvency II, despite the significant challenges they faced. For example, EIOPA reported that 100% of companies tested met their minimum capital requirements (MCR) and 99.98% met the much higher Solvency Capital Requirement (SCR). However, just because insurers have enough capital to cope with this conservative approach does not mean it is not wasteful or will not have consequences. Important improvements are needed to ensure that the framework works as intended, justifies the huge cost and effort involved in developing, implementing and operating it, and to avoid unnecessarily disincentivising insurers from making much needed long-term investments in the European economy.”

The key issues that require attention according to Insurance Europe include:

  • The need for capital requirements to reflect the true risks that insurers face. Currently, when insurers make long-term investments, Solvency II treats them as if they are short-term traders and bases the risk measurement on short-term risks. Unnecessary barriers to investment and costs remain, impacting all forms of long-term investment including equity, corporate bonds and property. This could have a range of negative effects, including reduced long-term investment by insurers, lower returns and less protection for policyholders and insurers, which could lead to more pro-cyclical behaviour.
  • Simplifications and practical application of the proportionality provisions allowed by Solvency II. This will help Solvency II to become more workable in practice and avoid unnecessary costs for all insurers, and is particularly important for small and medium size insurance companies.
  • More appropriate calibrations and methods to better reflect the true risks and liabilities in several specific areas including longevity risk, catastrophe risk and currency risk.

With a stronger American voice at the negotiating table, the IAIS and EIOPA might find itself having to soften its approach if the whole international capital standards project isn’t to be jeopardised. Insurance Europe might find itself making some interesting alliances across the Atlantic in the next few months.


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