Solvency II equivalence is designed to create a level playing field, but George Crooks, Business Analyst at Wolters Kluwer Financial Services, warns that the introduction of concepts such as ‘broad equivalence’ and ‘deemed equivalence’ will leave European firms at a competitive disadvantage.
Firms in the European Economic Area (EEA) are facing major strategic decisions surrounding the rigorous Solvency II regime. Preparing for Solvency II demands extensive time and resource from firms and it is widely agreed across the industry that the regulation will ultimately result in a valuable and valid set of rules and regulations with significant future benefits.
But the introduction of third country equivalence – the proposal to allow non EEA firms to operate as if they met the Solvency II standards – is threatening to put European firms at a competitive disadvantage.
While third countries do have to demonstrate that certain mechanisms are in place, they only have to meet minimum requirements in order to receive the same benefits as EEA countries that have implemented full Solvency II programmes.
This is not to suggest that EIOPA should adopt the sternness of a Sarbanes-Oxley type approach to regulation: demanding that all countries become Solvency II compliant. Clearly this would not work for a number reasons, including the differing legal, economic and political systems of various regions. Sarbanes-Oxley was designed with a preventative methodology, not a progressive one like Solvency II. However, the argument still stands – if EIOPA is expecting high standards from European insurers, then surely similar standards must be expected from non-EEA countries?
Both EIOPA and the FSA explained that equivalence was not to be applied in the narrow sense of the word. Instead they talk about a concept of ‘broad equivalence’, meaning that an appreciation of local customs and activities had to be considered when applying the Solvency II principles to third countries.
Broad equivalence has a role to play when assessing a third country’s application. However, it should be restricted to issues such as the types of insurance policies being offered (the product), policies and treating customers fairly. EIOPA could consider relaxing rules relating to policy holders, but should require the same standards for third countries for all other issues. For example, the proposed governance guidelines that are expected to be implemented by EEA countries should also be required of non-EEA countries as a minimum standard.
The question of levels of equivalence is becoming more complicated and could further threaten the competitiveness of the European insurance industry with the recent introduction of the term ‘deemed equivalence‘ by Professor Karen Van Hulle, Head of Unit Insurance and Pensions at the European Commission.
Deemed equivalence, according to Professor Van Hulle, means that countries other than those already being considered for equivalence status (i.e. Bermuda, Japan and Switzerland), can operate under a provisional equivalence status if they meet certain EIOPA requirements. It is anticipated that countries able to take advantage of the deemed equivalent status (such as the United States) will have a transitional period of about five to seven years to operate within the EIOPA framework before gaining full equivalence.
The idea that having gone through the high costs and pains of complying to EIOPA requirements, EEA countries must now compete with countries subject to even less stringent Solvency II requirements would suggest EEA firms are being placed at a competitive disadvantaged position as a result of European authorities allowing these varying degrees of equivalence.
The situation becomes even more ironic when viewed from a micro prospective. A firm from an EEA country may face penalties for not meeting Solvency II requirements, whilst firms in countries deemed to be equivalent will not be expected to face any such pressures and are therefore, by default, able to gain a competitive edge over their fully Solvency II compliant counterparts.
The crux of the matter is that Solvency II should create a level playing field for competing firms. It is set against other highly competitive regulatory regimes and must consider the implications for European insurers. Europe is the third largest insurance region in the world (measured in gross written premiums) and must compete with regions such as the USA and Japan to maintain or gain market share of the insurance industry.
There are significant gains to be made in a standardised insurance environment, but if one group is restricted by rules and regulations they consequently face disproportionate costs compared to the others. If those competitors are free to dip in and out of the limited European insurance market without being subject to costs or penalties, how can Europe maintain market share, let alone compete in such adverse circumstances?
The author is a Business Analyst at Wolters Kluwer Financial Services. The views expressed are the author’s own.