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19 January 2017 Insurance

Level playing field to boost reinsurance competition in the EU and US

After more than 20 years of discussions between both sides on reinsurance collateral in particular and almost a year of formal negotiations, the European Union and the US on January 13 unveiled an agreement which removes collateral and local presence requirements for reinsurance.

For EU-based reinsurers operating in the US this is expected to free around $40 billion of collateral. The agreement will enable players like Munich Re, Hannover Re or Scor to deploy this capital more effectively. Some estimates suggest that this $40 billion actually translate into opportunity costs of $400 million – if the way that money could have otherwise been deployed is considered.

That said, it seems likely many of the benefits from the removal of the capital requirements could be passed on to policyholders.

“By having the same rules that apply to US reinsurers, the EU reinsurers will become more competitive than now, when the collateral requirements put them at a competitive disadvantage,” says Cristina Mihai, head of prudential regulation and international affairs at Insurance Europe.

German giant Munich Re has also welcomed the agreement. “This is an important step, which Munich Re has always supported and welcomes,” the company told Intelligent Insurer.

Hannover Re says it expects that the reduced requirements for capital reserves will boost the profitability of its US business.

It is, however, difficult to quantify how much capital Hannover Re will be able to free through the agreement, says York von Falkenhayn, general manager regulatory affairs at Hannover Re. He notes that the reduction of regulatory collateral capital will happen gradually over a period of five years.

US reinsurers operating in Europe are also set to benefit as the agreement reduces regulatory barriers, making the region more attractive for business.

“Before this agreement was reached, a reinsurer wanting to operate in Europe was required to establish multiple branches in Europe and competitors did not have to. That’s a very big deal," says Tracey Laws, senior vice president and general counsel of Reinsurance Association of America (RAA).

The US reinsurance industry has been complaining about new trade barriers which emerged in Europe through the introduction of Solvency II rules in January 2016.

While the framework aims to harmonize the regulatory regime in the European Union, some countries made it harder for reinsurers of other jurisdictions such as the US to underwrite risk when translating EU legislation into local law. Among these countries are Germany, Poland and the Netherlands.

As a result of Solvency II, German law currently requires a US re/insurer to have a local presence to underwrite business there. An alternative would be to have a subsidiary in a Solvency II-equivalent jurisdiction. But companies that have existing relationships and don’t have a branch or a legal entity in Germany or in a Solvency II-equivalent jurisdiction have to rely on the ceding company in Germany to initiate the renewal of a relationship and can’t do it through a broker.

Laws notes that the clarity around market access makes US companies operating in the EU much more competitive.

According to a joint statement by the EU and US the agreement establishes that “US and EU insurers operating in the other market will only be subject to worldwide prudential insurance group oversight by the supervisors in their home jurisdiction.”

The joint EU/US statement further explains that “for the United States, this [agreement] preserves the primacy of the US regulators with respect to oversight of US insurance groups. For the EU, this preserves the primacy of EU oversight of EU insurance groups. The limitations on the exercise of worldwide group oversight outside of the home jurisdiction include limits on matters involving solvency and capital, reporting, and governance.”

Laws explains the aim of the negotiations. "What the US negotiators tried to do on an outcome basis was to achieve many or the same benefits that one would get under Solvency II equivalence without having to meet Solvency II regulatory requirements."

While public disclosures on the geographical breakdown of reinsurance collateral are limited, Fitch notes, in a January 17 statement, that material proportions of capital are also tied up in the EU by the collateral requirements for US reinsurers. This is despite a gradual reduction of collateral requirements in recent years.

Reinsurers are most effective in performing their role when they are allowed to operate globally undeterred by regulatory barriers, but the industry has been flagging concerns over increasing protectionism in some parts of the world, particularly in Asia. The Covered Agreement is therefore praised as an exceptional achievement by regulators and politicians within the industry.

Furthermore, the RAA believes that the agreement reached between the EU and the US could facilitate the elimination of trade barriers in other countries and regions.

"We are encountering trade barriers all over the world. Now we can say look at the agreement, we recognize the strength of one another’s regulatory framework. We can go arm in arm into those jurisdictions and say that the US and the EU are very well regulated, so you shouldn’t impose collateral or any other barriers on our companies. It helps our argument abroad," Laws explains.

What might also help other countries to follow suit and reduce trade barriers for reinsurers are the advantages that come with a more open market for reinsurance.

Through the Covered Agreement, policyholders on both sides of the Atlantic are likely to benefit from increased choice, lower premiums and better pay-outs from cost savings through the implementation of the Covered Agreement.

“The agreement allows US reinsurance companies to underwrite business in the EU under lighter regulatory requirements,” says von Falkenhayn. “This can result in more intensive competition,” he notes.

The removal of collateral requirements and other hindrances should increase the attractiveness of doing transatlantic reinsurance, boosting business and diversifying risk exposure, according to Fitch. But the deal is also set to make the EU market more attractive for US reinsurers, leading to greater competition putting pressure on pricing and profitability, Fitch warns.

Reinsurers are already facing a soft market globally, particularly in property/casualty. Prices have come under pressure as alternative capital flooded the reinsurance market in search for higher yields in a historically low interest rate environment. The absence of large losses has contributed to pricing pressure.

But higher competition in the reinsurance sector has been one of the intentions of regulators negotiating the EU/US deal.

“The agreement is meant to support the competitiveness of both EU and US re/insurers in each other's markets,” Mihai notes.

Yet companies outside of the EU and therefore not affected by the Covered Agreement may be at a disadvantage when operating in the EU or in the US.

Swiss Re for example, which is regulated in non-EU member state Switzerland, has yet to be granted similar access conditions to the US market as included in the Covered Agreement.

But “collateral reform has been ongoing for some years and important improvements have already taken place,” Swiss Re notes in a statement.

And Switzerland has already signaled to the US that it is also interested in a similar covered agreement. Now that the EU/US deal has been finalized, negotiations with Switzerland could be initiated.

Despite uncertainty about an agreement between Switzerland and the US, Swiss Re is confident that it will remain competitive. “Swiss Re will retain a competitive position based on its financial strength during the phase-in period [of the EU/US Covered Agreement] and thereafter,” the company said in a statement.

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