23 October 2017 Insurance

US–EU agreement unlikely to mean demise of legal entities

The bilateral “covered agreement” between the US and EU provides regulatory clarity and reduces the regulatory burden for US and EU reinsurers operating in each other’s markets, according to AM Best.

But in a report titled Signing of Covered Agreement a Good Step for EU and US Reinsurers but Five Year Journey Ahead, the rating agency stressed that it will be several years before the agreement is fully implemented.

It also noted that while one of the implications of the agreement is to extinguish the need for reinsurers to post collateral, AM Best does not believe the agreement will lead to the winding up of legal entities, whose purpose was in part to avoid the need to post collateral.

“There remains value in having a local balance sheet and presence on both sides of the Atlantic as clients view this as a sign of long-term commitment to the market and are subject to local laws and insurance regulation, for example, as regards to insurance contract wordings,” the rating agency said

It noted that for EU reinsurers operating in the US, the elimination of collateral requirements will level the competitive playing field by allowing them to operate under the same conditions as US companies. The liquidity and fungibility benefits that stem from this will be a positive for these entities.

“Likewise, the elimination of local presence requirements for US reinsurers operating in the EU improves their liquidity and the fungibility of their capital. However, measures that reduce the regulatory burden for foreign companies and promote the cross-border flow of business increase competition in local markets, leading to negative pricing pressure,” AM Best said.

“Consequently, the agreement may have a detrimental impact on the performance of domestic reinsurers operating in the US and the EU. Conversely, an increase in the level of competition in the local reinsurance market benefits domestic primary insurers as they are able to take advantage of lower rates.

“For US insurers, a reduction in the level of collateral posted by their reinsurers will increase exposure to credit risk and the amount of required capital, as calculated by Best’s Capital Adequacy Ratio model (BCAR), is likely to increase modestly.”

The report also explained how the full process will take five years. “Of particular importance to EU reinsurers operating in the US is the removal of collateral requirements, subject to certain solvency standards being met. US states have five years to adopt these particular reforms, and collateral requirements for current reinsurance agreements will not be affected.

“However, once implemented, the reforms will have positive implications for liquidity and the fungibility of EU reinsurers’ resources,” it said.

It also noted that Lloyd’s and London Market reinsurers will be disappointed that this long fought-for concession will not apply to them post-Brexit, but they will hope that the UK will be able to negotiate a similar deal now that a precedent has been set.

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