SST / Solvency II Market News Special Edition
Summary of EIOPA Draft Report on the Equivalence of the Swiss Insurance Regulation and Solvency II
August 25, 2011
The topic of Equivalence is important because
- Switzerland is outside of the European Economic Area (EEA) and thus Solvency II will not be mandated to Swiss based entities.
- FINMA regulates insurance entities using Swiss Solvency Test (SST).
- Swiss reinsurers (or Swiss based holding companies) obtain a great deal of their business from EEA entities (independent insurers or intra-group retrocession) and receiving the Equivalence designation from the European Commission impacts how much value the EEA insurer receives from the reinsurance treaty with the Swiss entity.
- Equivalence positively impacts EEA insurance groups with Swiss subsidiaries.
Please note that the question of Equivalence is EIOPA judging the Swiss regulation and if granted allowing certain activities; Equivalence should not be mistaken with reciprocity. Regardless of whether or not Switzerland receives a positive assessment on Equivalence, all insurers in the EEA, even if a subsidiary of a Swiss holding company, must submit at a solo basis their financial statements to their regulator using Solvency II rules and must meet all Solvency II Pillar 2 and Pillar 3 requirements.
To understand the document issued by EIOPA we need to briefly review three articles in the Level 1 text.
Article 172 – covers reinsurance activities of reinsurers with their head office in a third country (e.g. Switzerland). If Switzerland were granted Equivalence, then any reinsurance contract between an EEA based insurer and the Swiss reinsurer would be treated in the same fashion as reinsurance contracts within EEA entities.
Article 227 – covers third country (e.g. Switzerland) based insurers which are part of EEA groups. If Switzerland were granted Equivalence, an EEA group compiling its consolidated accounts can use local calculation of balance sheet and capital requirements (i.e. SST) rather than recalculating the third country entity on a strictly Solvency II basis. Without Equivalence, the third country entity would need to be recalculated on a Solvency II basis.
Article 260 – covers supervision of insurance groups whose holding company is located in a third country (e.g. Switzerland). If Switzerland were granted Equivalence, then FINMA would be the lead regulator for the group.
To illustrate this, consider the following example, assuming Equivalence is granted:
- Holding company in Switzerland: SST has to be submitted to FINMA. Subsidiary in the EEA: SST for consolidated reporting to FINMA, Solvency II for local regulatory reporting.
- Holding company in the EEA: Consolidated reporting on Solvency II basis to its lead supervisory authority. For a subsidiary in an Equivalent jurisdiction the local regulatory calculations (e.g. SST) can be used in the consolidation.
Subsidiary in Switzerland: SST for local regulatory reporting.
I.e. Equivalence means that EEA supervisory authority accepts local standards (to calculate the solvency capital requirements) as Equivalent.
Brief summary of the key elements of the draft Swiss Equivalence assessment
EIOPA outlined its criteria for assessment in a consultation paper (CP 82). For each of the criteria the Swiss regulation was assigned a grade using the following five categories: equivalent, largely equivalent, partly equivalent, not equivalent and not applicable.
EIOPA’s draft report to the European Commission summed the grade for all the criteria to arrive at an overall assessment. For each of the three articles listed above one of the following overall country assessment was given:
- Meets the criteria set out by the Commission.
- Meets the criteria but with certain caveats.
- Needs to undertake changes in the following areas (...) in order to meet the Commission criteria for equivalence.
For Article 172, EIOPA stated that Switzerland meets the criteria set out in EIOPA’s methodology for equivalence assessments under Solvency II, but with certain caveats. FINMA was deemed only partly equivalent in regards to its governance and public disclosure requirements. For SST to achieve equivalence with Solvency II standards FINMA will need to require insurers to have a compliance function and internal audit function comparable to that of the Solvency II.
For Article 227, EIOPA found Switzerland to be equivalent on all criteria.
For Article 260, EIOPA stated that Switzerland meets the criteria set out in EIOPA’s methodology for equivalence assessments under Solvency II, but with certain caveats. Similar to statements for Article 172, FINMA was deemed only partly equivalent and changes will have to be made in regards to governance, public disclosure requirements, compliance function and internal audit function.
Our overall conclusion is that the country assessment is accurate and not controversial. Please keep in mind that Switzerland has not been granted Equivalence. FINMA will have to make certain changes and once Solvency II level 2 implementation measurers are completed Switzerland will undergo another evaluation. It is this second evaluation which will decide if EIOPA will recommend to the European Commission that Switzerland be granted Equivalence.
What can we expect in the coming 18 months?
There are a set of possibilities for FINMA to implement the required changes to Swiss insurance regulation (which can complement one another):
- an adaptation of the Swiss Code of Obligations,
- a (part) revision of the Swiss Insurance Supervision Law,
- the issuance of Circulars,
If we accept the premise that FINMA will implement the required changes and provide guidance on governance, disclosure and key functional areas (compliance and internal audit) we surmise that the new requirements are likely to be similar to what is currently being proposed by EIOPA.
We could see FINMA requesting
- more insurers complete an updated Swiss Quality Assessment
- the submission of SQA being done annually
- the requirements becoming more explicit and increasing over time
As a result we believe Swiss based insurers will begin to place greater focus on the design, implementation and documentation of their governance, risk management system and control functions in order to comply with the possible new FINMA requirements.
Please note that the current version of the Omnibus II Directive states an effective implementation date for Solvency II of 1 January 2014. Omnibus II provides for a third-country Equivalence transitional period. This transitional period ends at the earlier of five years or when the third country regime is considered Equivalent.
On that note, the big news we expect next month is another version of Omnibus II.
- Consultation paper no. 3 - EIOPA Draft Report - Equivalence assessment of the Swiss supervisory system in relation to articles 172, 227 and 260 of the Solvency II Directive
- Consultation paper no. 4 - EIOPA Draft Report - Equivalence assessment of the Bermudan supervisory system in relation to articles 172, 227 and 260 of the Solvency II Directive
- Consultation paper no. 5 - EIOPA Draft Report - Equivalence assessment of the Japanese supervisory system in relation to article 172 of the Solvency II Directive
EIOPA is seeking input on all three documents; the consultation period ends on 23 September 2011.
This publication has been written in general terms and therefore cannot be relied on to cover specific situations; application of the principles set out will depend upon the particular circumstances involved and we recommend that you obtain professional advice before acting or refraining from acting on any of the contents of this publication. Deloitte Consulting AG would be pleased to advise readers on how to apply the principles set out in this publication to their specific circumstances. Deloitte Consulting AG accepts no duty of care or liability for any loss occasioned to any person acting or refraining from action as a result of any material in this publication.
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