Standard & Poor’s (S&P) Global Ratings said the U.S. – EU Covered Agreement (CA), which it called a “milestone in improving transparency and regulatory cooperation” could come under threat from fierce U.S. opposition and the Trump administration’s preference for deregulation, but this isn’t expected to have a significant material impact on reinsurers.
The Obama administration’s closing days oversaw the completion of the agreement – which is set to lift reinsurance collateralization requirements, and requirements for reinsurers to establish local branches, and permit the U.S. and EU to oversee prudential insurance solvency and capital, governance, and reporting requirements for re/insurers based on their respective head office jurisdictions, during a five-year phase-in period.
S&P Global Ratings credit analyst, Tracy Dolin, said; “We believe the CA is a fruitful milestone in increasing U.S.-EU regulatory harmonization.
“The CA provides a more-level playing field within the world’s two largest insurance markets–with about $1.35 trillion and $1.32 trillion in combined 2015 life and non-life premiums generated within the EU and the U.S., respectively.”
S&P Global Ratings report said the CA was a tribute to how the Dodd–Frank Wall Street Reform and Consumer Protection Act empowered the Federal Insurance Office to advise U.S. Treasury and Trade Representative in international insurance negotiations.
The agreement includes a model memorandum of understanding (MoU), where insurance supervisors from both sides agreed to report confidential information.
However, analysts said this all now “hangs in the balance” with resistance coming from National Association of Insurance Commissioners, insurance trade groups, and members of Congressional committees.
And Trump’s deregulation agenda has cast a further shadow of doubt onto whether the new administration will embrace or reject the CA.
But amidst the uncertainty, there’s good news for re/insurers, Dolin said; “If the CA were to unravel, we would expect (re)insurers headquartered in the U.S. and EU to come out relatively unscathed with no ratings impact.”
S&P analysts anticipate the CA’s removal as not significantly impacting the industry’s financial benefits: the CA hasn’t yet been implemented as it was set to be gradually phased in, many large re/insurers already have local branches in place, and the U.S. is expected to work towards Solvency II standards to renew its provisional equivalency status in 2026:
“We believe implementation of the CA is a step in the right direction for leveling the regulatory playing field. However, we don’t anticipate (re)insurers on either side of the Atlantic seeing any near-term material financial benefits, and if the CA doesn’t materialize, we don’t think either side will come under ratings pressure.
“European reinsurers generally post collateral through letter of credit facilities, which, in part due to low-interest rates, are very cheap even when drawn. So, the ongoing cost of posting collateral is not material in the context of the reinsurers’ operations.”
“Furthermore, many of the largest European reinsurers have legal operating entities in the U.S. that will retain a large amount of the reserves instead of ceding them back to their European parent groups. These reserves, held net on the balance sheets of U.S. subsidiaries of European reinsurers, are not subject to these collateral rules.
“Lloyd’s is a notable exception, since it doesn’t have any risk carrying legal entities in the U.S. Though even without the CA, we wouldn’t expect the U.S. to force Lloyd’s to open operations in the U.S.–a tactic contemplated in some EU countries.”
The CA alternative is that the U.S. could have to work towards adopting Solvency II principles in order to keep its provisional equivalency status when it expires in 2026, S&P believes.
The report concludes that it doesn’t expect “the U.S. to apply for full Solvency II equivalence in order to preserve the state insurance regulatory system,” however, analysts note, its moving to create group capital standards such as are underway through the NAIC’s capital modernization model law efforts.
And for now, the rating agency said; “the combination of the CA and the U.S. provisional Solvency II equivalency status is unofficially a hodgepodge of equivalence, since it addresses in principle the three tenets of Solvency II.”
