By Bob Haken, Senior Associate, Norton Rose LLP
As the focus of regulatory authorities turns to the scope of the internal model, insurance groups headquartered outside the EEA are considering whether their legal structure could actually bring benefits under Solvency II requirements.
Companies hoping to use an internal model to calculate their Solvency Capital Requirement (SCR) under the new Solvency II regime from 1 January 2013 were required to submit their pre-application qualifying criteria document to the FSA by 28 February 2011. Up to this point, most businesses will have concentrated their attentions on the calculation kernel, the quality of their data and the model governance (including the “use test”). However, with the FSA requiring groups to clarify which companies are covered by the internal model, the time has come to consider legal group structures and to identify whether difficulties will arise when Solvency II comes into force, or alternatively whether there are opportunities to derive benefits.
Leaving for the moment the question of the equivalence of third country group supervision, international insurance groups will need to calculate a group SCR for any EEA sub-groups within their overall group structure. Typically, they will choose to do so through an internal model in order to recognise diversification benefits to the greatest possible extent. As more groups are submitting applications to calculate group SCR through an internal model, the FSA is looking more closely at group structures and asking groups to take legal advice on the composition of any EEA sub-group.
Group structures tend to evolve organically over time, meaning that the scope of group supervision is often broader than expected. This might be due to the inclusion within the sub-group of non-EEA insurers (such as off-shore captives or third country insurers) or other regulated entities (such as asset management arms). Some groups will also have Lloyd’s corporate members (whose capital requirements will be set by the Lloyd’s internal model) which will contribute to the own funds and group SCR. If these other companies are within scope of the model, not only does the group need to calculate their impact on the SCR, other requirements of Solvency II such as the need for consistent risk management, valuation of assets and liabilities and the ORSA will also apply. It is therefore essential to understand which companies will fall within scope, and what can be done about it.
Very often, if there is no good reason for companies to be within the EEA sub-group, the solution will be simply to move them elsewhere within the group, whilst ensuring that doing so does not itself create another sub-group that is subject to group supervision. As ever though, intra-group reorganisations should be planned carefully, as dividend traps, tax planning and the need for regulatory consents can all cause difficulties.
Another common issue for groups is that there are actually two EEA sub-groups which do not have a shared EEA parent. The group will effectively need to have two group internal models, and depending on the location of the holding companies, these may need to be approved by different regulators. Again, one solution may be to bring the different arms of the group together under a common EEA parent, but this is not necessarily the optimal solution. An alternative might be to consider whether having common directors on the boards of the two different sub-groups would be sufficient to create an “Article 12(1)” relationship, which would mean that the sub-groups would be treated together even without common shareholders.
Another potential benefit derives from Article 231 of the Solvency II directive, which allows groups to use a single model to calculate both their group SCR and the solo SCR of each insurer within its scope. Although the process for approving such an internal model needs to include all relevant supervisory authorities, ultimately the decision rests with the group supervisor. This may therefore assist groups with undertakings in jurisdictions where the regulator does not have sufficient resource to consider model applications on a solo basis. If the group supervisor, in consultation with the other relevant regulators, can approve the model as a whole, the individual solo SCRs can be calculated using the model without needing to go through the whole approval process in each jurisdiction. It should be noted that it is open to individual supervisory authorities to derogate from the group supervisor’s decision, but it is expected that this power will be used relatively rarely.
What then about the equivalence of group supervision at the level of the ultimate parent undertaking? The directive is clear that if worldwide group supervision is being undertaken in an equivalent manner, EEA regulators should rely on that and not seek to supervise the global group themselves. EIOPA is currently assessing the equivalence of Bermuda and Switzerland for the purposes of group supervision, but many groups are headquartered elsewhere. The draft Omnibus II directive also allows the European Commission to decide that a jurisdiction might be equivalent on a transitional basis. In the absence of a decision from the European Commission, group supervisors are able to form their own view of the equivalence of a particular regime. Indeed, group supervisors have more flexibility in that they can assess whether the supervision of a particular group is equivalent, without needing to consider the entire regime. The key here is early engagement - groups headquartered outside of the EEA, Switzerland and Bermuda should initiate a dialogue with their European regulators. To support their arguments, groups should be carrying out their own analysis of the equivalence of the regime, both from a strict legal position and from their practical experience of how the rules are actually applied.
It is clear that regulators across the EEA want clarity over the scope of their group supervision and the composition of groups, but it is equally evident that groups themselves should be considering these issues. Failing to do so might result in inappropriate application of the Solvency II rules, whereas a proper analysis of the group structure might actually yield significant benefits.
As we move into the next phase of Solvency II, the industry needs to address group structures now despite the uncertainty as to the final form of the Level 2 measures and the changes and transitional periods contained in Omnibus II.
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