US-EU covered agreement adds clarity but will take time to implement

The covered agreement reached between the United States and the European Union in response to the bloc’s Solvency II directive provides regulatory clarity and reduces the regulatory burden for U.S. and EU reinsurers operating in each other’s markets, according to a briefing by A.M. Best Co. Inc.

Both the U.S. and the EU are progressing towards provisional application following the signing of the agreement on Sept. 22, but full implementation may take five years, the Oldwick, New Jersey-based rating agency said in a briefing published on Tuesday.

For EU reinsurers operating in the U.S., a particularly important element is removal of collateral requirements, subject to certain solvency standards being met, according to the brief.

U.S. states have five years to adopt these reforms and collateral requirements for current reinsurance agreements will not be affected, according to the briefing.

“However, once implemented, the reforms will have positive implications for liquidity and the fungibility of EU reinsurers’ resources,” Best said. “Lloyd’s and London market reinsurers will be disappointed that this long-fought-for concession will not apply to them post-Brexit, but will hope that the (United Kingdom) will be able to negotiate a similar deal now that a precedent has been set.”

U.S. insurers operating in the EU will be “relieved” that their worldwide operations will not be subject to the regulatory burdens of Solvency II, according to the briefing. U.S. reinsurers will also welcome the removal of the obligation to establish a local presence — either a branch or subsidiary — in the EU, according to Best, which added, however, that it is unlikely that the signed agreement would lead to the desolation of legal entities, whose purpose was partly 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,” Best said.

“Although the execution of the covered agreement may have implications for individual A.M. Best-rated entities, it is not expected that these will be sufficiently material to lead to rating actions,” the agency stated. “The impact of the agreement on (re)insurers operating in the two markets will depend on individual business models with favorable implications for some and adverse implications for others.”