EIOPA sets supervisory expectations on reinsurance concluded with third-country (re)insurance undertakings

QuickTake

On 4 April 2024, the European Insurance and Occupational Pensions Authority (EIOPA) published its final supervisory statement on the supervision of reinsurance concluded with non-EU (i.e., third-country) (re-)insurers.Available here along with links to an (i) impact assessment, (ii) feedback statement and (iii) resolution of comments from the earlier.Show Footnote This supervisory statement follows on from a public consultation and EIOPA has published a feedback statement for context. EIOPA’s supervisory statement does not introduce new legal requirements, but rather clarifies and harmonises the existing ones under the Solvency II framework and other EU rules. The supervisory expectations in the statement are intentionally drafted, in this current applicable version, as high-level and thus embed flexibility, allowing for supervisory judgment and proportionality, and may be further developed in the future based on feedback and experience.

EIOPA recognises that reinsurance is a crucial means for capital and risk management along with risk diversification, access to additional underwriting expansion, addressing protection gaps and facilitating increased financial stability. Accordingly, EIOPA recognises the numerous advantages cross-border reinsurance, including with third-country (re-)insures, can offer EU (re-)insurance firms.EIOPA, in keeping with EU regulatory terminology, uses the word “undertaking” as opposed to the more common market usage of the term “firm”, as used herein.Show Footnote

Nevertheless, EIOPA notes that it is crucial to evaluate the nature of “actual risk mitigation taking place” in cross-border reinsurance. As explored in this Client Alert, the purpose of EIOPA’s supervisory statement is to emphasise its expectations and those of EU-27 National Competent Authorities (NCAs) when reviewing third-country reinsurance activity by EU-27 (re-)insurance firms and ultimately the activity of firms’ administrative, management or supervisory bodies (AMSB). The supervisory focus relates to how firms and AMSB’s review risks associated with using reinsurance from third-country reinsurers that operate under regulatory regimes that are not considered equivalent to the EU’s Solvency II Directive regime. Some parts of EIOPA’s supervisory statement, where relevant and explicitly stated, apply also to reinsurance arrangements with reinsurers from those third-countries that have a Solvency II “equivalence decision”.Details available here.Show Footnote

Thankfully EIOPA’s supervisory statement does recognise differences in the risk profiles of reinsurance arrangements and whether they are performed by reinsurance firms retroceding their risks (accepted from primary insurance firms) or by insurance firms mitigating (ceding) their risks. EIOPA’s supervisory statement primarily addresses insurance undertakings that utilise reinsurance as a means of mitigating risk but, as highlighted by EIOPA, may also be applicable to reinsurance undertakings that transfer their risk, taking into account a proportional and risk-based approach to supervision and considering their respective business models.

Key takeaways from EIOPA’s supervisory expectations

EIOPA’s supervisory expectations are delivered under three key drivers for firms and AMSB’s to consider and ultimately for NCAs to supervise compliance with. These include the firm and AMSB conducting assessments of the:

1. business rationale for using third-country reinsurance and early supervisory dialogue; 
2. insurance firm’s system regarding the use of third-country reinsurers; and
3. reinsurance agreement itself.

In delivery of the three assessments EIOPA expects that a firm and/or its AMSB as well as the actuarial function:

• clearly define, implement and monitor the reinsurance strategy (generally and specifically with respect to third country exposures), considering its advantages and disadvantages, creation of additional risks (specifically basis and counterparty risk); 
• properly consider and evidence (for NCAs to assess) the trade-off between reinsurance premiums and additional risks and the impact on the Solvency Capital Requirement as well as other regulatory considerations stemming from the use of third-country reinsurance with Solvency II equivalent and non-equivalent third countries; 
• review the use of risk mitigation techniques as set out in the EIOPA Opinion from 2021 on the use of risk mitigation techniques by insurance and reinsurance undertakings (the 2021 EIOPA Opinion)Available here.Show Footnote and to prepare for greater supervisory dialogue (on an on-going basis, including for material changes) with NCAs, in particular where a material level of risk (such as counterparty default risk and life underwriting risk) is transferred through reinsurance to equivalent and non-equivalent third countries. EIOPA expects that this dialogue may start prior to the conclusion of the reinsurance agreement to allow NCAs to understand the reinsurance strategy and impact on the solvency position; 
• ensure that the risk management and internal control systems are in line with the reinsurance strategy and policies and demonstrate that material risks associated with (Solvency II equivalent and non-equivalent) third country reinsurance arrangements are appropriately captured by the firm’s risk management framework and in particular the Own Risk and Solvency Assessment (ORSA). NCAs are specifically expected by EIOPA to assess whether a firm’s: 
  
  • strategies, processes, and reporting procedures are adequate to continuously identify, measure, monitor, manage and report on the risks to which the undertaking is or could be exposed taken into account the different domiciles of its third-country reinsurers; 
  • assessment of risks arising from third-country counterparties to the reinsurance agreements (with the risks in the type of agreementNotably how the risks may differ by type of agreement, i.e. whether intragroup or non-intragroup reinsurance, short or long-term reinsurance, reinsurance of primary insurance or retrocession (and thus equally, any retrocession arrangements and terms).Show Footnote of course warranting a detailed review in its own right so as to meet Arts. 209-211 and 213-214 of the Solvency II Delegated Regulation) include identification of any legal/compliance risk arising from the law of the third countries concerned, including for example counterparty risk and in cases where the type of agreements/risk transfers are envisaged to complex. Furthermore, the supervisory statement highlights, as part of the overall need to assess the agreement’s terms do not jeopardise the effective transfer of risk, the need to review termination rights of the third-country counterparty (such as breach of local solvency requirements or other unilateral termination rights), terms of any side letters that introduce additional termination rights or alters a clearly established claims’ hierarchy in case of default for say local accounting or third-country recovery and resolution requirements; and
  • risk management policies developed by the undertaking cover the principles for the selection of reinsurance counterparties (including the ones from third countries) as well as procedures for assessing and monitoring the creditworthiness and diversification of reinsurance counterparties.

EIOPA’s supervisory statement expects that NCAs will consider how EU-27 insurance firms also assess the “qualitative elements of the selected [third-country] reinsurer”. This effectively expands on the risk due diligence measures highlighted above and sets out that the EU-27 firm’s standard of diligence (and NCA’s assessment of that diligence) of the third country reinsurer should, whether conducted by the firm or its professional adviser, consider (collectively, as opposed to any order of importance): 

• the geographical risk diversification and its pedigree in markets; 
• the reputation of the reinsurer and its proven willingness to pay, fair behaviour
• legal consequences arising in the case of insolvency (or such analogous proceedings) or recovery and resolution mechanisms, including impact on enforceability of pledged collateral and/or claims on the counterparty in (particularly a Solvency II non-equivalent) third country as well as any mitigating measures; and
• results of the country/domicile assessment. 

The outcomes of the assessments in each of the three key drivers are supposed to fuel the use of tools that EIOPA sets out at the end of the supervisory statements as proposals (that NCAs may “recommend” – read “require”) for firms to consider employing in order to mitigate any additional risks. Some of these borrow from principles long-established elsewhere in the EU’s Single Rulebook for financial services. Nevertheless, that these are singled out in the supervisory statement. The supervisory statement is also drafted, perhaps on purpose, extremely high-level, so as to allow supervisory flexibility in how and where scrutiny may be applied. Nonetheless, means firms may want to revisit existing or implement new measures to ensure they are meeting the tools EIOPA (and NCAs) expect to be employed. These include firms, in addition to the risk management techniques in the 2021 EIOPA Opinion: 

1. assessing counterparty risks and concentration exposures by pre-emptively limiting exposures on certain (equivalent and non-equivalent) third country re-insurers, through a careful diversification of the re-insurance panels. This is particularly the case in respect of only single or “relatively few” (undefined term) re-insurers are concerned, particularly for long tail lines of business and/or types of reinsurance treaties which may generate large recoverable amounts; 
2. mitigating counterparty default risks of third country re-insurers from a Solvency II non-equivalent jurisdiction with collateral agreements/pledge assets/premium and reserve deposits in case of securities with adequate precautions to prevent situations where the collateral might be insufficient or unavailable in the case of insolvency (or such analogous proceedings). This includes assessing the quality of collateral, its location and ability to enforce. EIOPA notes that collateralisation should not be considered a default practice but should be applied considering the risks that present themselves and other risk mitigation tools used; 
3. ensuring that firms have a direct claim against a (Solvency II equivalent or non-equivalent) re-insurer in the case of (i) a credit event set out in the reinsurance agreement or (ii) in the event of default or insolvency (or other such analogous proceedings); and 
4. include clauses for regular “commutation” or threshold-initiated execution of commutations agreements with third-country re-insurers. As EIOPA notes, “A commutation agreement is “an agreement between a ceding insurer and the reinsurer that provides for the valuation, payment, and complete discharge of all obligations between the parties under a particular reinsurance contract”. It can be used for the final settlement of best estimates for outstanding claims in case the cedent and/or the reinsurer desires to end the contract. A commutation agreement can also be added to long duration reinsurance contracts to avoid the build-up of large best estimate exposures. In such cases the commutation agreement specifies the frequency for best estimate account settlement and reset or defines a specific reinsurance recoverables threshold trigger for the commutation.”

What should firms focus on now?

EIOPA’s supervisory statement and expectations have been a long time coming and perhaps not everything in them is new nor innovational in thinking. It is however supposed to wrap the supervisory standards around a topic that has long been and will likely remain also a political one on convergence versus divergence.

From a practical perspective, EIOPA’s expectations certainly impact EU-27 firms but also those in (Solvency II equivalent and non-equivalent) third-countries. As a result, while EU-27 firms have a primary compliance requirement to meet EIOPA’s supervisory expectations along with any further aspects that NCAs may add on, it is also third-country firms who will have an indirect obligation to help EU-27 firms meet those expectations. If firms (as well as third-country firms) are set to be subject to stricter scrutiny in more prescriptive standards, then some may want to take preparatory action in respect of revisiting their legacy arrangements and ensure the supervisory expectations are reflected in new arrangements.

Some firms may also be well advised to consult with their professional advisors as well as NCAs and EIOPA on their reinsurance strategies and arrangements with third-country reinsurers and seek legal and regulatory advise on the implications of EIOPA’s supervisory statement for their business operations and compliance obligations. Some firms may also benefit from RegTech horizon scanning solutions (such as Rule Scanner) and managed horizon scanning to track legislative and regulatory rulemaking in third-countries that may impact their contractual and other arrangements in place with third-country reinsurers.

Outlook and next steps

While the EIOPA supervisory statement marks a step in increased supervisory awareness and scrutiny that will be applied, it is also likely that EIOPA may choose to issue subsequent iterations thereof in particular to delve into further detail from what are otherwise high-level principles on both risks and appropriate tools.

Ultimately EIOPA’s supervisory statement may require some EU firms to review and adjust their reinsurance strategies, risk management systems and reinsurance agreements to comply with EIOPA's expectations and any additional requirements from NCAs. Firms may also need to enhance their due diligence, monitoring, and reporting of third-country reinsurers, and to consider the use of risk mitigation tools such as collateral, direct claims, and commutation agreements. Firms may face challenges in accessing and assessing information on third-country reinsurers, especially those operating under non-equivalent regimes and in negotiating reinsurance contracts that meet the Solvency II standards where they do not apply a more robust diligence and on-going monitoring set-up to stay up to speed on developments affecting their third-country relationships.

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Moreover, we have developed a number of RegTech and SupTech tools for supervised firms, including PwC Legal’s Rule Scanner tool, backed by a trusted set of managed solutions from PwC Legal Business Solutions, allowing for horizon scanning and risk mapping of all legislative and regulatory developments as well as sanctions and fines from more than 1,500 legislative and regulatory policymakers and other industry voices in over 170 jurisdictions impacting financial services firms and their business.

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If you would like to discuss any of the developments mentioned above, or how they may affect your business more generally, please contact any of our key contacts or PwC Legal’s RegCORE Team via de_regcore@pwc.com or our website.