Last month, a significant development took place in Europe that so far has not been widely reported in the US, even though it will likely have profound effects on global economic competitiveness. The European Union (EU) Parliament voted on July 18 to begin the process of rolling back the Solvency II regulatory framework that has governed Europe’s insurance market for nearly a decade
As we described in Forbes and in a previous post here, the Solvency II mandates made it “prohibitively expensive for insurance companies to buy equities such as stocks and relatively cheap to purchase bonds, particularly those issued by governments and the biggest corporations.” The capital requirements set by the EU were the impetus for increased insurance premiums for European consumers and shortage in Europe of long-term insurance policies such as annuities, as well as a significant factor in the overall stagnation of the EU economy. These regulations will now be revised to “unblock billions of euros and widen asset allocation options to allow increased investment,” as reported by Reuters correspondent Huw Jones.
Yet, just as the Europeans are loosening the constricting mandates of Solvency II, a powerful association of insurance regulators in the US is considering enacting a similar regulatory framework here. In the US, states primarily regulate the insurance market, but many state insurance commissioners follow the regulatory rules and guidelines of the National Association of Insurance Commissioners (NAIC). At its ongoing Summer Meeting this week in Seattle, the NAIC is considering proposals put forth by a “working group” within its membership that could hike capital charges for equities held by U.S. Insurers to levels on par with Solvency II.
Under Solvency II, capital charges for equities held by EU insurers range from 39 to 49 percent, while for bonds they range from 10 to 20 percent. These charges were assailed by the United Kingdom’s House of Commons Treasury Committee, which said, “Solvency II has been very costly to implement… extra costs complying with the rules, and loss of access to some asset types, are leading to poorer value” for British consumers.
Yet warnings from the UK and EU about the effects of Solvency II did not seem to break through to the working group at the NAIC. In June, the “Risk-Based Capital Investment Risk and Evaluation Working Group” proposed to immediately hike capital charges on “residual interests” to 45 percent, putting U.S. insurers in midrange in capital charges for equities set by the EU under Solvency II.
We noted in Forbes that the residual interest rule would actually hit the American insurer harder than the European Solvency II frame since implementing these capital charges would have a shorter time frame for rollout. Though delayed by a year, the capital charge would still disrupt U.S. insurers and could severely harm the US economy. As we detailed, “it may result in a sudden dumping of assets by insurers to remove equities from their books that may trigger the capital charges.” This would damage the U.S. insurance market and, perhaps, the broader US economy.
An insurance industry insider in the US tells us that as currently proposed, the rule’s “increased charge could apply to residual interests in private equity funds, real estate joint ventures, and other investments that have been widely held for decades by the most stable of American insurance companies.” And ironically, if Solvency II is any indication, the proposed NAIC mandates could also choke off investments in an economic sector favored by the left: so-called “green” energy sources such as renewables.
According to Reuters, a major reason for Solvency II reform efforts that influenced the EU’s action is to “unlock up to 90 billion pounds ($117.89 billion) of investment capital for high-growth companies and green and infrastructure projects, widely viewed by backers of Brexit as a financial market gain from leaving the EU.”
The NAIC needs to learn from the mistakes of the EU, and withdraw this regulation that would put many U.S. insurers and consumers on a course to higher insurance rates, less capital availability, and, ultimately, less investment in the essential growth sectors of the US economy.