A simple step by Europe could loosen Iran’s grip on the Strait of Hormuz

John Berlau is director of finance policy at the Competitive Enterprise Institute.

As European nations ponder unilateral actions to bring shipping back to the Strait of Hormuz, they should consider one simple step: suspending insurance regulations that are harming their economies and inadvertently empowering Iran in this ongoing standoff.

By curtailing flawed provisions of the Solvency II insurance regulatory framework, Europe’s leaders would provide needed assistance to the United States in its negotiations with Tehran and would take the first step toward ridding the European economy of this harmful red tape.

Crafted by E.U. bureaucrats and ratified by the European Parliament in 2014, Solvency II was one of the issues that fueled the successful Brexit campaign in Britain, yet post-Brexit governments have done little to change it. The regulation sets burdensome and unrealistic capital rules that have raised costs significantly for insuring several vital economic activities in the European Union and Britain, including shipping. These rigid mandates limited the ability to insure ships sailing in the strait when the conflict with Iran began and may ensnarl commercial shipping in the passage even if hostilities wind down.

European insurers that specialize in shipping, including members of the Lloyd’s of London insurance marketplace that has been providing war risk insurance to commercial ships in combat zones for more than 200 years, have been confounded by Solvency II’s “value-at-risk” rule, a complex formula that requires an insurer to hold enough capital to withstand, with 99.5 percent confidence, a once-in-200-years extreme event that could bankrupt the company.

Experts have called the 200-year time frame highly subjective and counterproductive, as it prevents companies from deploying capital to reduce actual long-term and short-term risks. A paper from the British-based Institute and Faculty of Actuaries states that “a 1-in-200 likelihood is beyond what is reasonably foreseeable given a 60-80 year living memory and a 20-40 year working memory.”

Today’s war risk insurers have seen a lot in a 40-year working memory and have a pretty good idea of how to price for risk with that knowledge. During the multiyear Iran-Iraq Tanker War of the 1980s, the warring countries attacked more than 400 merchant vessels in the Persian Gulf. Insurance premiums did spike as much as fivefold to reflect the increased risk, but “trade continued, because war risk insurance itself did not withdraw entirely from the market,” notes Aditya Sinha, financial commentator and former officer of the Indian prime minister’s economic advisory council.

By contrast, within hours after Operation Epic Fury began in late February, underwriters started canceling policies for ships traveling through the Strait of Hormuz, leading to a dwindling number of ships making the passage over the next few days. As this happened well before the Iranian government declared the strait closed on March 4, many observers fingered Solvency II as the prime motivator for the coverage cancellations.

Read the full article at Washington Post.