Solvency requirements for Insurers in Europe and Brazil – A comparative law analysis

Source: Editora Roncarati

By CARSTEN FRANZ OTTO1

Foreign Associate DR&A Advogados

As a result of the financial crisis of 2007, the European Union introduced new solvency requirements for the big players on the financial markets: banks, asset managers and insurances. The legislation for the latter was done through the directive 2009/138/EC on the taking-up and pursuit of the business of insurance and reinsurance (hereafter Solvency II).

The main goal of the new directive was the protection of the insured and the financial stability of the insurance companies and subsequently of the financial markets. The solvency II directive consists of three pillars:

  • Solvency requirements;
  • Requirements for governance and risk management of insurers; and
  • Disclosure and transparency requirements.

The guidelines follow a risk-based approach, similar to the Basel II regulation, which is applicable to the international banking system. 

As a directive, Solvency II is not directly applicable and must be implemented into the national law of the member states. It sets a minimum standard, but leaves the member states with a certain amount of leeway on how the rules are adopted. As the European Union is the biggest single market in the world, legislation from the EU has an extraterritorial effect on other states that aim to access and participate in the European Market. Therefore, states – as for example Switzerland and Bermuda (both non-EU members) have already adapted their insurance law in accordance with Solvency II and are deemed as “equal jurisdictions” for reinsurance and group solvency requirements. Insurers from those countries therefore do not have to comply with Solvency II regulation when operating in the European market as long as they fulfill their national solvency requirements. Brazils insurance authorities also seek to receive an equivalence status to Solvency II from the European Insurance and Occupational Pensions Authority (EIO- PA), as Brazil has established a risk-based capital assessment mechanism following the Solvency II guidelines.

The following article shall explore the solvency requirements for insurers in the EU directive and compare it with the current legislation of Brazil.

Whereas in Brazil the Conselho Nacional de Seguros Privados (CNSP) and Superintendência de Obras e Serviços Públicos (SUSESP) are supervising insurances, in the European Union, the EIOPA is responsible for Solvency legislation. However, the national supervisory authorities of the member states are responsible for the implementation and the enforcement of the European rules. Moreover, the national supervisory authorities can introduce further rules and requirements but may not go below the minimum standards as set in Solvency II.

Both jurisdictions differentiate between minimal capital requirements (MCR) and solvency capital requirements (SCR).

In Brazil, insurers must continuously meet the MCR which is the higher value bet- ween the base capital and the risk capital. The base capital is composed by a fixed amount depending on the offered insurance (e.g. life insurance, reinsurance) and a surplus depending on the federal states the insurance company operates in. Therefore, the base capital varies between R$ 1,200,00-15,000,000. The risk capital is calculated according to the sum between capital instalments based on the risk of underwriting, credit, operation and market.

In the European Union, legislation solely focuses on the probability of the insurers to meet all their obligation over the following twelve months. Assets and liabilities are assessed according to international accounting standards. The capital requirement therefore depends on the potential risks and the future obligation of the insurers and must meet those with a probability of 85%. Several member states have furthermore introduced sumplump capital requirements depending on the offered insurance (e.g. Polish life insurers must have a minimum base amount of 3.6 million EUR.). The underlying risk margin is either calculated according the following formula or by using its own internal model approved by the respective Central Bank:

RM = CoC . ?/t?0 SCR (t)/(1+r (t+1)) t+1

where: 

  • CoC denotes the Cost-of-Capital rate;
  • the sum covers all integers including zero;
  • SCR(t) denotes the Solvency Capital Requirement referred to in Article 38(2) after t years;
  • r(t + 1) denotes the basic risk-free interest rate for the maturity of t + 1 years.

The solvency of the assets is calculated according its characteristics (FX Swaps, fixed income bonds, but also denomination, liquidity etc.) following again a complex mathematical model. A deeper explanation of the underlying mathematical assessment is however not done in this article.

 In both jurisdictions, the minimal capital requirements and the solvency capital requirements are closely connected. Whereas Solvency II requires that the insurer must be able to meet all its obligations over to following 12 months with a 99,5% probability, Brazilian insurers must meet the highest of the following values:

  • Base capital + Risk capital as outlined above;
  • 0,2 x total net revenue from premiums; and
  • 0,33 x the annual average of total claims of the last 36 month.

As long as Brazil does not obtain an equivalence status, European insurers ope- rating in Brazil have to comply with the Brazilian solvency requirements and vice versa. However, the implementation of the risk-based capital requirement approach in the EU already effects the Brazilian market. As a result, higher overall capital requirements were introduced, and it is likely that insurers adjust their product and business mix in order to optimize their regulatory capital consumption.

Finally, reinsurances, as a regulatory capital management tool, might be used more often in Brazil as it can offer capital reliefs under the new solvency regimes.

1 Franz Carsten Otto graduated from the University of St. Gallen (Master of Law and Economics) in 2018 and has completed exchange programs from the Université de Fribourg and the University of California, San Diego. Prior joining DR&A Advogados, Carsten worked in inter- national law firms in Zurich and Prague as well as in a legal department of a Swiss financial service provider.