43Although FSOC’s final rules for the designation process have

been in place for many months, there are several related rules that have not yet been finalized. These include final rules establishing which activities are “financial in nature.” Only companies “predominantly engaged in financial activities” are eligible for FSOC designation, which generally requires that 85% of the company’s assets or revenues be derived from activities “financial in nature.” This is a potentially critical threshold and one for which several proposed rules have been released to no effect. Generally, however, regulatory agencies have adopted final rules relating to the Dodd-Frank Act at a much slower pace than many anticipated in 2012, likely contributing to FSOC’s slow start to the designation process. Further, FSOC has not made any official public announcements regarding the status or progress of the designation process or when the process is expected to be completed. The most recent development occurred in October 2012, when certain non- bank companies, including at least one insurance company, voluntarily announced they had received notice that they will be reviewed by FSOC in Stage 3, suggesting that final FSOC designations may be imminent. Until then, many observers appear to agree that FSOC will almost certainly designate at least one (but likely more than one) company from each of the following market segments: insurance companies, asset managers, investment advisers, private equity funds, hedge funds, non-bank lenders and other financial services companies.

3. EU/U.S. Dialogue Project

In January 2012, U.S. and EU insurance regulators began the EU/U.S. Dialogue Project (the “Project”), a cross-border effort designed to achieve a greater understanding of “the overall design, function and objectives of the key aspects of the two regimes, and to identify important characteristics of both regimes.” The Project has been guided by a Steering Committee of three U.S. and three European officials, including FIO’s Director and the NAIC CEO as well as the Chairman of EIOPA and the Head of the Insurance and Pensions Unit of the European Commission.

Building on 10 years of communication between U.S. and EU regulators, FIO initiated the Project in an attempt to increase bilateral clarity on regulatory and capital expectations and requirements and to provide an alternative to either side performing unilateral adequacy assessments of the other’s regulatory system. It comes at a time when the implementation of Solvency II and its regulatory equivalency requirements now look to be delayed further, possibly to 2016 or 2017.

In December 2012, the Project Steering Committee issued a joint report that describes the commonalities and differences between the U.S. (state-based) and the EU (Solvency II) insurance regulatory frameworks with respect to: (a) professional secrecy and confidentiality; (b) group supervision; (c) solvency and capital requirements; (d) reinsurance and collateral requirements; (e) supervisory reporting, data collection and analysis and disclosure; (f) supervisory peer reviews; and (g) independent third-party review and supervisory on-site inspections.

In December, the Project also released formal objectives for the next five years, in the form of its “Way Forward” plan. These objectives include: (i) promoting the free flow of information between regulators; (ii) establishing a robust regime for group supervision that incorporates a holistic approach to determining a group’s solvency and financial condition and is complementary to solo/legal entity supervision; (iii) improving approaches to valuation; (iv) achieving a consistent approach to reinsurance collateral requirements, including the examination of the possibility of reducing or removing collateral requirements in both jurisdictions; and (v) increasing the consistent application of requirements such as peer reviews. In early 2013 the Steering Committee expects to formulate detailed plans to take action on these objectives. The NAIC International Insurance Relations Leadership Group has recommended that the NAIC engage appropriate committees as necessary to evaluate and carry out the work contemplated by these objectives.

V. Regulatory Developments Affecting Insurance Companies

44

4. Solvency II

The major European regulatory issue in 2012 was Solvency II and the question of when it is going to implemented. This issue has significance beyond Europe for a number of reasons. First of all, Solvency II affects international groups and how their group solvency is calculated and therefore affects the assessment of groups that have insurance companies in Europe and outside of the European Union; second, it affects reinsurers outside of the European Union who wish to reinsure European insurance companies; and third, Solvency II has been held up as a new gold standard to which international insurance regulation should aspire. That latter point has undoubtedly taken a hit to its credibility, given the continued delay over the implementation of Solvency II. Why is Solvency II being delayed? The answer to this has two aspects: the first has to do with the legislative timetable for implementation and the continual postponement of the steps that should have been taken under the original legislative timetable; and the second has to do with deeper anxieties about what Solvency II will mean in practice and is the real cause of the delay.

Slippage in the Legislative Timetable

The original Solvency II directive was made in 2009. However, the full implementation of Solvency II depends on the drafting and adoption of a series of subordinate rules that flesh out the higher principles set out in the Solvency II directive. These in turn will need to be translated into the domestic legislation and rule making of each Member State of the European Union. One of the regulatory responses to the financial crisis was the creation of new Europe-wide regulatory authorities that would have the power to make binding rules and coordinate a greater degree of regulatory cooperation among the individual European regulators. In the case of the insurance industry, EIOPA was created pursuant to European Regulation 1094/2010. However, before it could take up its powers to propose rules and issue binding guidance under the Solvency II regime, the Solvency II directive had to be amended; it also had to be amended to provide for transitional arrangements to the introduction of the new regime, which had not been adequately dealt

directive is the legislative means to amend the Solvency II directive. The legislative process involves the European Parliament, the European Commission and the European Council agreeing on the revised Omnibus II directive. Once the Omnibus II directive is adopted, the legislative framework will be complete and the subordinate rules and guidance can then officially be made.

In this process, participants have taken the opportunity to revisit some of the issues that had been debated in the run- up to the adoption of Solvency II and were causing concern. Of particular concern were two issues: one had to do with the valuation of so-called long-term guarantee products, i.e., life insurance products that are long-term, such as annuities, where the insurer has made promises to make certain payments in the future; and the second had to do with assessment of “equivalency” to Solvency II of regulatory regimes outside the European Union and what transitional arrangement may be made for countries that are not deemed equivalent.

In the course of negotiations between the European Parliament and the European Commission, considerable amendments to the drafting of the Omnibus II directive were made. But at each deadline set in the calendar where the European Commission and the European Parliamentary representatives were meant to agree to a finalized text, the decision has been postponed. This takes us to the deeper reason for the delay, which primarily is anxiety about the potential overall effect, not only on the insurance industry, but on the real economy, of the measures that have been proposed to deal with long-term guarantee (“LTG”) products.

The LTG Issue

The worry is that Solvency II could cause long-term products to be priced out of the market; it also could discourage insurers from investing long-term. At the end of 2010, the European insurance industry managed assets worth €7.4 trillion, which is about 50% of European GDP. It is a major investor in long-term projects and is important not only for the provision of its protection to policyholders but also as an investor and promoter of economic activity in the real economy. Accordingly, a reduction in long-term investment by insurers could significantly affect the real economy.

V. Regulatory Developments Affecting Insurance Companies

45