Solvency II, the European Union’s sweeping new regulatory framework, will rewrite the rules for insurers as it phases in, beginning in January 2013. While the legislation may be European in origin, its impact will reverberate across Latin America.

For big multinational insurance groups headquartered in the EU, Solvency II will significantly tighten requirements for how much capital they will need to hold, impose tough new rules governing how they identify and monitor risk, and set strict disclosure guidelines to increase transparency. The new rules’ long reach will extend to their subsidiaries in the Americas, which will feel the impact on their businesses as the corporate office changes their capital reserve requirements. The subsidiaries will also need to comply with changing local regulations in each country where they operate.

Latin American insurance groups that do not do business in the EU but compete against EU rivals in their home markets could enjoy near-term regulatory advantages as Solvency II’s new rules take effect. EU life and property-and-casualty insurers have made significant inroads across the continent in recent years. In 2010, European companies had about 25% market share in Brazil, approximately one-third in Argentina and nearly 40% in Chile. Their significant presence means that any action they take to increase prices or curb their risk appetite in specific lines could ease short-term pressures, to the benefit of local insurers that have not yet moved to more stringent capital frameworks.

Over the longer term, however, Solvency II may enhance the Europeans' competitive strength. For one thing, the diversification benefits of their Latin American exposure should help improve their capital efficiency, giving them a potential edge over less-diversified local rivals. Furthermore, the pressure Solvency II is imposing on them to develop more sophisticated risk and capital management capabilities could give them a head start over their local Latin American competitors in key areas like reinsurance, portfolio management and risk-adjusted pricing.

This poses a major challenge to Latin American insurers to start building their own strengths in these areas – something they will almost surely need to do sooner rather than later. Many regulators in Latin America are following the EU example and moving toward Solvency II-like frameworks. Local insurers that ready themselves now will be better positioned to compete with the Europeans and will have a clear advantage over less foresightful local competitors.