Grappling with change

It’s been said that the re/insurance industry is facing a tsunami of regulatory requirements and after spending some time with Michael McGuire, the chief financial officer (CFO) of Endurance, it’s pretty clear that he feels the same way.

Sitting in an office with a spectacular view of Bermuda’s Great Sound, McGuire cuts a relaxed figure—remarkable perhaps considering the conversation revolves around the stresses placed on the business by increased regulation.

He acknowledges that Solvency II will bring yet more regulatory oversight, but what concerns him more are the growing individual regulatory requirements of different jurisdictions, which have given rise to significant expenses and administrative burdens across the industry.

“Coming from the financial crisis of 2007/2008 there was a global kneejerk reaction by the regulators of all financial services businesses. The insurance industry as a whole weathered the financial crisis very well but the regulatory response to the financial services industry overall was extreme,” says McGuire.

Change from all sides

McGuire first came to Bermuda in 1996 and has been Endurance’s CFO since the end of 2005, having joined the company in 2003 to lead its external reporting and treasury initiatives as well as Sarbanes-Oxley compliance—itself a very significant piece of industry regulation enacted after several major corporate and accounting scandals, including those affecting Enron.

A Certified Public Accountant and a member of the American Institute of Certified Public Accountants, McGuire says he has seen the role of CFO change considerably in recent years.

“The mainstay of the job has not changed—financial management, accounting and reporting. It is the regulatory compliance aspects which have changed,” he says.

“Ten to 15 years ago the CFO made sure the accounting was accurate, the cash was in the bank and the audits went without a hitch. It is a much more strategic role now—partnering with our business leaders in the planning and execution of our strategy, financially managing a complex global company, and optimising our capital structure around the globe to meet the varying needs of multiple constituents.

“In addition, the significant expansion of global regulatory and capital requirements, the greater focus on compliance and controls, and the margin compression that all insurers and reinsurers are experiencing has substantially increased the importance and scrutiny of the CFO’s role compared to 10 years ago.”

There is a feeling within the reinsurance industry that companies are spending more and more time on the minutiae of capital requirements and regulations.

Many industry executives now say they consider regulation to be one of the most significant risks to the insurance industry and believe that individual actions by different jurisdictions complicate the situation.

McGuire appears to agree. “As a global company with operations in Bermuda, the US, UK, Zurich and Singapore—each location with its own requirements—there has been increased scrutiny of our capital levels and an increase in reporting requirements around the risk capital that we need to maintain.

“It creates a significant expense and administrative burden across the industry. In other jurisdictions outside Bermuda there is turf battle going on with each country’s regulator looking after the interests of domestic companies to the detriment of business elsewhere. It is a real challenge.”

McGuire says some jurisdictions have also been introducing capital charges or tax charges on the transfers of reinsurance business to companies outside their jurisdiction. “These are penal taxes which suppress competition and the free flow of capital. They make companies think differently about their capital structure,” he says.

The right balance

The combination of Bermuda’s progressive regulatory environment with the industry leading enterprise risk management regimes in place at most of the companies in the Bermuda market has allowed Bermuda to be a beneficiary of new capital formation in the insurance and reinsurance industry even as the business is increasingly global.

McGuire agrees, saying: “Bermuda is a well-respected jurisdiction and has been a good steward of the industry, with a regulatory regime that has strong oversight and compliance while maintaining a pragmatic approach with industry participants and the global regulatory community.

“There were no real insolvencies in Bermuda in the financial crisis and the Bermuda marketplace proved to be extremely resilient in crisis.”

“Each country has its own political and economic interests. To think they would fully cede authority to another country is an unlikely prospect.”

Although Bermuda is often perceived as having a lackadaisical regulatory system, McGuire points to a different reality. “That perception is not true. The BMA regulators regularly review the market and its participants and proactively reach out to companies at the early stages of industry developments to make sure they understand the companies’ operations and what the risks are.

“Other regulators have a broad-brush approach and are focused on compliance checklists and modelled outputs instead of truly understanding the risk and exposure within the company. Bermuda has a pragmatism that we do not see as much in other jurisdictions.”

McGuire is not anti-regulation: he acknowledges that he is in the risk business and that it is therefore necessary to have checks and balances to help protect companies, policyholders and shareholders. Having a regime that focuses on the level of solvency, liquidity and capital, he says, is important.

But he adds: “I would rather have one entity that could service all of our business globally with one regulatory regime—multiple entities with multiple regulatory regimes is not an efficient model.

“The concept of global regulatory convergence has been talked about for many years, however, the reality is that it is not going to happen any time soon. Each country has its own political and economic interests. To think they would fully cede authority to another country is an unlikely prospect.

“The reality is that we will have individual regulatory authorities each with their own reporting requirements adding layer upon layer of administration.

“In the longer term, it is one of the industry’s biggest challenges and it is only going to get worse, not better.

“Regulators must challenge themselves and answer ‘how much is enough?’.”

Effective capital allocation is key

Some CEOs have talked about moving capital to the business lines and geographic areas where they feel they can get the best returns. It is one of the advantages of being a global player.

While McGuire agrees with that principle, he also warns of the risk of being seen as ‘flighty’, adding: “As the markets wax and wane, companies shift capital based on opportunities to get the best return for shareholders.

“However, we cannot be in a market one day and out the next day. We need to maintain a core portfolio with diversity across products and geographies and, within this position, we scale up or down depending on market conditions and risk/return characteristics.

“A CFO’s role is critical in an organisation’s decision-making process of capital allocation and return optimisation.”

McGuire also commented on the importance of being able to transfer risk and capital internally to most effectively manage group capital and returns. “Although various local regulatory regimes make it difficult, we must be able to transfer risk between our various companies globally, matching the risk we take with the capital we hold throughout our jurisdictions.”

He also has some interesting thoughts on the trend within the industry in recent years of reinsurers forming sidecars—allowing them to leverage alternative sources of capital using different structures.

McGuire says the introduction of alternative vehicles into the reinsurance industry is not a new trend. Companies are underwriting risk on their own behalf, but they are also placing risk into these support vehicles.

“A real conflict could arise,” he adds. “What happens in a serious loss event if the company sponsoring these vehicles has a good result, and there is a significant differential between the results of the sponsoring company and the support vehicle?

“Investors in the separate vehicle could litigate against the company in this situation. It is a pessimistic view, but there is a real conflict potential. The incremental economic benefit from these structures may pale in comparison to the reputational and defence costs in these circumstances.”