The only certainty is uncertainty

It is no surprise that regulatory risk and compliance remain high on the list of concerns cited by members of re/insurance management teams when surveyed, and most would say that this will remain a concern for a number of years.

Uncertainty often accompanies election years, and voting has taken place in a number of jurisdictions this year, with Theresa May’s Conservative Party narrowly retaining power in the UK, a new French president coming from a political party barely a year old, and a change of government in Bermuda following the general election.

Article 50 of the Lisbon Treaty has been triggered by the UK, signalling the start of the 24-month countdown to the country’s exit from the EU, and parties are in the very early stages of discussing a wide range of topics related to the departure. In the US, President Trump continues to face challenges in the first year of his presidency as he works to pass key legislation promised during his campaign, some of which will affect the re/insurance industry.

US Healthcare reform under a cloud

The Trump administration continues to work toward passing healthcare reform legislation. With the Senate having agreed to debate a healthcare bill only in late July, the passage of healthcare reform remains elusive. A proposal to vote solely on the repeal of the Patient Protection and Affordable Care Act without an immediate replacement has been given a dire prognosis by the Congressional Budget Office.

Healthcare is one part of a broader tax reform package expected later in the year. In addition to tax reform measures that benefit individuals, the healthcare package currently includes provisions to cut the corporate tax rate and to impose a border adjustment tax. If the border adjustment tax does not exclude financial services transactions, the re/insurance industry would be materially impacted.

If the border adjustment tax is removed from the tax reform package altogether, replacement revenue would be needed and the government may turn to House Bill HR 1 (Rep. Dave Camp, R-MI), the Tax Reform Act of 2014, for sources of potential revenue. Although HR 1 was never passed, it provides a number of options for legislators to consider to offset individual and corporate tax cuts, including the disallowance of tax deductions on US reinsurance cessions to affiliates in jurisdictions where legislation does not tax reinsurance premiums (HR 1 §3701).

Including the disallowance of tax deductions for certain non-US affiliated cessions in tax reform would impact the re/insurance industry globally, and not just from a tax perspective. From
an enterprise risk management perspective, internal reinsurance aids the centralisation of key functions such as capital management, investment management, and reinsurance purchasing. Opponents of the provision argue that higher taxes would reduce capacity and increase rates, which would ultimately fall on the US consumer. The details of the tax reform package are expected by the end
of 2017.

The Covered Agreement with the EU

In July 2017, the US Department of the Treasury and the Office of the US Trade Representative announced their intent to sign the bilateral agreement commonly known as the Covered Agreement with the EU, which provides for mutual recognition in the areas of reinsurance, group supervision, and exchange of information, as well as reductions in collateral requirements.

Earlier in the year, the National Association of Insurance Commissioners (NAIC) and others expressed concerns to Treasury Secretary Steven Mnuchin about the lack of clarity in a number of the Agreement’s terms. The details of the Agreement were of particular concern to the NAIC because state regulators would be responsible for implementing many of the Agreement’s provisions.

The NAIC issued a statement in connection with the July announcement, noting that key elements of the Agreement would be clarified and that the primacy of state regulation was affirmed. This is a positive step forward, with more details to follow when the Agreement is signed and a US policy statement is issued.

The Agreement does not cover a small number of jurisdictions that are outside the EU but have received “qualified jurisdiction” status from the NAIC. Qualified jurisdictions are eligible for certification by a state as a certified reinsurer for collateral reduction purposes. In addition to Bermuda, Japan, and Switzerland, four EU countries have achieved this status for a five-year period—absent a material change in circumstances—from January 1, 2015. Bermuda and Switzerland are also Solvency II equivalent, while Japan has temporary equivalence with Article 172 (reinsurance) for five years and provisional equivalence with Article 227 (group solvency) of the Solvency II Directive for 10 years.

Post-Brexit the UK, a qualified jurisdiction, will also fall outside the Agreement and will undoubtedly seek Solvency II equivalence. Bermuda, a British Overseas Territory, will retain its Solvency II equivalence status following Brexit—it has never been a member of the EU—and it has already completed its equivalence review. Efforts are being made to apply the benefits of the Agreement to qualified jurisdictions outside the EU.

AM Best’s views remain unchanged

AM Best does not generally foresee any rating impact from the relaxation of collateral requirements resulting from the signing of the Covered Agreement, provided that companies adhere to the fundamentals of their credit risk reviews. Should counterparties decide to reduce or eliminate collateral requirements, the amount of required capital as calculated by Best’s Capital Adequacy Ratio model is likely to increase; on the other hand, all things being equal, having less collateral would improve liquidity for the reinsurer.

AM Best focuses primarily on the consolidated operating group and consolidated operating performance, net of tax. We will continue to communicate with re/insurance companies and other members of the industry as they navigate this period of uncertainty.

This article is an excerpt from AM Best’s 2017 Global Reinsurance Special Report.

Susan Molineux is a senior financial analyst at AM Best. Prior to joining AM Best, she was an insurance regulator at the Bermuda Monetary Authority. She can be contacted at: susan.molineux@ambest.com