1 January 1970

Regulation: a paradigm shift

Solvency II is set to come into force on the last day of 2012. The new standards that the European regime demands will raise funding requirements for many companies around the world during what some today are forecasting will still be a soft market. Not everyone in the industry is therefore thrilled at the prospect of Solvency II . Grumbling is heard, as they say, in the Shires.

In the most pressing example, the assumptions buried in Solvency II pose a major question of the life reinsurance industry. Its business model is different from that of, say, a property catastrophe reinsurer, to whose needs the Solvency II capital requirement level seems to be more closely tailored. Solvency II might therefore make certain jurisdictions that have attracted the mortality business less attractive, among them Bermuda.

Change, of course, is rarely welcome in insurance, that most conservative of financial bastions. Change means instability, which is the least desirable of operating conditions. So whenever change is in the air, cries of doom abound. Solvency II requires a fundamental change in some insurers’ way of thinking. Assimilating new thinking and increased capital requirements simultaneously, while a soft market is lowering all ships, has some in the industry unsurprisingly feeling aggrieved.

The European insurance watchdog in charge of Solvency II is the Committee of European Insurance and Occupational Pensions Supervisors (CEIOPS). Pronounced ‘Sea-ops’, its acronym gives the whole drama a faintly Cold War air. CEIOPS feels certain that, overall, the European sector will not need to raise new capital, although many of the smaller companies in Europe are unlikely to meet the new standards and may as a result be forced to look for a larger partner with which to merge.

Plucking the goose

Jean Baptiste Colbert, French economist and minister of finance under Louis XIV, wrote: “The art of taxation consists in so plucking the goose as to obtain the largest possible amount of feathers with the smallest possible amount of hissing.”

Asked about the insurance industry’s response to Solvency II , Michael Butt, chief executive officer of Axis, drew on Colbert’s wisdom. “The geese are going to hiss because, on the whole, they don’t want to be plucked,” he says. “I think we’re going to get some antagonism. I suspect that the nearer we get, the louder the noise will be.”

On the whole, however, Butt feels that Solvency II is heading in the right direction. Generally, he and most of his Bermuda industry colleagues are in favour of better regulation that leads to greater transparency.

Life onshore

Adding to the perceptions of uncertainty surrounding Solvency II is that its provisions have not yet been finalised in many areas. The life reinsurance sector is a good example. Solvency II may cost the offshore life reinsurance industry a competitive advantage, especially those with no European business. Such companies might be forced to relocate to a jurisdiction not imposing Solvency II standards, such as the US.

The life reinsurance sector is not huge in Bermuda, but has been growing. The fact that other jurisdictions might also lose some business will be cold comfort should the Bermuda life reinsurers up and run.


He continues: “It’s too soon to say what will and what might not happen, but for what we do, Solvency II, as currently constructed, is a deal breaker. We’d have to leave Bermuda.”“We’re looking very hard at what Solvency II means to us,” the chief executive officer of a Bermuda life reinsurer says, asking for anonymity because “the fat lady hasn’t sung yet, in this case.” He points out that increasing capital requirements on the life reinsurance business would more or less force his company and competitors onshore. “Our customers have their own capital cushions, and increasing ours would lead to redundant capital on our books,” he says. “We don’t want to maintain dead capital just because a regulator we don’t deal with fails to understand our business model.”

The US is dragged in...

Better, smarter and just plain more regulation is very much the flavour of the month around the globe.

Companies that write only US business and think of Europe only as a vacation destination are by no means immune from the potential effects of Solvency II. The US is undergoing its own regulatory change process, partly as a result of the advent of Solvency II, but also because the atmosphere for all financial services providers has been poisoned by the public perception of the behaviour of the banks.

President Obama is talking up a global ‘superfund’ to pay for future financial services sector bailouts. The punishment, aimed at bankers, has already spilled over to insurance and other financial sectors. The sense is that insurers will be asked to fund anticipated systemic weaknesses that failed to reveal themselves in the past two years.

“Any time you’ve got an increase in regulation, business is going to start to feel concerned,” says Colm Homan, partner at PricewaterhouseCoopers in Bermuda. Companies are “counting the cost, at a time when the economic environment is keeping them focused very much on the bottom line”, he says.

...Bermuda too

Why would Bermuda companies be interested in regulations based in Europe?


Most importantly, with the Bermuda Monetary Authority (BMA) seeking equivalence with its European regulatory counterparts, it’s a case of where Europe goes, so goes Bermuda, more or less. The BMA has been making preparations for Solvency II for three years, so companies that have not yet started their own programmes are facing catch-up challenges. Where structural change is involved, history tends to favour early adopters.As Solvency II and its equivalents go viral, they will become the de facto worldwide standard. Just about all the Bermuda majors have operations through subsidiaries in the European theatre, but Solvency II will have more pervasive effects. Those not compliant will face higher capital requirements when doing business in Europe, if they can find the business: customers will expect their carriers to meet Solvency II standards.

Risk-based thinking

The tendency is to think of Solvency II as a medicine for the big boys, but no aspect of the insurance world is free from the sea change roiling the global markets.

“I think some [captive owners] are probably quite nervous about the impact Solvency II will have on the ability of their organisations to operate as they have in the past,” says Jeremy Cox, chief executive officer of the BMA.

“In our view, Solvency II embodies a system of supervision that clearly matches up to the complexities of organisations that sit in our highest classes,” he says. Doubt remains whether the firepower of Solvency II needs to be brought to smaller companies. Cox has said that he will not necessarily make changes to the risk-based principles on which the BMA operates, which may mean that the lower-numbered classes of Bermuda companies, which include many of the single-parent captives, may not be subject to the full Solvency II effect.

“It is, though, important for us to have discussions about Solvency II and the potential implications for the captive sector, and we are having those discussions now,” Cox says.

Field testing

Gabriel Bernardino, chairman of CEIOPS, argues that Europe’s insurance industry as a whole is sufficiently well capitalised to meet the new solvency rules. “Overall, the European insurance industry will not need to have a higher level of capital at the end of the day than it does now,” he says, adding: “But, of course, that does not mean that some insurers or groups may not need to recapitalise.”

CEIOPS seemed last year to have backed down on the strength of capital requirements that the industry feared might force it to raise billions in extra capital. The larger, diversified European insurers are well prepared for Solvency II, but smaller insurers are concerned about their ability to meet the demands of the new regime. Increased demand for reinsurance looks a likely outcome.

A field test for Solvency II will be carried out later this year, which will show whether final changes are needed to the rules. Bernardino forecasts “no major changes” as a result of the test.

Solvency II: the future

Barring the collapse of the European Union, Solvency II is now a racing certainty. A number of issues remain to be agreed, however. The best guess is that when the dust has settled, Solvency II will prove to be a ‘Good Thing’ for most of the major players in the global market, that is, most international carriers of any size.

The effect on the smaller carriers might be more dramatic. Moody’s has predicted that Solvency II might help drive a wave of consolidation as smaller insurers are bought up by the larger groups.

Whatever happens, an industry that has, in large measure, made its way safely through the worst economic conditions of the past 70 years will be asked to become even more risk-averse. It may be some time before the real benefits of Solvency II are felt by the customers the new regulations are supposed to protect.