Best’s Katsipis Views on Reinsurance, Solvency II and U.S. Equivalence

A.M. Best’s analysts don’t expect to see much change in premium levels in the near future, nor do they expect to see significant changes in rating levels.

“We expect the rates to remain stable, and to show some decline in certain markets… and we could have some declines in reinsurance rates,” said Vasilis Katsipis, the rating agency’s general manager for European composite and life reinsurance, as well as the ratings for all insurers in the emerging markets.

“We see the pressures on the primary markets, but then, as you know, the reinsurers can actually have significantly different results by choosing the lines that they write, or indeed choosing the structures through which they write,” Katsipis said. This explains the “deviations in many markets” between the reinsurers and the primary insurers. “But,” he continued, “in the long term they have to come together.” When that occurs they will “share similar fortunes.”

At the conclusion of A.M. Best’s Conference on the European Insurance Market, Insurance Journal caught up with Vasilis Katsipis, for a discussion on rates and other issues affecting the industry.

Katsipis noted that most of the larger reinsurers are now composites; i.e. they write both life and non-life business. “Certainly the top five,” Katsipis said. He added that, as a result, although P/C coverage is more volatile, the “life business,” which is less so, “has contributed very well to their bottom line.” This gives them “an advantage over many primary non-life insurers,” who are “more vulnerable” to the impact of natural catastrophes.

“I think that more and more of the largest reinsurers will be focusing on life business, because it provides a constant return on investment. Non-life can give them higher returns in years when it’s good, but in years when it’s not so good, they need to develop something else.” More reinsurers are therefore asking themselves “is it right not to play on the life side.” In most years life business “returns around eight percent on investment,” he said. In good years non-life can produce “returns in double digits.” However, under present conditions Katsipis noted that Bermuda’s reinsurers are expected to return around 10 percent on investment, which “makes it [life business] a much more interesting proposition,” i.e. “a good return for less volatile business.”

Commenting on the apparent trend for companies to move out of Bermuda and other offshore domiciles into Europe, Katsipis said “they were looking to optimize their capital efficiency. Bermuda has been a great location for capital efficiency in the past, but with Switzerland having similarly low levels of tax as Bermuda, that has meant that Switzerland has become more and more competitive.” In addition Switzerland also has “more readily available human resource capital.”

However, he also indicated that the pace of redomiciliation would probably slow down, “now that Bermuda seems to be getting regulatory equivalence with the EU, so there isn’t going to be a big drive to come back to the EU.” Ultimately company business plans will influence the decisions. “If a company is looking to write business in the U.S., probably Bermuda is your best bet.”

The U.S. hasn’t been included in the first tier of countries to be accorded regulatory equivalence under Solvency II. So far only Switzerland, Bermuda and Japan are on track to receive it, but Katsipis doesn’t “expect U.S. companies to be regulated by Solvency I, which means there will be “an ultimate regulator in the U.S., which will be deemed to provide similar regulation as CEIOPS will be providing in the EU.” He also indicated that there’s really “no appetite for something like that [Solvency II] right now.” The two regulators will therefore “come to an agreement.”

He added that the main problem in the U.S. is a regulatory system with 50 different regulators. If you end up having an “oversight regulator for the U.S., then things become much easier.” If this structure is established, it would have the advantage of providing counterparty in the U.S. who can speak ‘one to one’ on regulation.”

However, Katsipis remains somewhat skeptical about the prospects for such an arrangement. During his career he explained that he had become involved with “companies that actually were owned by U.S. parents, and I’ve seen how independent the different regulators in the U.S. tend to be, so I think there will be a great need for a great push from a high up political force to bring regulators together to create one supervisor for the whole of the U.S., but maybe there’s another solution I’m missing.”

Katsipis acknowledged that the most talked about part of Solvency II in Europe continues to be focused on capital levels. “But, in all honesty, that’s only the tip of the iceberg. The big, big issue is what comes under the first part of Solvency II.” This is the “quantitative part” of the three pillar regulatory approach.

The fact that the regulations have to be “vetted by the EU,” and not by “technicians,” require information to be considered by politicians. As a result “Solvency II is going to land at a point where the average or the median of the market is going to remain unaffected. There will be some companies that will fall below, and equally there will be companies above the capital requirements of Solvency II. So I don’t think there’s going to be the massive bankruptcy or filing for protection.

“What is going to be significant is what’s coming under Pillar two, which is embedding risk management – new processes to make sure that your risk management is line with the business that you do.” This means that regulators will have the authority to look at and review “your business plans, and tell you that you have capital in accordance with your business plans. This is regulation looking forward, and I think that’s where the big game change is going to be.”

As a consequence, Katsipis predicted that there will be a greatly increased demand “for specialized resources like actuaries and so on, who will be sought after by both regulators, consultants and insurance companies in the same space of time.” The requirements for accurately predicting future events won’t be easy. He pointed out that both regulators and companies are going to find it very difficult “to say, OK, what do you do after your model.”

As far as the third Pillar, which mandates more transparency in insurance transactions, is concerned, Katsipis said “that’s going to be good, but expect changes only after 2018, because counties are allowed to apply for five years of grace period.” During that time local companies won’t be required to “publish the full details of what they’re doing.” He found this situation somewhat ironic, as the intent of the regulation is to inform consumers, but now they “have to wait five years” before the requirements become effective.

In addition, as new IFRS standards are also in the process of being adopted, Katsipis thinks that you’ll “probably end up with something that probably only analysts will be able to understand, and even the analysts will only just be able to understand it.”