Lloyd’s McGovern Navigates Turbulent U.S. Waters; Part I

By | October 15, 2010

A recent article in Lloyd’s “Market” magazine noted that Sean McGovern, General Counsel and, since February 2010, the Director of Lloyd’s North America, “loves to mess about in boats in his spare time.” As he’s now responsible for two posts, each with heavy responsibilities, he’s probably got a lot less spare time.

He did, however, take time out to talk to the IJ about impending regulatory changes and Lloyd’s plans for reorganizing some of its operations in Canada and the U.S. “Things are moving,” McGovern said, and “there are many possibilities.” He was not only addressing the situation in the U.S., but also the impending draft regulations of Solvency II in the European Union, which will overhaul insurance regulation throughout the community, putting it on a “risk-based” regime..

As Lloyd’s General Counsel since 2000, McGovern has had primary responsibility for making sure that the London market’s position in general and Lloyd’s in particular, are presented and considered by CEIOPS, the committee that is preparing the Solvency II legislation.

That assignment, led to his being selected to take over from Sue Langley as the head of Lloyd’s North American operations. “I was visiting the U.S. rather frequently to oversee U.S. regulations,” he said. As a result CEO Richard Ward decided it was logical for McGovern to assume overall responsibility for the region. It is Lloyd’s largest market, contributing around 45 percent of premium income. The U.S. is the biggest and Canada is the third largest. Both require pretty constant attention.

Changes in U.S. Financial Regulation

McGovern described the enactment of the Dodd-Frank financial reform act as “puting significant factors in play.” He said the “power to enter into international agreements on insurance regulation” was perhaps the most important. But he added that Lloyd’s was still assessing the new situation.

McGovern also stressed that “we don’t have problems with state-based regulation,” and “we’re not pushing for a federal charter.” However, he said “the establishment of a Federal Insurance Office (FIO) is a positive step. It gives us someone we can talk to, and it has the authority to preempt inconsistent state regulations.”

That provision aims to harmonize conflicting state laws with one federal standard, a condition that the surplus lines industry has been advocating for years. As a big player in that market – its largest activity in the U.S. – Lloyd’s is quite naturally in favor of an active FIO that would be able to remove some of the roadblocks the industry has to cope with.

Reinsurance and Collateral Requirements

Lloyd’s has long had to endure another roadblock in the form of the 100 percent collateral requirements for its reinsurance activities, the second largest segment of its U.S. market operations. “Lloyd’s is the third largest reinsurer in the U.S. market,” Mc Govern said. “We take risks out of the U.S. economy, and we helped to rebuild it after the 9/11 attacks and the hurricanes Katrina, Rita and Wilma.”

However, he continued, “we have to post 100 percent collateral, [on the U.S. business Lloyd’s reinsures] as we are considered ‘alien reinsurers.’ The assumption is that we somehow don’t have sufficient regulatory protection.” He also explained that, while Lloyd’s is probably the most affected by the requirements, as it doesn’t have U.S.-based subsidiary companies, other “foreign” reinsurers “are also affected by ceding back premiums to their head office.”

He’s not the first senior executive at Lloyd’s to point out the essential unfairness of the anachronistic requirements, but under his watch they could be abolished, or at least eased.

“The NAIC has called for the system to be changed; however it hasn’t happened yet,” McGovern said. He was referring to proposals, first taken up seriously in 2006, to make changes in the requirements. There was actually a bill ready to be introduced, but, as McGovern pointed out, it “couldn’t get the U.S. sponsors needed, so no action was taken.”

The situation may now be more propitious. “A number of big U.S. states want change – notably Florida and New York and maybe New Jersey, so the momentum is going.” Most people who have studied the subject would admit that there’s really no need to “protect” U.S. companies from the possibility that they won’t get their reinsurance claims paid. The Lloyd’s syndicates that write coverage are healthy and well supervised by both the FSA (the UK’s Financial Services Authority) as well as Lloyd’s own Underwriting Performance Board. They’re also backed by a central fund that now tops $3 billion.

‘Equivalence’ and Solvency II

At this point McGovern explained that the impending introduction of Solvency II in the EU will also have an impact on insurance regulations elsewhere. Several countries, notably Switzerland and Bermuda, who transact substantial business in the EU, have begun harmonizing their insurance regulations with Solvency II requirements. It’s highly likely that they will both be accorded “equivalent status,” which would give insurers in those countries the same standing as EU-based companies.

“The U.S. has not yet been given equivalent status,” McGovern said; “a decision could be made in November or December.” No one thinks that all 50 states, or even a few of them, are going to undertake major changes in their insurance regulations to comply with Solvency II, which makes the existence of a federal body, empowered to harmonize regulations, so significant.

“We should respect each others’ regulations,” McGovern said. “The EU has opposed the 100 percent collateral requirements for a long time. As significant factors are now in play, [it makes the] FIO very important.” A certain amount of flexibility – on both sides – will be required, he explained, and it’s unlikely to come to fruition before 2012; “it’s just too ambitious beforehand.”

In addition to reaching an agreement on the collateral requirements some accords need to be reached in other areas, notably “group supervision.” McGovern believes that it “is possible to have equivalence with Solvency II. The EU and the U.S. have to look at their core regulatory requirements, to insure that they are adequate.” If that happens the result will be “more capital efficiency, a benefit to U.S. consumers and provide some ‘architecture’ for the federal government” to build on.

Part II will discuss Lloyd’s relationship to the U.S. market and its activities in promoting business and making it easier for brokers and MGA’s to do business with London.

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