Unlock the Editor’s Digest for free
Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
The writer is Partner at Skadden, Arps, Slate, Meagher & Flom
“Singapore-on-Thames” has become a common meme used by politicians to pitch a hypothetical new model for the UK economy. But should the wholesale insurance market in London instead be pushing for a Bermuda-on-Thames regime for the UK reinsurance industry?
With the UK’s excellent plumbing into global insurance markets, could an anglicised version of the prudential regulatory regime in Bermuda, which has emerged in recent decades as a leading market for offloading risks, turn London into an uncontested world leader in reinsurance? If so, this could bring significant capital flows and many new jobs to London, with commensurate increased tax revenues for the UK.
The UK government has announced, and is implementing, its so-called Solvency II reform of capital rules leading to a new British regime Solvency UK. Regulators now have a secondary competitiveness and growth agenda. While Solvency II reform has been thoughtful, the net effect of the changes is likely to be limited. The critique is the reforms are tinkering rather than making radical change.
For example, the net amount of capital released by the reforms into investment in UK productive assets is likely to be tiny in comparison with the size of the UK economy. And, pertinently, tiny compared with the formerly productive capital sucked out of UK corporate defined benefit pension schemes into conservative investment. This unhappy “capital trap” is a not insignificant contributor to the UK’s productivity problem.
Moreover, the Solvency II regime is not designed around reinsurers. Reinsurance is a sophisticated product only available to other insurers. It involves an insurer economically laying off risk to a reinsurer. Indeed, in some regulatory regimes around the world, reinsurance is subject to limited regulation — recognising that reinsurance is a risk mitigation technique for professional counterparties, based heavily on credit rating or contractually-governed collateral — so the system largely self-polices.
Nonetheless, reinsurers under Solvency II are subject to the same complex and strict rules as an insurer writing retail personal lines, such as motor or home insurance for domestic consumers. This is hardly proportionate or appropriate. In contrast, the Bermuda regime (which is deemed by regulators to be “equivalent” to Solvency II) is more of an economic framework than a set of prescriptive rules. As a regime for reinsurers, it has worked well and has acted as a huge magnet for business.
How might a ‘Reinsurance UK’ regime work? There are three options. The natural instinct in the UK for regulatory reform is incrementalism. If we use Solvency UK as a starting point, there is a risk that the project runs into the sand, as working out which aspects of the existing regime to strip away might just be too painful. That would, however, be in line with modern practice.
A second approach would be to adopt the Insurance Capital Standard (the ICS) being developed by the International Association of Insurance Supervisors, tailoring it specifically for reinsurers. That is an attractive option, as the ICS is likely, over time, to become an increasingly adopted basis for insurance solvency regimes around the world, so provides for a substantial degree of future proofing.
A truly exciting third way would be to look at the economic and legal operation of reinsurers and ask exactly what regulation is trying to achieve. Ultimately, an insurer wants to know that its reinsurers are sufficiently creditworthy and liquid. Reinsurers tend to go out of their way to establish and maintain balance sheets that place creditworthiness and liquidity beyond doubt, as a necessity of attracting business. When insurance companies cede risk to reinsurers, they heavily scrutinise them either directly or via careful monitoring of their credit rating reports.
Additionally, they may seek collateral as a means of protection. Might we therefore cut through the existing solvency regime and say that as long as a UK reinsurer maintains minimum credit rating and liquidity requirements, submits to a regime of fulsome and transparent public disclosure and adheres to best governance practice, then that should be enough?
Combined with a special tax regime, Reinsurance UK would be a knockout success for London, given the insurance infrastructure in London already. That truly would lead to a huge net benefit for UK tax revenues, new jobs in the London market and create an inflow of assets to be managed and invested in and from the UK. It is certainly worthy of serious consideration.
