Corporate insurance partner Michael Skrbic discusses the issues and challenges surrounding insurance and risk management.
This article was first published in the July edition of Lawyer Monthly
This month, Lawyer Monthly’s International Roundtable feature looks at the issues and challenges surrounding Insurance and Risk Management. To this end we speak to Michael Skrbic, a Corporate Insurance partner at Kennedys Law LLP. He has over 25 years of international insurance and banking transactional, product and regulatory experience having previously been based in Hong Kong, Bermuda and London. He returned to private practice with Kennedys last year to lead the Corporate Insurance practice in London after fourteen years of senior in-house insurance and investment banking legal roles.
What are the key trends affecting the London Insurance Market?
London is a world-leader for speciality (re)insurance but globalisation and technological changes are having an impact on the market’s historic position and competitiveness. The London Market Group, comprised of senior representatives from London’s underwriter and broker associations, commissioned Boston Consulting Group to examine the condition of the market and their recent report detailed the current opportunities and challenges. Included in the findings was the fact that £60 billion of gross premium was written in London in 2013, more than Bermuda, Switzerland, and Singapore combined. Despite this substantial contribution to the UK economy, a loss of market share in emerging markets and in reinsurance was also identified, driven by the development of competing regional insurance hubs and increasing preference of customers to purchase cover locally. The effect of the perceived “regulatory burden” on the cost of doing business in London was another challenge noted in the report, as was the soft market “propagated by the superabundance of capital and the securitisation of insurance risk”. London’s strengths in the ability to underwrite large and complex specialist risks, the depth of talent concentrated in the “Square Mile” of the City of London, and its reputation for innovation and new product development, mean that the market is well placed to respond to these opportunities and challenges.
You mentioned “regulatory burden” as one of the factors affecting London’s competitiveness. Is regulation in London particularly burdensome?
Financial stability underpinned by proportionate and robust market regulation and oversight attracts investors and customers to the London market. Of course it is important to keep the balance right between ensuring market stability, and an appropriate level of consumer protection, while also allowing financial institutions to carry on profitable business and to innovate. Following the Global Financial Crisis (GFC) in 2008 the regulatory agenda has been predominated by the well-publicised failures in the banking sector and there are some concerns that the prudential capital regulations designed primarily for banks are not entirely appropriate for insurance companies. The unified Financial Services Authority has also been replaced by a “Twin Peaks” model comprised of the Prudential Regulation Authority (PRA) and the Financial Conduct Authority (FCA) prompting suggestions of duplication and additional costs for insurers. This was followed by the formation last year of the Competition and Markets Authority and the concurrent investigation and enforcement powers granted to the FCA in April 2015, adding another layer of regulatory complexity. The risk-based capital requirements of Solvency II are now due to be implemented from January 2016. Solvency II is a European Union maximum harmonisation directive and should not therefore be subject to “gold plating” (the process where individual State regulators impose additional measures) as confirmed by statements from the PRA. The PRA and the FCA do consult with the industry, as in the case of the recent changes designed to strengthen the individual accountability of senior managers of insurers, but inevitably there will always be concerns regarding the additional implementation and compliance costs of new regulations. The question again comes back to balance. The deserved reputation of London as a well-regulated market is vital to its continued success but if the regulatory regime is overly burdensome this could affect the market’s competitiveness.
You worked as a lawyer in the investment banking sector for a number of years before returning to private practice with Kennedys. Could you expand on why the regulatory standards being applied to banks may not be appropriate for the insurance sector?
Banks are involved in maturity transformation - borrowing short term through customer deposits and the financial markets, and lending on a long term basis. They are also exposed to liquidity risks and are systemically connected through the inter-bank lending markets. This connectivity and fragile capital base was a major contribution to the GFC. Liquidity dried up as banks stopped lending to each other due to the collapse of confidence in the disclosure of derivatives exposures. In the UK this lack of confidence materialised at the retail level with the “bank run” on the former mutual building society, Northern Rock. General insurers’ primary liability is to claims by their policyholders, although they do also have investment exposures. In the life and pensions sector surrender charges and restrictions on the withdrawal of pension funds militate against a “run on the bank” scenario. Catastrophic events could lead to liquidity stress for insurers but here the reinsurance sector plays an important role in providing additional capital. Although the PRA recognises that insurers are not “systemic” in the same way as banks concerns remain that some insurers could pose risks to the financial system. At the international level in 2013 the International Association of Insurance Supervisors (IAIS) designated Allianz, AIG, Generali, Aviva, AXA, MetLife, Ping An, Prudential Financial, Inc and Prudential plc., as Global Systemically Important Insurers (GSIIs). By November 2015 the IAIS is expected to have completed the revision of its GSII assessment methodology. The list of GSIIs may therefore be expanded in 2016 and could include reinsurers.
What is your reaction to the recent statements by the UK government supporting the development of London as an ILS centre?
I first became involved in the Insurance Linked Securities (ILS) market in Bermuda in 2000 where I worked on some of the early catastrophe bond deals. After moving in-house I was also involved in a variety of buy-side capital markets transactions executed in a derivative or reinsurance form. In 2003 I returned to London to join the investment banking sector specialising in capital markets/insurance “convergence” transactions. The ILS market has now developed to include a range of alternative capital market instruments and structures - Catastrophe Bonds, Side-Cars, Industry Loss Warranties, life-insurance securitisations, longevity swaps, and collateralised reinsurance - involving the provision of third party capital to the (re)insurance market. The low yields currently available in other asset classes have driven the growth of ILS with outstanding issuance of around USD25 billion. An ILS loss generally depends on the occurrence of a natural event such as an earthquake rather than a collapse of the financial markets and ILS are therefore viewed as non-correlated assets. Pension funds have emerged as investors and demand exceeds supply for new issuance. Historically ILS has been structured in off-shore jurisdictions - Bermuda, Cayman Islands, or Guernsey for example - where the regulatory and tax regimes are favourable. Following the implementation of the EU Reinsurance Directive in 2007 it is already possible to form Insurance Special Purpose Vehicles in the UK but these vehicles have not proved popular. Regulation and tax laws in the off-shore jurisdictions are tailor-made for ILS and, unlike the offshore jurisdictions, the UK currently lacks protected cell legislation which would lower transaction costs. One of the most important factors in favour of the off-shore jurisdictions is regulator accessibility and response times. The off-shore territories are highly motivated to accommodate ILS sponsors. Despite these challenges London is well positioned to attract ILS business as a major reinsurance hub with a reputation for innovation. It also has the advantage of being in the European Economic Area (EEA) and the applicability of English law and our well regulated market should be viewed as positive factors. European ILS transactions have mainly been issued out of Ireland and London may therefore expect to be competing with Dublin for business, but both Gibraltar and Malta have also emerged as alternative ILS jurisdictions within the EEA so ILS sponsors are spoilt for choice. The London Market ILS taskforce recently had their first meeting with the UK Treasury and the process of developing London as an ILS centre is therefore now underway. Developments here will no doubt be watched closely by the ILS market.
This article was first published in the July edition of Lawyer Monthly