Rick Hodgdon believes that one small tweak to the proposed European Union Reinsurance Directive could make a huge difference to everyone in the market

No one has been able to explain why within the confines of the European Union Reinsurance Directive, an EU ceding carrier is not able to attain at least 75% solvency margin relief when reinsuring within an EU regulated jurisdiction?

For a direct carrier, the Life Directive limits the credit for reinsurance in the Required Minimum Margin (RMM) calculation to 15% of the reserves component and 50% in the amount at risk component. At present, a life reinsurer is eligible for 100% in the RMM calculation for retrocession in an unregulated environment.

With the introduction of a uniform baseline for reinsurance regulation within the EU, a rational outcome would be enhanced credit for reinsurance ceded to regulated EU reinsurers, say 75%. This would reduce friction on additional capital entering the reinsurance market. It would reduce pressure on insurance costs to consumers and diversify the concentration of credit risk within the market.

However, not only will the limit for direct carriers remain the same, but moreover the Directive would also enact the same limit on life reinsurers upon retrocession. The use of retrocession is a key risk management tool for many reinsurers either with third parties or to balance risk exposure with location of capital within groups.

The EU Reinsurance Directive should continue to apply a full solvency margin credit for life reinsurers, comparable with other regulated reinsurance jurisdictions, in recognition of the beneficial impact that the transfer of risk can have on claims volatility.

In its current form with respect to reserve and solvency margin credit, the Directive will significantly reduce the re/insurers ability to manage risk in a cost effective way, will create instability in the insurance industry, and will lead to higher prices for the consumer exacerbating the magnitude of the protection gap.

It could be argued that considerable amounts of risk that could be carried by the reinsurance market are instead retained in the primary market, with the consequence that the risk is accumulated and concentrated in the primary market, and the diversification that could be achieved through additional reinsurance is substantially reduced.

A small tweak and we could be smart!