The FSB’s reinsurer list for globally systemically important financial institutions will be a double-edged sword
When the Financial Stability Board (FSB) published its final list of insurers classed as globally systemically important financial institutions (SIFIs) this summer, the reinsurer market was reminded of what was on the horizon.
Next year, the FSB will publish its list of SIFI reinsurers. Until then, the reinsurance market is hotly debating the cost and criteria for being deemed a SIFI, as well as working out the likely consequences.
Reinsurers have good reason to want to avoid being designated a SIFI. First, the designation will cost them more money, as it will require them to hold more capital.
Second, they will be required to hold more capital of a high quality, which is likely to mean choosing more safe investments with lower returns, further squeezing already low investment returns.
Brake on returns
That is in turn likely to dissuade some investors from buying shares in SIFIs. An insurance lawyer said: “In terms of having to handle more high-quality capital, that is going to act as a sort of brake on the returns that investors can get from investing in SIFIs.”
Being designated a SIFI could also affect reinsurer competitiveness, as they may be forced to put up rates to cover increased their increased costs and capital requirements.
There is little hope for those looking to appeal the process, as Prudential wants to do. An insurance lawyer says that appealing the designation will be very difficult.
“It’s a question of public law,” he says. This is compounded by the global nature of the SIFI process, he says: “The FSB is making the decision that you are a SIFI, though the local regulator implements the decision of the FSB.
“I suspect the best way to appeal would be through lobbying, both formal and informal.”
Reinsurers could also appeal through the legal system, such as by applying for a judicial review in the UK. But this will be difficult, the lawyer says.
“I think it is quite difficult to do it that way, because so much of it is being done at a G20 level. It really is that grey area between politics and the law. Other jurisdictions may not have the equivalent of the judicial review.”
But there are some good points about being designated a SIFI. Reinsurers could wear their SIFI status as a badge of honour, and sell the point that they are more stable, less likely to become insolvent and more likely to be bailed out in the event that something goes wrong.
Additionally, SIFIs could find themselves becoming more attractive to investors looking for a long-term, safe investment, and who are prepared to stomach lower returns to do so.
DAC Beachcroft partner Adrian Williams said: “Everyone will welcome reforms that reduce volatility and complexity in the financial markets, making interconnectedness more obvious and outcomes more predictable. But we must beware of unintended consequences of any new regulation.
“Logically, the HLA (higher loss absorbancy) requirements will reduce the income returns that GSIRs (global systemically important reinsurers) can generate on their solvency capital. One would expect them to compensate by cutting costs and raising premiums.
“As a result, GSIRs may find that they are forced into a position where all they can sell is a super-premium product, for which there may well be a limited demand, and that they face new challenges in servicing with reduced resources.
“If GSIRs are forced into the ‘super-premium product’ trap, we can expect them to look for ways to regain some of the volume and profit that they might lose, perhaps trying to do so outside the scope of the GSIR regulations. It isn’t hard to imagine complex trust or asymmetric return structures being attempted with this in mind.”
Rating agencies tend to take the middle ground on whether being designated a SIFI reinsurer will be good or bad.
“We view the overall situation as neutral,” says Fitch Ratings managing director and head of EMEA insurance Chris Waterman.
Increased capital requirements are good for credit ratings, he said, but these could be balanced out by the higher burden of increased reporting to regulators that comes with SIFI status.
So what will a SIFI reinsurer look like? The FSB has not published guidance on how it will determine a SIFI reinsurer, and this has caused uncertainty in the industry.
“I think that as this story develops, one of the key elements will be that the industry itself isn’t sure what parameters mean they will end upon that list,” says Fitch Ratings insurance director Martyn Street.
However, the FSB is likely to use some of the same criteria it used to designate SIFI insurers: size, global activity, interconnectedness, non-traditional activity and substitutability, i.e. how easily other companies could step into the space left by a collapsed company.
Reinsurers still have some time to prepare for the upcoming SIFI register. It is impossible to say whether SIFI status will have an overall positive or negative effect at this early stage, and this is also likely to depend on the structure of reinsurers’ businesses.
Still, the reinsurance market can learn some important lessons from how the primary market reacts to their SIFI designations, and ensure that they are as prepared as they can be for 2014.