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Patria Re: Mexico and Solvency II – One year after inception

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Mexico and Solvency II – One year after inception

Mexico has closed its first full year since Solvency II came into force. Different from Europe’s approach, we decided to jump full into implementation, sort out the problems and negotiate the final details as we figured out how it was going to work and how it should be implemented. It has been a strenuous year both for the authorities and the Industry but we have made it through and it is time to look at some of the results:

Preliminary numbers show that the market grew 11.7%, however Life represents 42.5% of the market and growth in this sector and this line of business saw a major impact from a fundamental change in the way it is now accounted for. As it happens the new law requires companies to annualize insurance premium and this made a dramatic difference in long term life. Life as a whole grew 17%. This regulatory change also an impact in other lines of business, if we take it out, growth really was 6.5%.

It is interesting to note that administration cost on the other hand increased 13.2%, which is twice the increase of the gross premium income. However it dropped one basis point, from 7.5% of Net Retained Premium in 2015 to 7.4% in 2016.

Investment Asset portfolios remained roughly the same with 78% fixed income and 12% equities. A sample of 68 companies that represent 94.28% market share, show the following results in terms of solvency levels:

For the market at large, the solvency index on Q4 stands at 2.02, three companies have an index below 1. The lowest level is 0.76 and the highest 31.92. There was however and important change when compared with Q3. From one quarter to the other Solvency Risk Capital decreased 10.5%, Admissible funds decreased 28.9% and the Solvency index dropped 20.5%.

Which means we are still wondering how much volatility we are going to see.

One of the most important differences between the Mexican model and the European model is that the later uses a standard formula whilst Mexico follows a stochastic methodology for most risks, with the exception of Natural Perils. Another important difference is that in the specific case of Natural Perils, Mexico applies a return period of 1,500 years and requires that such a PML is covered either with reinsurance or with Capital plus Cat Reserves.

From our perspective the most difficult part of the negotiation was really about making theory meet with practice. Regulators took a very theoretical approach to what Solvency II implied, many of the negotiators lacked sufficient practical knowledge of the insurance market and did not have enough experience to factor reality in. Some were not open to listening to reason and for a moment it almost felt like a third marriage was taking place and with it we were to live the triumph of theory over practice!

Ultimately what we have today is a model that works as it is, but that it really is a black box for most market participants. The model requires loads of information and this means the processing is very slow. This was so important that some important exceptions had to be introduced in the course of the year. For example, the model contemplates a risk margin as a factor of the capital that is calculated after the technical reserves are run through; in order to come to the final number several iterations were needed. This meant that large companies discovered after closing Q1 that it took them 40 days of work to close a single month. Even if the learning curve could be improved the gap in time was so large that an exception had to be created and the numbers were estimated without iterations between reserve and capital calculations.

Another important comment is that Solvency II supposedly was about self-regulation, and if we really take a look at the current state of the art, it is clear that we are a lot more regulated than before. And the thing is, are we convinced this new regulatory scheme brings more transparency and quality information in decision making? Our feeling today is that the Boards are flooded with information, indicators, and noise. This means that they will have to trust their gut even more than before or look complacently at the system and let the horde of technicians run the company. The equilibria between entrepreneurial spirit and corporate governance and control has now swung in favor of the later, at a time when disruptive technologies are driving the former. It will be an interesting fight.

The battle is starting to present some interesting twists. One of which candidly feels like protectionism though it is not yet clear why, or against whom. In 2015 the European Union granted regulatory equivalence to Switzerland, The US, Australia, Canada, Bermuda, Brasil and Mexico and yet when the Mexican Reinsurer Patria Re has offered capacity to German and Belgian companies, this has been declined on the argument that because Solvency II led to a massive investment for the insurance market in the EU to be compliant with this complex system, the EU wants to avoid companies which are not regulated under Solvency II to have a competitive advantage. Apparently in spite of the resolution establishing that the Mexican Solvency Regime is to be considered as provisionally equivalent to the regime laid down in Directive 2009/138/ EC, there is still a question as to how this ultimately applies.

This content is provided by Euromoney Seminars for informational purposes only, and it reflects the market and industry conditions and presenter’s opinions and affiliations available at the time of the presentation.