Insurance predictions for 2018 – Clyde & Co

Clyde & Co has produced its insurance predictions for 2018, suggesting that a wave of mergers and acquisitions (M&A) could follow the losses from Hurricanes Harvey, Irma, Maria and Nate, and the US could see a spike in M&A activity. The law firm also predicts that the US-EU covered agreement will lead to opportunities for EU re/insurers, with non-EU jurisdictions expected to push for similar arrangements, while parametrics, cyber and D&O are set to take off in Latin America in 2018. And the Middle East will see Solvency II-style regulations start to arrive in 2018.

M&A
Clyde & Co believes that losses from Hurricanes Harvey, Irma, Maria and Nate could act as a catalyst for deals in 2018. It notes that M&As have taken something of a back seat in the insurance industry during the past 18 months or so due to persistent uncertainty, particularly in Europe with Brexit acting as a significant brake on M&A activity.

However, Clyde & Co says it expects a number of insurance businesses will see their balance sheets come under increasing strain, from an increasingly difficult trading environment, investment returns remaining under pressure, and abundant liquidity in the market.

Andrew Holderness, global head of corporate insurance group, Clyde & Co, also points to the rise of broker facilities and an increasing number of managing general agents entering the market, which is putting additional pressure on insurers. “Add into the mix this year’s devastating hurricane season, the losses for which are still being worked out but will certainly run into the tens of billions of dollars, and we expect a number of insurance businesses will see their balance sheets come under increasing strain. This could serve as a trigger for a wave of M&A in 2018 as re/insurers look for partners to help absorb these losses or consider putting their businesses up for sale,” he says.

Clyde & Co predicts that the volume of M&As in the US insurance industry should be higher in 2018 than in 2017, with a range of factors driving dealmaking, including a decrease in pricing pressure (or conversely the ability to raise pricing) for some lines of business due to recent hurricanes and other events which could allow companies to focus on strategic M&A activity, and the impact of insurtech.

Vikram Sidhu in Clyde & Co’s New York office says there are two negative factors that could also drive insurance M&A in the US: “First, if alternative sources of capital expand into new areas beyond the lines of business where they have remained concentrated up to this point, the result will be additional pressure on pricing which could result in some businesses being put up for sale. Second, business-specific pressures will drive activity. However, a recession, a fall in the stock markets, global political conflicts or other negative global events could potentially override the factors above and put a chill on insurance M&A in 2018.”

US-EU covered agreement
Clyde & Co notes that as a result of the covered agreement, non-EU reinsurers will face competitive disadvantage compared to both US and EU reinsurers. During the past several years, many states have amended their laws to allow highly-rated non-US reinsurers from ‘qualified jurisdictions’ (currently Bermuda, France, Germany, Ireland, Japan, Switzerland and the UK) to become ‘certified’ to post less than 100% collateral (down to 10%) based on financial ratings.

In 2018, some non-EU jurisdictions – particularly the currently ‘qualified jurisdictions’ – will push the US National Association of Insurance Commissioners (NAIC) to secure the same treatment for their reinsurers as those from the EU.

However, Mr Sidhu says that could be difficult to achieve: “Because the covered agreement was negotiated by the US federal government and pre-empts states’ insurance laws (albeit in a limited way), NAIC and the states were opposed to it and the process for its negotiation due to concerns about encroaching federal regulation of insurance, which is otherwise left to the states. Given that background and given all else that will be on the NAIC’s and states’ agenda, non-EU jurisdictions will find it difficult to place their reinsurers in the same position as EU reinsurers under the covered agreement.”

Latin America
Re/insurers in Latin America are being confronted with various new impact scenarios, which are leading to demand for new or additional coverages, according to Stirling Leech in Clyde & Co’s Rio de Janeiro office. He explains that new approaches to risk transfer such as parametric insurance for loss resulting from weather and catastrophic events have begun to arrive in Brazil, expanding the range of risks that can be covered.

The country has just seen its first climate-indexed parametric insurance policy offered by Swiss Re to a large agribusiness corporation, and Clyde & Co expects that this will now develop further in the country and elsewhere in the region.

A second impact scenario is the consequence of corruption. Operation Car Wash in Brazil, and its developing equivalents in other countries, have become a trigger for companies to purchase D&O liability insurance policies, as domestic and multinational companies have found themselves embroiled in bribery, anti-competition, and other investigations by the Brazilian and other Latin American Governments, says Mr Leech, and he adds that this trend in the need for additional coverage seems set to continue.

And finally, 2018 will be the year cyber insurance takes off in Latin America. Fewer than 10% of companies in Latin America currently have cyber insurance in place. As global insurers rush to launch cyber cover offerings in the region, Clyde & Co says it expects more to come.

Middle East
Clyde & Co points out that although risk-based capital models have been in place for some time in the Middle East’s international financial centres, such as the DIFC in Dubai, most jurisdictions in the region apply a simple minimum capital requirement for insurers, which is supplemented by the requirements to hold technical reserves.

But in January 2018, the United Arab Emirates will be the first country to fully implement a model based on Solvency II, when the final phase of the Insurance Authority’s Financial Regulations come into effect. Peter Hodgins in Clyde & Co’s Dubai office says it is likely that other countries in the Gulf Cooperation Council will follow suit shortly. Saudi Arabia, for example, has already introduced requirements in relation to disclosure and risk management for insurers which will readily provide the underpinnings for a Solvency II model.

“One slight concern in the development of prudential regulation in the region is the trend towards requiring branches of foreign companies to hold capital locally,” says Mr Hodgins. “If continued into the insurance sector, this will lessen the distinction between a locally incorporated company and a branch of a foreign company, and may result in some insurers exiting local markets.”