Face to face: the forthcoming Reinsurance Directive will be a factor as renewal talks begin in Monte Carlo in September.

As insurers and reinsurers gather in Monte Carlo, Monaco, for Rendez-Vous de Septembre, renewal talks will be affected by a growing awareness of the implications of the European Union's Reinsurance Directive.

The directive will introduce a single reinsurance protocol across the European Union. The European Union's 25 member states have until December 2007 to enact the directive into their national laws.

Rendez-Vous, scheduled this year from Sept. 9 to 12, marks the opening Of the reinsurance renewal season. Insurance industry leaders will sound each other out, as they have since the event began in 1957. The talks will move on to specifics, at a lower corporate level, in October in Baden-Baden, Germany.

Irish and British regulators have signaled their intention to follow the directive's free-form approach, moving quickly to adopt the measure.

Special Purpose Vehicles

The directive will encourage the formation of special purpose vehicles, whose chief characteristic is that they are funded by the issuance of debt. Special purpose vehicles draw heavily on the capital markets.

Historically, special purpose vehicles in the United Kingdom and Ireland have been treated the same as traditional insurers, including a lengthy authorization process and strict capital requirements. The debt that underpinned the special purpose vehicles worked to limit the amount of business the vehicles could accept, said Melanie McLaren, a partner in the Assurance/Business Advisory Services unit of consultants PricewaterhouseCoopers in London.

"There is quite a lot of excitement in the market about what [the directive] might mean in a number of levels, and particularly in terms of opening the securitization market and so accelerating balance sheets," McLaren said.

Regulators are taking a "consumer beware" approach to the special purpose vehicles, said McLaren, letting investors decide what will be the catastrophic events that would demean quality in terms of their lending to the special purpose vehicles.

The market has wanted this for some time, McLaren said. On the wholesale side, there is an aversion to the kind of "nanny-type approach" that would be deemed to be more suitable in the retail market, she said.

The Reinsurance Directive also offers the potential for reinsurers to be more competitive on pricing, McLaren said. But she added: "If you talk to most reinsurers, it's not regulatory capital that drives them. It's credit rating capital."

The U.K.'s Financial Services Authority has laid the groundwork to enable the special purpose vehicles to use the nation's regulatory platform as the basis of their writing of business. "I think the FSA is well placed to license those entities because it has experience as an integrated regulator with other parts of the financial services industry," said Dave Matcham, chief executive of the London-based International Underwriting Association.

In Matcham's view, the Reinsurance Directive will demonstrate that the EU has a set of minimum and recognized reinsurance standards. One possible effect, he said, would be to suggest the attractiveness of the European Union as a place in which reinsurers from other regions might write business. "It does raise the bar in certain countries," Matcham said of the likely effect of the directive on some European Union member states.

Bermuda Factor

The FSA will spend much of the second half of 2006 working on its policy statement in relation to the Reinsurance Directive. The authority is likely to be influenced by Bermuda's success in attracting new money in the wake of the 2005 hurricane season, McClaren said. In the past, she said, regulatory hurdles might have prevented the formation of a special purpose vehicle. "I think that there's a kind of freshness of approach in that area," McLaren said.

Last year's hurricanes bolstered the presence of the reinsurance sector in Bermuda. These new operators are likely to make their voices heard in Monte Carlo. "I would imagine they will be out in force," Matcham said.

The new Bermudan entrants will bring new capacity, Matcham said. "And they probably bring some pretty strong balance sheets and a lack of legacy hindering them," he added. "So that's all to the good in terms of their business offering." And while the Bermuda reinsurers may lack the long-established traditions and diversification of other markets, Matcham said, they are world leaders in certain fields.

Solvency II

The long-term picture for the reinsurance sector within the European Union is clouded by the interim nature of the Reinsurance Directive. The directive will, in some ways, be a placeholder for Solvency II, which will apply EU-wide solvency standards for the insurance and reinsurance industry, with implementation likely in 2010.

Solvency II is likely to be discussed at Monte Carlo, particularly by the chief risk officers of larger reinsurers. These organizations would like to see a Solvency II regime that reflects the management of risk and allows for the use of internal models. While there should be a base level of regulation, Matcham said in an interview at the IUA's offices, there should also be a recognition that "there are companies out there who have got highly sophisticated techniques in place."

Reinsurers should pay close attention to the development of Solvency II, McLaren said, because it "will apply to them in the same way that it applies to insurers."

similarities to the United Kingdom's system of individual capital assessments. Also, capital held for rating purposes will be more closely aligned to that held to satisfy the regulator.

Directives do not always get adopted by the deadline, "so there is potentially another year of uncertainty," McLaren said.

Collateral Debate

There is also likely to be some discussion of collateralization. The Reinsurance Directive will end collateralization within the European Union, something that is likely to strengthen the argument from Europe for an end to collateralization requirements in the United States. That campaign, in which Lloyd's has taken a vocal part, is apparently showing progress. Lloyd's position is that there is no need for such rules in strong, well-regulated markets. One result of the end of these rules, suggested Julian James, director of worldwide markets at Lloyd's, would be greater capacity.

James does not expect the Reinsurance Directive to have an immediate impact on 2007 renewals. He noted that the directive reflects the thinking of the European Commission that there is no role for collateralization within the European Union.

The end of internal collateralization will help create a more level playing field within the European Union for reinsurance, James said. "And over time it will allow the European Union to speak with one voice on the issue of reinsurance regulation when speaking to non-EU countries," James said. "And long term that's a very important step."

Collateralization is so important to the IUA that Matcham expects to forgo Monte Carlo in favor of the U.S. National Association of Insurance Commissioners meeting in St. Louis, also scheduled for Sept. 9 to 12. The collateralization debate is expected to air there, following the regulatory organization's new proposal to ease collateral requirements for non-U.S, reinsurers by exploring the implementation of a rating standard. The IUA, which represents the London company market, has long pushed for a change in U.S. collateralization rules.

Hurricane Watch

Matcham also expects some discussion of catastrophe modeling at Monte Carlo. He noted the failure of the modeling agencies to predict the extent of the 2005 hurricane damage. "They've obviously had to work on their models since last year's experiences," he said.

James warned against what he fears will be an obsession at Monte Carlo over hurricane risks. To do so, he argued, would be to miss the full picture. "We need to remind ourselves that other challenges still exist: terrorism, increased concentration of value, increased claims costs."

For instance, it will involve a reliance on risk-based capital, with

Key Points

* The Rendez-Vous de Septembre marks the opening of the negotiations that will lead to the January reinsurance renewals.

* Implications of the forthcoming European Union Reinsurance Directive, which is in the process of being enacted into national laws by the 25 member countries, will play into negotiations.

* As they sound each other out, the attendees also will consider changing collateralization requirements.