The new Insurance and Surety Institutions Law (Ley de Instituciones de Seguros y de Fianzas, LISF), together with amendments to the Insurance Contract Law, were first drafted back in 2008. From 2008 to 2011 the draft was discussed among key industry players and in October 2012 it was presented to the Mexican Congress. The law was approved in February 2013 and thereafter published in April 2013. The sector will have a total of 730 days to adjust to the new rules until its full implementation in April 2015. Frédéric Fischer, chief financial officer at AXA Insurance Mexico, told OBG that the process was carried out efficiently and that the industry had been given a voice through the Mexican Association of Insurance Companies (Asociación Mexicana de Instituciones de Seguros, AMIS). At the same time, Fischer also said that more time is needed for companies to fully adapt, which would also have a more positive effect, noting that the same process took 10 years in Europe. As the name says, the new law applies to both insurance and surety companies, creating a single regulatory framework. The regulation of reinsurance will not see major changes and will continue to be indirect.
A Stronger Model
Under the new law, some principles contained in the Law for Credit Institutions (2008) and in the Law for Securities (2005) will be adopted by insurance and bond institutions. This new legal framework aims to implement a regulatory and supervisory framework based on the solvency II regime.
Solvency II was established by the EU to harmonise insurance regulations among member states and is expected to come into effect in 2016. Within the Latin American region, Brazil, Chile and Peru are also in the process of adopting solvency II principles.
The new framework replaces the previous regime adopted in 1990 and is based on three key pillars: quantitative requirements; qualitative requirements such as supervision and corporate governance; and disclosure and transparency requirements. Regarding the first pillar, the risk-based character of supervision will be reinforced – insurance companies will be allowed to use either a standard formula developed by the Insurance and Surety National Commission (Comisión Nacional de Seguros y Fianzas, CNSF) for solvency capital requirements (SCR) or to develop their own model according to its risk profile. This internal framework would have to be approved by Mexican regulators. “The reform will change the way companies are currently managed,” Fischer told OBG. “For companies it is a very good thing to use their own internal models, as they will be able to manage and control their risks.”
During 2014, the CNSF will continue to conduct qualitative and quantitative studies to assess the impact of the reform on companies, as well as the market as a whole, a continuation on 2013. The standard SCR will be defined based on these quantitative studies. The SCR for both standard and internal models has to take into account different risk categories for the establishment of capital requirements. Stress tests must be carried out each year by firms to assess if their eligible own funds (EOF) are enough to comply with the SCR. This evaluation will have to consider not only the amount, but also the different risk categories of the EOF ( market, mismatch, liquidity, credit, concentration and operational), as well as different possible scenarios.
Regarding investments, the reform grants autonomy for the board of directors (BoD) and managers to create an investment policy that adheres to actuarial and prudential principles. The new law also provides more flexibility for investments in equities and debt instruments. Under its provisions, securitisation will now be allowed for insurance companies.
Alejandro Meléndez González, deputy director of investments and investor relations at Quálitas, a local insurance group focused on the automobile segment, recognises that regulators are working on flexibility and that they (regulators) have to be aware of the global character of financial operations and allow more international investment options. “We can invest in foreign securities through the International Quotation System, but with more restrictions than other agents, I believe more international options are necessary,” he told OBG. Moreover, allowing more investments in higher risk securities, such as variable income and private debt, would not only benefit companies, but could help develop the market for such instruments.
According to Fischer, the laws governing investments should be more flexible, as they are for banks and pension funds. Such a change could be made without posing any risk to the system, he said.
Regarding pillar two, under the new law the responsibilities of the BoD and managers are defined more precisely and will be expanded. Corporate governance will encompass five main functions: risk management; internal control; internal audit; actuarial; and oversight of outsourcing activities. One of the most important relates to risk management, which involves monitoring, managing, measuring, controlling, mitigating and reporting the risks to which each firm can be exposed. As such, insurance companies will have to perform their own risk and solvency assessment, which involves, among other things, solvency requirements in line with the company’s risk profile, risk tolerance, compliance with the established SCR and technical reserves requirements. Regarding internal control, it involves compliance with laws, regulations and procedures determined by the BoD, as well as screening activities on a regular basis. Internal audit and control are related. The latter will be strengthened via the creation of an audit committee independent from the company’s operations. It replaces the compliance officer and will be responsible for assessing the observance and effectiveness of internal control procedures. The fourth function, actuarial, is related to technical features such as reserves and underwriting policy, and is in accordance to efficient actuarial procedures. Finally, the oversight or supervisory function must ensure that contractual relationships with third parties are carried out according to legal requirements.
The new regulatory framework will demand adaptation, not only from firms, but also on the part of the regulators. The CNSF will have its supervisory mandate broadened, absorbing some functions previously carried out by the Ministry of Finance and Public Credit, especially the processes of firms entering and leaving the market, in particular licensing and authorisation procedures for new companies, revocation of licences and processes of liquidation. This is in addition to issuing details of the regulatory framework. Changes related to pillar three include disclosure of information concerning financial soundness of the firm, especially capitalisation and risk profile, as well as the need for a minimum credit rating. To this end, firms will have to publish a solvency and financial condition report on an annual basis. Further, registering insurance products will involve greater obligations regarding customer rights.
While the reform is an important attempt to enhance and grow the insurance industry in terms of risk-based regulation and advanced corporate governance, it does not cover some central issues of the Mexican insurance market, namely low penetration and consumer protection. The objectives of the reform are more related to strengthening companies, which is also undoubtedly very important, but more efforts are needed to develop the market and allow companies to make use of the law’s high potential. For González, the reform will bring two main benefits. Firstly, greater institutionalism of companies (pillar two) that will have to operate almost as public entities, with strong and transparent corporate governance, preventing key decisions from being made by small groups of people. Secondly, companies will be strengthened by higher capital requirements, although sectors such as automobile and damage will not be greatly affected. “It is a comprehensive reform, but the objective is not to increase penetration. It is mainly to make companies more solvent,” González told OBG.
For Fischer, apart from some minor adjustments, the “spirit” of the new law is positive. He noted that while smaller firms may have more difficulty in adapting to the new legislation, this could lead to mergers and acquisitions and thus a more concentrated market.
Meanwhile, an important project being carried out by the CNSF is mandatory automobile insurance. Compulsory insurance is generally seen as a good “entrance door” for insurance and other financial products, not to mention the direct impact on the increase in premiums. According to González, states may have an advantage on enforcement, given that they control automobile registers and can more easily identify vehicles without cover. At the same time, developments in federal law also hold potential as regulators are currently working on secondary laws to improve enforcement. Obligatory automobile insurance could be positive, not only for companies by increasing written premiums, but also for consumers, said González. In many ways it is a difficult circle to break – low volume of insurance makes premiums expensive, which, in turn, prevents the volume from growing. Mandatory automobile insurance would cause a jump in volume, thus the circle could be broken, making premiums cheaper and thus benefitting consumers.