Bermuda will lose some of its regulatory flexibility in gaining “third-country equivalence” with Solvency II so it needs to be sure that equivalence will really mean equivalence in practice.That’s the view of XL Group chief executive officer Mike McGavick, who is also concerned about the negative impact higher capital requirements will have on innovation in the re/insurance industry.In an interview with The Royal Gazette, Mr McGavick suggested that the Bermuda market would never have been able to form, had the industry been subject 25 years ago to the new European Union regulations, known as Solvency II, due to take effect in 2013.However, the XL boss said he supported the Bermuda Monetary Authority’s drive to gain “third-country equivalence” with Solvency II, a process going through the assessment phase this year.“The BMA believes that gaining equivalency with Solvency II would be a huge boon for the market over time,” Mr McGavick said.“There’s a couple of things that have to come true for that vision to really have meaning. First, we have to gain equivalence, which I’m very hopeful we will and I think we should.“Second, equivalence would have to have real meaning, particularly in the case of group supervision. For example if it’s decided that Bermuda is the group supervisor of an important international institution, but then they say, ‘because it’s important to us domestically then we’re going to regulate it as though nothing changed’, then nothing is gained.“The premise of Solvency II and the group regulation approach is supposed to be that you have one group regulator, who, because you have agreed you’re operating on equal standards, will be trusted for those purposes. To an extent, if no other element of regulation is reduced, but you just add on top a group regulator, then you’ve gained nothing through Solvency II.“If that were to happen, that would be terrible for Bermuda, because Bermuda is giving up some of the flexibility that has historically been part of its business model.“There does need to be something gained. If real equivalence happens, then operating in that part of the world becomes more efficient and that benefits everyone, most importantly the customer.”An increase in capital requirements, which will be necessary for some companies under the Solvency II directive, is not a positive development, according to Mr McGavick.“The banking sector failed and as a result of what happened in the banking sector, they want to impose upon the insurance sector higher capital requirements,” he said. “During that same, really singular crisis, the insurance industry performed quite well. I continue to believe that the banks would do well to learn from us, instead of us from them.“Insurance is already a pretty low rate of return business with a pretty high level of volatility. To add even more capital burden to a business like that, one that’s already proven it can weather a crisis like the Great Recession, seems to me to risk making the sector even less attractive.“The industry will tend to do safer things on a greater scale, meaning there will be greater consolidation, fewer players and worst of all, fewer innovators. The customer loses when that happens.”The CEO added that it was ironic that he was opposing a change that would favour well-capitalised incumbents and raise entry barriers for prospective newcomers to the market.“You’d think I’d be saying ‘bring it on’ and we’ll go out and gobble some folks up,” he said. “But in reality, we’ll all become utilities one day if that’s what we choose to do. And I’d much prefer to see a more scattered array with lots of innovation going on. That’s a healthier marketplace. But you can’t get better if you require too much capital.”Such regulations would have smothered early plans for a Bermuda market, had they been in place a few decades ago, he added.“Where would we be if all of this had been in place and along comes Bermuda trying to climb on board?” Mr McGavick said. “There wouldn’t have been a Bermuda market if the world that’s envisioned by Solvency II had come into play in the wrong way.“So there’ll be no future ones. Maybe we should all say great, let’s pull up the ladder after ourselves. That’s the wrong answer. The world would be a more risky place if there were fewer centres of capital. We need more markets, more centres of innovation, not fewer.”After several years of declining rates for most lines of insurance and reinsurance, a slew of major catastrophes over the past 18 months, wiping out billions of dollars of industry capital, has caused many in the industry to see changes in the market. A report by Guy Carpenter this month estimated insured losses through 2010 and the first four months of this year at close to $100 billion.“It’s changed the conversation,” Mr McGavick said. “The conversation before was always with the expectation of lowering pricing. Now the conversation is about flat to increases, depending on the product line.“Underwriters are reawakened to the sense they should always have that there’s more risk out there than it seems. That’s what these things do. They change the psychology of the underwriter and that changes the conversation with the broker and client. That’s the predicate to changing markets.“Some segments are clearly changed. Clearly the property-catastrophe marketplace has already experienced some positive change, more so in zones that have been more dramatically affected. But I think there’s a broader move under way. There are some lines on the primary side where we’ve seen some change. We’ve experienced a fair amount of other property activity, a lot of marine activity. All of those add up to smaller cyclical changes.“We’re not ready to say the whole market has turned, but this is the first move in a positive pricing direction in a long time. That’s overdue and needed by the industry.”