European Developments in Insurance Regulation

Article by Stephen Browning and Pollyanna Deane

These changes are stimulating within the European Union an increasingly sophisticated approach to regulation which has its origins in the Financial Services Action Plan produced in 1999 by the European Commission. The key aims of the Action Plan (full implementation of which is targeted for 2005) are:

• to create a single market for wholesale financial services;
• to ensure that retail markets are accessible and secure; and
• to provide state-of-the-art prudential rules and supervision.

As far as the insurance sector is concerned, the Action Plan has given rise to a number of legislative changes and proposals at the EU level. There are three key areas namely, solvency, reinsurance and intermediaries.

Existing solvency margin requirements for insurers were set in the 1970s. 30 years on, their adequacy had clearly become questionable and accordingly a series of measures was proposed. These are generally referred to as "Solvency I" and "Solvency II" and cover both life and non-life insurers.

SOLVENCY I

The measures required under the Solvency I Directives (which became law in March this year and must be implemented before 20 September 2003) include the following:

• An increase to €3 million (in most cases) in the minimum guarantee fund and indexing in line with inflation.
• Increased powers of early intervention for supervisors.
• Higher solvency margin requirements for volatile categories of business (such as marine, aviation and general liability).
• The ability for a life company to count up to 50% of its future profits for solvency until 31 December 2009 using the calculations set out in the relevant Directive, with supervisory approval.
• A more rigorous accounting approach in calculating the "availability" of assets for the solvency margin.
• The ability of Member States to establish more stringent solvency requirements.

SOLVENCY II

Solvency II aims to establish a solvency system that is better matched to the true risks faced by insurers. The project is closely linked to the development of international accounting standards for insurance contracts and EU proposals for the prudential supervision of reinsurers. Further aims are that the new system should not be overly prescriptive, avoid undue complexity, reflect market developments (such as derivatives and ART) and, where possible, be based on common accounting principles. A Baselstyle approach to capital adequacy is to be adopted and senior management is to have a pivotal role in the use and effectiveness of the risk management techniques proposed. The EU is currently working on proposals for the further development of the Solvency II project, which are expected to be published before the end of the year.

Proposals for a new, second reinsurance directive (the existing 1964 Directive is very limited in scope and did not impose a common approach to regulation) were first mooted in 1999. On 31 January 2002, the European Commission published a study¹ of reinsurance supervision examining the similarities and differences between insurance, reinsurance and other risk transfer methods, the main risks to which reinsurers are exposed, the rationale of supervision of reinsurance and existing levels of supervision. A draft second directive may materialise next year, although it is possible that further progress on reinsurance regulation will take place over a longer timescale in conjunction with Solvency II. Either way, the principal aims of the new rules will be to facilitate the following:

• A level playing field within the EU for reinsurers.
• Removal of the existing barriers to a single reinsurance market arising from different approaches to regulation.
• Improvements in the financial strength of reinsurers.
• Improvements to market stability and consumer protection.
• A possible basis for moving to higher solvency margin reinsurance deductions for direct insurers.
• A basis for negotiations with other markets for mutual recognition agreements and the removal of trade barriers (e.g. US trust funding requirements).

On 30 September 2002 the EU Council of Ministers approved the Insurance Mediation Directive. The Directive will come into force in late 2004 and will apply to all individuals and companies which carry out insurance or reinsurance mediation, who will be able to operate throughout the EU using the same freedoms to provide services and of establishment as are available to insurers. The Directive will require all such intermediaries to be registered in their home Member State, subject to meeting a common set of minimum professional and financial requirements. These cover appropriate knowledge and ability, good repute, adequate professional indemnity insurance cover (at least €1 million per claim and €1.5 million in the annual aggregate) and sufficient financial capacity.

Intermediaries will also be required to give most of their clients clear explanations for their advice in the light of the client’s individual requirements. Member States will be able to adopt more stringent provisions, but only for intermediaries registered in the Member State concerned.

Globalisation and consolidation in the insurance and reinsurance sectors are resulting in wide-ranging European regulatory action. Other recent EU regulatory developments include the adoption last year of a Directive on the Reorganisation and Winding-up of Insurance Undertakings and the forthcoming Financial Conglomerates Directive. All this takes us further towards the EU holy grail of a level playing field within Europe for insurance and financial services generally, in which customers can have greater confidence. For reinsurers providing traditional reinsurance and ART products it will be very interesting to see to what extent future EU regulation of reinsurance may, in conjunction with possible global developments through the International Association of Insurance Supervisors, level the playing field more widely.

1 "Study into the methodologies for prudential supervision of reinsurance with a view to the possible establishment of an EU framework".