The Draft EC Reinsurance Directive

Article by Stephen Browning and Fiona Russell

Harmonised reinsurance supervision could contribute to a general increase in quality of reinsurance protection for direct insurers, which would have direct insurance policyholder protection benefits through enhancements in the financial stability of direct insurers. In light of this the European Commission has recently published a draft directive concerning reinsurance (the "Directive"). This article reviews some of the key provisions of the Directive in its present draft form. It has been tentatively proposed that the Directive may be able to be presented to the European Council and the European Parliament in 2005 with the intention of it being adopted by Member States in 2007.

The draft Directive defines reinsurance as "the acceptance of risks ceded by an insurance undertaking or another reinsurance undertaking". This definition is taken from the existing definition of reinsurance in the Insurance Groups Directive (98/78/EC). It is proposed that the Directive will not apply to direct insurers already subject to the nonlife and life directives which also carry on reinsurance activities, although it is still to be decided whether the prudential rules in the Directive should be applied to the reinsurance activities of direct insurers if those rules are significantly different from those for direct insurance.

The taking up of reinsurance will be subject to prior authorisation by the competent authorities of the Member State in which the head office of the undertaking is situated (the "home Member State"). Authorisation will be valid for the entire European Community and any reinsurer wishing to set up a branch office or provide services into another Member State will be able to do so under the right of establishment or the freedom to provide services. Authorisation will distinguish between life and non-life activities (i.e. be granted for life, non-life or both).

The draft Directive contains broadly similar provisions regarding sound and prudent management and ownership/ control to those contained in the EU directives applicable to direct insurance.

It is proposed that reinsurance undertakings must comply with a restriction similar to that imposed on direct insurers in respect of the business they conduct. A reinsurer will be required to "limit its objects to the business of reinsurance and related operations". This proposed language is slightly different to that of the current restriction applying to direct insurers. This is to ensure that reinsurers are not impeded from carrying on activities such as the provision of actuarial advice, statistical services and risk analysis to clients as well as other activities such as weather derivatives or ownership of a direct insurance undertaking.

In order to ensure consistency between the legal framework governing insurance undertakings and other financial services directives, the Financial Conglomerates Directive (2002/87/EC) has been taken into account in preparing the draft Directive. For example, provisions apply whereby a Member State must in certain circumstances, before authorising a reinsurance undertaking, consult with relevant regulators in other Member States if the reinsurance undertaking is part of a financial conglomerate.

The financial supervision of a reinsurance undertaking is to be the sole responsibility of the home Member State. In summary every reinsurance undertaking will be required:

1 to have sound administrative and accounting procedures and adequate internal control mechanisms;

2 to establish adequate technical provisions in respect of its entire business, determined in accordance with the rules set out in the Insurance Accounts Directive (91/674/EEC). (It is felt that the rules contained in the Insurance Accounts Directive may not be sufficient to establish technical provisions for life reinsurance contracts. Therefore, where applicable, it is proposed that the principles in the recast Life Directive (2002/83/EC) may be used by Member States to establish more concrete rules). Equalisation reserves will be required where a reinsurer reinsures credit insurance. Member States may also require equalisation reserves to be set up for classes of risk other than credit reinsurance;

3 to maintain an adequate available solvency margin in respect of its entire business at all times. The rules contained in the draft Directive in relation to solvency margins reproduce the regime adopted for direct insurance.

The draft Directive does not require Member States to provide for authorisation of reinsurance branches in a Member State of entities whose registered offices are outside the EC. Member States must not apply a regime to such third country branches which is more favourable than that applied to EC reinsurance undertakings. The Community may, by agreement with third countries, provide a regime applicable to branches of reinsurance undertakings established outside the EC for the purpose of ensuring, under conditions of reciprocity, effective market access and to provide for mutual recognition of supervisory rules and practices.

Lastly, the draft Directive contains provisions for grandfathering whereby reinsurance undertakings already authorised to conduct reinsurance business in a Member State before the date of application of the Directive will be exempted from requiring a new authorisation. A "grandfathered" reinsurer will of course be subject to all provisions of the Directive which are not concerned with new authorisation, such as those dealing with the limitation of a reinsurer’s objects to the business of reinsurance, submitting a scheme of operations to the home Member State and sound and prudent management. The prudential rules contained in the Directive will also apply to a grandfathered reinsurer, although a 2 year window is envisaged for compliance with minimum solvency requirements.