Russia to introduce quasi-state compulsory reinsurance

Russia
Available languages: RU

The provisions amending the Law on Organisation of the Insurance Industry in the Russian Federation to create a national reinsurance company (the “NRC”) were passed by the State Duma of the Russian Federation in the third and final reading on 21 June 2016. It took the legislators about two months to adopt the bill.

The idea of incorporating a state reinsurance company is not new and did not originate in Russia. After lying dormant for years, the topic became hot again after several foreign governments put various restrictions on certain Russian entities and persons (together “Persons”) as well as sectors. As a result, foreign reinsurers representing major international reinsurance markets started either to refuse accepting risks associated with such Persons and sectors or to insist on the inclusion of the so-called sanctions clauses in contracts. That said, no case of non-payment of reinsurance indemnity due to these sanctions clauses has been reported since the end of 2014 (i.e. after the first renewal of the existing international reinsurance policies since the introduction of the restrictions that included these sanctions clauses).

In this context, the Central Bank of Russia, in its attempt to counter the effects of these sanctions, initiated the bill on creation of the NRC. During the protracted and painful discussions in 2015 and early 2016, the representatives of both the Russian insurance industry and the legal community voiced serious criticism against the bill. Yet, the bill was hastily submitted to the State Duma, where it quickly passed through three readings with hardly any changes to the initial version and the second and third readings taking place on the same day and time.

We will learn one day the reason behind such hurry. In the meantime, let us take a look at the main provisions of this bill which will certainly change the current Russian reinsurance practice if the bill is signed into law by the Russian President. These provisions can generally be divided into two groups. One group relates to organisational issues, while the other deals with the activities of the NRC. Also, the bill’s transitional provisions deserve special
attention.

Organisational issues

First, the NRC will be created by the insurance supervisory body. The Central Bank of Russia will establish the NRC as a joint-stock company, which will be 100% held by the Bank. It can be deduced from the bill that in future, and apparently upon the discretion of the Central Bank of Russia, the shares of the NRC could be sold, in which case no shareholder, except the Central Bank, would be able to hold more than 10% of the shares in the NRC.

Second, the NRC will be managed in accordance with the Civil Code of the Russian Federation and the Law on Joint-Stock Companies. However, the bill broadens the authority of the board of the NRC beyond the usual requirements and authority of boards of directors and provides for special requirements in relation to the NRC board members. For instance, according to the bill, representatives of the Central Bank and their affiliated persons cannot be NRC board members.

Third, the NRC will establish an advisory body, the Reinsurance Council. The Reinsurance Council will be responsible for defining the main directions of NRC’s activities, regulations on risk assessment and risk management and submitting the same to the NRC’s board for review. The NRC charter will spell out how the Reinsurance Council will be established and how it will operate. The bill only states who can be members of the Reinsurance Council. These are representatives of insurers and insurance brokers with over 10 years of professional experience in insurance, representatives of insurers and brokers associations as well as scholars and actuaries. The Reinsurance Council will only play an advisory role and cannot influence the activities of the NRC. Generally, it follows from the bill that the NRC will only report to its founder, i.e. the Central Bank of Russia.

Interestingly, the bill does not deeply elaborate on the provisions regarding the establishment and corporate governance of the NRC. One could, therefore, expect that the charter and internal regulations of the NRC that will apparently be drafted by the Central Bank of Russia will contain some surprises regarding NRC’s corporate governance and its reinsurance activities.

Reinsurance activities

Pursuant to the bill, the NRC must apply for a reinsurance licence by submitting an application to the insurance supervisory body which also happens to be its sole founder, the Central Bank of Russia. One can rest assured that the NRC will not experience any problems obtaining the licence.

Ironically, the bill contains only one clause that is dedicated to the protection of its “target audience”, i.e. persons “subject to restrictions, which are directly or indirectly related to the decisions of foreign state bodies or foreign organisations that prevent the reinsurance of such persons’ interests outside the Russia”. In addition to these persons, the bill also protects homeowners who have insured their properties against the risks of occurrences of natural disasters and other emergency situations and their catastrophic effects, but only in cases stipulated by the respective laws of the Russian Federation.

The interests of these groups of persons certainly require special care. The bill deals with this by introducing the so-called compulsory cession. Notably, the bill provides for the compulsory cession of 10%, not only for reinsurance policies, but also for retrocession policies. It means that the NRC will act both as a reinsurer and retrocessionaire. In other words, the bill introduces obligatory reinsurance and obligatory retrocession in relation to risks associated to these specially protected groups of persons.

One can deduct from the bill that the terms and conditions of such obligatory contracts will be dictated by the NRC because they must take into account its internal regulations on risks assessment and risk management as well as its accounting policy. On the other hand, the bill introduces for the first time the concept of follow-the-fortunes. The NRC will have to comply with the terms and conditions of other reinsurance policies (if any) and to “follow the decisions taken by the reinsured in cases when an insurable event occurs and when paying insurance indemnity under the underlying insurance (reinsurance) policy”. While this condition is widely used in international and domestic reinsurance practice, it usually requires the reinsured to fulfil all of its obligations under the reinsurance policy as a condition precedent.

The most controversial provision of the bill, which was removed and reinstated several times in the course of public discussions, is the requirement of compulsory cession in relation to all other insurance and reinsurance contracts concluded on the Russian insurance market. With respect to these contracts, the bill introduces treaty-facultative reinsurance (retrocession). The reinsured (retrocedent) must offer 10% of the reinsured risks to the NRC, while the NRC can accept this share, decrease it or refuse to accept it. One cannot but mention that this obligation of the insurer extends also to the existing obligatory reinsurance policies. It seems this provision tacitly makes the application of the law retroactive as obligatory reinsurance contracts could remain in force for many years.

Apparently, reinsurers under such obligatory reinsurance contracts and indeed other contracts as well would have to simply accept that they will lose 10% of their premium income pursuant to the law and at the discretion of the NRC. The expert report of the Presidential Council for the Codification and Improvement of Civil Law was strongly against this idea for “conceptual reasons” as it is contrary to the basic principles of civil law – freedom of contract and equality – and creates unjustified advantages for the NRC. Nevertheless, this provision was left intact in the final text of the bill.

If the NRC accepts 10% of the risk it will have to abide by the terms and conditions of other reinsurance policies (if any) and to “follow the decisions taken by the reinsured in cases when an insurable event occurs and when paying insurance indemnity under the underlying insurance (reinsurance) policy”.  

Finally, it important to note here that the obligation to transfer part of the risk to the NRC extends to insurance and reinsurance pools.

Transitional provisions

The bill contains one of the most interesting transition provisions in the history of Russian legislation.

As most other laws, this bill once signed by the President will come into force after its official publication. The obligation to transfer the risks to the NRC will come into force 60 days after it secures its reinsurance licence but not earlier than 1 January 2017. In other words, if the NRC obtains its licence before 1 January 2017, it can accept risks only after 1 January 2017. So far, so good, but the last paragraph of the bill can confound even the best legal minds. It says “from 1 January 2018 the effect of the law will be extended to relationships arising from reinsurance contracts concluded prior to 1 January 2017”.

Does this mean that the provisions of the law, for instance, the follow-the-fortunes clause, will apply to the reinsurance contracts signed by the NRC prior to 1 January 2017 only after 1 January 2018? Or does it mean that part of the risk under reinsurance contracts entered into before 1 January 2017 must be compulsorily transferred to the NRC after 1 January 2018?

Many reinsurance policies remain in force for a long time until full and final settlement of all the reported claims and almost indefinitely in liability cases. Does this mean that the NRC is ready to step in as a reinsurer in all the existing reinsurance contracts, including those where the premium has already been fully paid and also take a 10% share of losses, including from cases which are being disputed in Russian and foreign courts?

Surely, one could come up with even more interpretations of this provision. But, in any case, it is far from meeting the bill’s declared purpose, namely, the provision of additional protection of the interests of the insureds and ensuring the financial stability of the insurers.

Comments

When the law comes into force, it could lead to different consequences for reinsureds and reinsurers. Reinsureds with complex (primarily international) reinsurance programmes could face the need to bring the terms and conditions of such programmes in line with the NRC’s internal policies on risk assessment and risk management. In particular, these conditions include the scope of the cover, leader and claims control clauses, proof of loss, indemnity payment provisions and so on. Reinsurers would lose 10% of their business and everybody would have to partner with a state company with a lot of red tape and objectives that are far from adequately safeguarding their business interests.

The influence that the compulsory cession to the NRC – which is expected to have a low rating (as it cannot be higher than that of Russia: Standard & Poor's “ВВ+”) – could have on the capital adequacy models of international insurance groups with subsidiaries in Russia deserves a separate discussion. This stems from the additional credit risk of obtaining reinsurance indemnity from the NRC.

Also, there is the question of whether the introduction of a compulsory cession in favour of the NRC is in line with Russia’s WTO commitments in relation to the commercial presence of foreign insurers and reinsurers through their local subsidiaries in the country. One can hardly see how this controversial arrangement can provide additional protection to the insureds and ensure the insurers’ financial stability.

If you have any questions on the matters referred to in this Alert, please do not hesitate to contact CMS Russia expert Leonid Zubarev or your regular contact at CMS Russia.