The regulation of reinsurance industry is
undergoing significant overhaul due to the EU’s Reinsurance
Directive. The new regulatory framework was approved by the
European Parliament two years ago and is due to be implemented in
all member sates of the EU and EEA by 10 December 2007. The
key feature of the Directive is the harmonisation of regulation
amongst the member states, which in turn will have a major impact
on reinsurance business on both sides of the Atlantic. The
Directive does not though have direct effect in individual
countries; it is a Directive addressed to national governments to
introduce implementing legislation in their own territories.
Therefore, much will depend on how the Directive is implemented in
individual countries.
The Reinsurance industry in Europe has prospered for 150
years without harmonised regulation, so why now?
- This new Directive represents another building block to advance
consumer protection and provide equal access to markets in
EU. Previously, the regulation of reinsurance companies
depended on the individual member state: some states did not
regulate at all whereas others, such as the UK, regulated
reinsurance companies much the same as primary insurers.
There are currently no harmonised reinsurance supervision rules in
the EU. The different member states use common law, Napoleonic
codes and some communist influenced regulation which all provide
for varying degrees of supervision. The concern is that leaving
reinsurance unregulated may result in primary insurers ending up
with inadequate protection and therefore could have disastrous
consequences for policyholders.
- Another important consideration of the Directive is to promote
an efficiently-run internal market within the EU. By creating a
level playing field, the reinsurance market should become more
competitive which will indirectly benefit the policyholders.
- Many financial institutions such as the International Monetary
Fund and the World Bank have applied pressure on the EU to change
the system. A bone of contention has always been the collateral
requirements imposed on alien reinsurers by the US. US regulators
have been reluctant to relax this requirement without being
satisfied that the regulation of European reinsurers in their home
jurisdictions provides adequate protection for US reinsureds, and
thus indirectly for US policyholders. Insisting on the
harmonisation of regulation has therefore formed part of the US
negotiating stance in transatlantic talks regarding mutual
recognition.
New elements of the Directive affecting EU
and non-EU reinsurers
- The Directive requires non-EU reinsurers to obtain
authorisation separately in every Member State in which they want
to do business. Companies will need to establish a subsidiary in a
EU State if they want authorisation for the whole EU. This is
a significant incentive for non-EU reinsurers who operate through a
branch office or branch offices in member states to set up a
subsidiary in a suitable EU member state. A non-EU and non-admitted
reinsurer can still cover risks based in the EU. Member states can
implement indirect supervisory rules permitting recognition of the
insurance supervisions of non-EU countries. If recognition is
granted then non-EU companies could do business without needing any
more permits.
- The new rules eliminate collateral requirements among member
states: the reinsurer will be subject to financial regulation only
in its home state and will not be required to make financial
filings or to maintain assets in other member states.
- The Directive grants passporting rights among member states: so
long as a reinsurer is domiciled in one member state, the company
can do business in the others. However a reinsurer based outside
the EU with a branch within the EU will not have any passporting
rights: this has had an impact on company structures (see
below).
- Reinsurers in run-off will be exempt from the need to seek
authorisation.
- Reinsurers can transfer portfolios across borders in the EU. In
the UK, for instance, transfer of books of business have been
possible for many years but before Part VII of the Financial
Services and Markets Act (FSMA) 2000 it was not possible to
transfer the reinsurance with the liabilities. FSMA introduced the
possibility of transferring the reinsurance. It remains to be
seen whether other EU member states will implement the Directive in
such a way that it will be possible to transfer the reinsurance. We
understand that the German implementing legislation does not permit
this.
- Member states can develop their own rules regarding finite
reinsurance contracts including the right to prescribe mandatory
conditions for inclusion in all finite reinsurance contracts and
maintenance of solvency margins for finite reinsurance
activities.
- Most importantly, the solvency margin requirements for
reinsurers are to be equivalent to those for direct insurers, but
with the possibility of a 50% increase for certain risks categories
of non-life reinsurance business.
The implications of the
Directive
- International trade negotiations should be assisted.
Previously, it was harder for EU reinsurers to enter the US market,
because of the collateralisation requirements. One reason US
regulators insisted on those requirements was the lack of EU
harmonisation, which made mutual recognition agreements more
difficult. The European Commission may now be able to conclude
mutual recognition agreements with the US once the Directive has
been implemented. This development should strengthen the EU
market’s ties with the US.
- All non-US reinsurers were previously required to post
collateral to US insurers and maintain reserves for all future
claims. The NAIC (the National Association of Insurance
Commissioners) voted last year to review collateral requirements
with the intention of using a ratings- based approach to setting
collateral requirements in the future. The financial strength of
the reinsurer will therefore be key and no longer the
domicile.
- Several reinsurers are preparing for major internal
reorganisation because of the Directive. Swiss Re recently moved
its corporate headquarters out of Switzerland into
Luxembourg. Munich Re is planning to merge
with other subsidiary companies in the EU. These moves are
motivated by a combination of tax, regulatory, management and
political reasons.
- The portfolio transfer provisions should make it possible for
suitable books of London market business to be transferred from one
member state to a UK company and finality sought by means of a
Scheme of Arrangement.
- The Directive will make it easier and faster to establish
insurance special purpose vehicles in the EU. This is a booming
area with catastrophe bonds, for example, which have doubled in
volume growing to $4.69 billion in 2006. The UK, which implemented
the Directive in December 2006, has seen a great increase in the
trade of these insurance-linked securities.
Conclusion
According to Michael Diekmann, chief executive of
Allianz: “What we want is a single, modern and proportionate
prudential framework”. By establishing the principle
that one single regulator will be responsible for a EU reinsurance
company, the Directive should fulfil the needs of the reinsurance
industry whilst protecting insureds and their policyholders. The
new structure will have a significant impact on business on both
sides of the Atlantic. In Europe, it will allow reinsurers to
be established in one member state (including, for example,
existing subsidiaries of US-based reinsurers), whilst in the US it
may allow the relaxation of collateralisation requirements and
permit European reinsurers to compete with local companies on more
of a level playing field. Only time will tell whether the framework
Mr Diekmann refers to will actually operate across all member
states in the modern, proportionate and prudential fashion he, and
most people with a vested interest in the insurance industry,
want.