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Winds of Change
Exactly what will recently approved Reinsurance Directive mean for European reinsurers? Paul Murray explains.
As the European Parliament has now approved the long awaited Reinsurance Directive, it is an appropriate time to consider
what opportunities will be presented by this Directive for the European reinsurance sector.
The proposed Directive will provide for a single passport system for reinsurers similar to that which currently applies to direct insurers. The proposal envisages that the authorisation and supervision of European reinsurers would be the responsibility of the EU member state of the head office of the reinsurer (the ‘home state’). Once licensed in the home state, a reinsurer would automatically be entitled to conduct reinsurance business in all EU member states under the principles of freedom of establishment and freedom to provide services. The proposed Directive provides that the financial supervision of a reinsurer, including that of the business it carries on in other members’ states, either through branches or under the freedom to provide services, is the sole responsibility of the home state. Furthermore, it provides for the abolition of ‘collateralisation’ of unearned premiums and outstanding claims in member states in so far as EU reinsurers and insurers are concerned.
• EU reinsurers will be obliged to limit their objects to the business of reinsurance and related operations.
• EU reinsurers will be obliged to establish adequate technical reserves to cover their reinsurance obligations. Additionally, reinsurers will be required to invest assets covering their technical reserves and their equalisation reserves (which are required in the case of credit reinsurers) in accordance with a prescribed set of rules. These rules require a reinsurer to match its investments to its expected claims payments and also require diversity across asset classes and counterparties. Investment in derivatives is permitted only to reduce investment risks or to facilitate efficient portfolio management. In addition, each member state is permitted to require reinsurers established in its territory to also comply with the more quantitative rules set out in the proposed Directive provided they are prudentially justified.
• EU reinsurers will be obliged to maintain a solvency margin ‘free of any foreseeable liabilities’. In the case of non-life reinsurers, the required solvency margin will be based on the higher of a premium basis or a claims basis calculation. In respect of premiums, a ratio of 18% will apply on the first 50 million Euro, with 16% applying on the excess. In respect of claims, a ratio of 26% will apply on the average burden of claims determined by reference to a number of preceding financial years up to 35 million Euro with 23% applying on the excess. Premiums and claims figures for certain classes of business, particularly liability classes 11 (aircraft), 12 (ships), 13 (general liability) will be 50% higher.
• One third of the solvency margin will constitute a minimum guarantee fund, which must not be less than 3 million Euro. Each individual member state may set a lower minimum guarantee fund of 1 million Euro for captive reinsurers established in its territory.
• The proposed Directive envisages a special regime for special purpose reinsurance vehicles (SPRVs) and finite reinsurers. It envisages that each individual member state will lay down the conditions under which activities will be carried on by an SPRV/finite reinsurer established in its territory. These conditions will relate to the mandatory conditions to be included in all contracts issued, rules regarding administrative and accounting procedures, adequate internal control mechanisms and risk management requirements and requirements regarding technical reserves and solvency margins.
• The proposed Directive contains a provision exempting from its scope reinsurers in run-off as of the date upon which the Directive is to be transposed into national law by each member state.
It is currently anticipated that the Council of Finance Ministers (ECOFIN) will consider the proposed Directive at its next meeting at the end or June or early July 2005 and it is likely that the terms of the proposed Directive will be finalised at that stage. Allowing approximately six months for translation into the official language of each member state, it is likely that the proposed Directive will be published in the Official Journal of the EU towards the end of 2005 or early 2006. Member states will then have a period of 24 months within which to transpose the proposed Directive into national law. Furthermore, in order to take account of potential difficulties that member states might encounter with the abolition of collateral requirements in national legislation, the European Parliament has proposed a transitional period of 12 months to comply with the requirement in addition to the two years provided for the application of the Directive as a whole.
As regards transitional arrangements, the proposed Directive provides that member states may allow EU reinsurers which are carrying on business at the date of entry into force of the proposed Directive, a further two years within which to comply with, inter alia, the requirements regarding establishment of technical reserves and the solvency margin and guarantee fund described above. It is not currently expected that the Irish Financial Services Regulatory Authority (IFSRA) will avail of this concession.
A European Directive on the authorisation and supervision of reinsurers is undoubtedly consistent with the European ideal of creating a single integrated financial services market. However, the Commission’s ambition to eliminate discriminatory treatment and barriers to trade (such as additional licensing procedures, deposits and similar requirements) in the European reinsurance sector must be seen in the context of global trade negotiations. The Commission is of the view that a harmonised supervisory framework could help to improve access for European reinsurers to foreign markets (and, in particular, the US market) where they face significant barriers to entry such as the requirement to post collateral for the value of their commitments. The Commission envisages that a harmonised regulatory system would give European reinsurers a quality stamp or badge of approval which would also be recognised in non-EU countries, with the ultimate aim of creating standards of regulation which allow EU reinsurers to access other trading blocs on a reciprocal basis.
The Commission’s stated policy objective of securing access for European reinsurers to international markets is reflected in the terms of the proposed Directive which provides that the Commission may submit proposals to the Council for the negotiation of bilateral agreements with non-EU countries. The proposed Directive provides that these agreements will, in particular, seek to ensure effective market access for reinsurers in the territory of each contracting party and provide for mutual recognition of supervisory rules and practices. Such agreements will also seek to ensure that the competent authorities within the EU are able to obtain information necessary for the supervision of European reinsurers conducting business in non-EU countries. Conversely, such agreements will be seeking to ensure that the competent authorities in non-EU countries are able to obtain information necessary for the supervision of reinsurers established in such countries and conducting business in the EU.
While accessing global markets could be considered the ‘Holy Grail’ for many European reinsurers (and particularly those based in Ireland whose primary focus is already on international markets), it is certainly far from clear whether the necessary bilateral arrangements can be put in place in the medium term. In particular, it is difficult to see how a reciprocal arrangement could be reached between the US and Europe while US reinsurers continue to be constrained by a regulatory system which is carried out on a state by state basis. It would seem that mutual recognition will not be feasible until US reinsurers are permitted to do business throughout the US in a manner that will maintain a level playing field with non US reinsurers. In other words, a single licence to do business in the US through mutual recognition with Europe would need to be preceded by a single licensing and regulatory authority within the US.
Furthermore, it is likely that many other developed jurisdictions will be reluctant to encourage free international competition where to do so would put local reinsurers at a competitive disadvantage. In this regard, it is worth noting that the proposed Directive provides that member states cannot apply provisions that result in a more favourable treatment to non-EU reinsurers than that accorded to EU reinsurers.
While it might be cynical to view the Commission’s ambitions to achieve a greater liberalisation of the global reinsurance market as merely aspirational, it would appear unlikely that this goal can be achieved in the short to medium term. However, the establishment of common standards of supervision for all EU reinsurers should create a level playing field and help to enhance competition across the EU and this in itself will present enhanced opportunities for European reinsurers.
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