The Reinsurance Directive in the UK
This guide is based on UK law. It was last updated on 1st
April 2008.
On 10th December 2007, a series of statutory instruments
completed the implementation of the Reinsurance Directive into UK
law.
In particular, the Reinsurance Directive Regulations 2007 amend
the schedules to FSMA (the Financial Services and Markets Act 2000)
to give effect to the passporting regime and new rules on transfers
of business by reinsurers.
Harmonisation
Before the Directive there was no EU-wide supervisory regime
governing reinsurance business. Each member state had its own
localised requirements. The UK had a well-established regulatory
regime for reinsurers. But in many states, provided a
reinsurer was considered to be suitably solvent, it was generally
left to its own devices.
Poorly capitalised reinsurers, however, put reinsureds (and
ultimately insurance policyholders) at risk. The Directive was
introduced to increase confidence in the market, avoid unnecessary
regulatory duplication and remove barriers to cross-border
trade.
Its key provisions include authorisation and financial
supervision by a reinsurer's "home" state regulator, mutual
recognition of such authorisation between member states, the
abolition of collateral requirements (funds pledged to cover a
reinsurer's liability) and the harmonisation of minimum standards
across the European market.
The European Commission also hopes the Directive will strengthen
its negotiating position in persuading non-EU jurisdictions to lift
their collateral requirements, notably the US, which requires
"alien" reinsurers to provide collateral equivalent to 100% of
gross liabilities for US risks.
Scope
The Directive applies only to "pure" reinsurers - reinsurers who
only carry out reinsurance business. This includes captives –
entities set up solely to provide reinsurance cover for the
undertakings to which they belong.
"Reinsurance business" includes related activities, such as
providing claims management services or actuarial advice.
The Directive does not apply to direct insurers who also carry
on reinsurance business ("mixed" insurers) or to Lloyd's market
underwriters. These continue to be regulated under the Non-Life and
Life Insurance Directives. Nor does it apply to reinsurers which
have stopped accepting new business and are in run-off.
Territorially, the Directive covers the European Economic Area
(which covers all the EU member states plus Iceland,
Liechtenstein and Norway). All EEA member states were due to
implement the Directive by 10th December 2007.
Prudential supervision
The prudential requirements in the Directive were implemented in
the UK on 31st December 2006 by amendments to the Financial
Services Authority's Handbook.
The new measures include changes to the rules governing
technical provisions (the funds allocated to meet the reinsurer's
future liabilities), solvency margins (broadly, the excess of
assets over liabilities) and the minimum guarantee fund (below
which the solvency margin must not fall).
In addition, the FSA broadened its "prudent person" investment
principles and removed other restrictions on admissible assets for
pure reinsurers, in line with the Directive requirement that member
states should not require reinsurers to invest in particular
categories of assets.
ISPVs and finite reinsurance
The Directive gives member states the discretion to develop
their own rules on the setting up of Insurance Special Purpose
Vehicles – entities set up by (and taking on specific risks from)
an insurer or reinsurer.
In the UK, the FSA Handbook applies a light regulatory touch to
ISPVs proportionate to the lower risks posed by such vehicles,
including a "fast-track" authorisation procedure.
Member states are also free to draw up their own rules on finite
(or financial) reinsurance contracts, which transfer risk to a
reinsurer but only to a limited extent.
The main concern with finite reinsurance contracts is that they
may sometimes be used to distort the reinsured's balance sheet
because of the way reinsurance (as opposed to, say, a loan) is
treated in financial accounts and in the calculation of regulatory
capital. If in reality there is little or no actual risk
transferred, the contract should properly be accounted for as a
loan.
To address this issue, the FSA has adopted a principles-based
approach that balances any benefit to the reinsured's balance sheet
against the extent to which there has been actual risk transfer.
This principle applies to all types of reinsurance arrangements,
including finite reinsurance and ISPVs.
The new passporting regime
By harmonising standards and ensuring the mutual recognition of
those standards, the Directive sets up a regime that allows a
reinsurer authorised in its "home" member state (where it has its
head office) to carry on reinsurance business anywhere in the
EEA.
Armed with this "single passport", a reinsurer can set up a
branch in another member state (the right of establishment) or
provide reinsurance services there from its home or another member
state. The host state cannot impose any additional regulatory or
supervisory requirements.
The passporting provisions were implemented in the UK on 10th
December 2007 by the Reinsurance Directive Regulations.
Unlike the passporting regime for direct insurance, there is no
requirement for information about the reinsurer to be provided to
and by regulators in the host state.
In March 2008, however, CEIOPS (the Committee of European
Insurance and Occupational Pensions Supervisors) published a
revised protocol on collaboration that provides that the home state
regulator should provide information to the host state where the
reinsurer intends to set up a branch within one month of being
notified of the reinsurer's intention. The protocol has been
adopted by all CEIOPS members.
In the UK, the FSA (which is a member of CEIOPS) has asked
reinsurers with their head office in the UK to provide it with
details of their branches in other EEA states.
Non-EEA reinsurers
The Directive provides that non-EEA reinsurers should not be
given more favourable treatment than EEA reinsurers.
A non-EEA reinsurer can carry on reinsurance business in Europe
either through a subsidiary company authorised in an EEA state, or
via a branch in an EEA state.
A subsidiary incorporated and authorised in an EEA member state
will be treated in the same way as an EEA reinsurer and so can take
advantage of the passporting regime to carry on business in any
member state. The subsidiary's home state regulator must, however,
notify any host state that the company's parent is situated outside
the EEA.
But a non-EEA reinsurer that sets up a branch in an EEA state
will not benefit from the passporting regime and so will have to
obtain authorisation from the member state and from any other
member state where it wishes to do business.
As a result, many non-EEA reinsurers that have previously
operated through branches in the EEA may prefer to set up an EEA
subsidiary instead, obtain the necessary authorisation from the
chosen home state and transfer any business carried on by the
branches to the subsidiary.
Portfolio transfers
The Directive provides that a reinsurer's home state regulator
can authorise transfers of books of pure reinsurance business
within the EEA, provided the transferee's home state regulator
certifies that the transferee reinsurer will have the necessary
solvency margin after the transfer.
In the UK, this has meant some changes to existing procedures
for portfolio transfers under Part 7 of FSMA. These were
implemented on 10th December 2007 by the Reinsurance Directive
Regulations.
Part 7 requires all insurance and reinsurance business transfers
to be approved by the court in what can be a lengthy and expensive
process.
The amended rules introduce a simpler alternative for pure
reinsurance business transfers from the UK into the EEA. If all the
policyholders affected by the transfer consent to the proposal,
there is no need to obtain court sanction. Instead, the
transferring reinsurer simply needs a solvency certificate from the
transferee's regulator.
Impact
One of the main aims of the Directive is to create a level
playing field for reinsurance across the EEA. Whether this can
wholly be achieved when member states are still given the option to
develop their own rules in relation to ISPVs and finite reinsurance
is questionable.
The new regime, however, is likely to have the greatest impact
on those member states that previously imposed few regulatory
requirements on reinsurers.
In the UK, the immediate effect will be limited as there was
already a fairly stringent regulatory regime in place. If anything,
the new rules are a relaxation. Eligible reinsurers, however, will
benefit from the new freedoms brought by the single passport and
the streamlined Part 7 procedure.
In the long term, the intention is that all the prudential
supervision provisions in this Directive and the Life and Non-Life
Insurance Directives will be consolidated into Solvency II, the
EU-wide, risk-based solvency regime planned to come into effect in
2012.
Contact: Charlotte Hooper (charlotte.hooper@pinsentmasons.com
020 7418 8214)
See:
See also: Recent changes to the Part 7
transfers of insurance business, an OUT-LAW Guide.
