For the first time in the history of Europe's integrated single insurance market, two powerful insurance associations, the British and German, have got together to promote pan-European regulation of the reinsurance sector “with a view to encouraging discussion on an EU-wide, and possibly worldwide framework intended to improve reinsurance security and allow the introduction of a single passport for reinsurers based on common standards.”

The jointly produced “Draft Framework for a European Regime for the Supervision of Cross Border Reinsurance” is understood to have the support of both the Financial Services Authority in the UK and the Comité Européen des Assurances and is being taken seriously by the European Commission. It is also under review by a technical sub-committee of the International Association of Insurance Supervisors (IAIS).

Supported by an analysis of the current regulation of reinsurers in the EU and a list of barriers to the conduct of reinsurance business worldwide, the draft framework cites the globalisation of risks and convergence of risk transfer mechanisms as one of the motivating factors for a new regime alongside securing stability in international markets and co-ordination of regulatory requirements.

EU

At EU level the key objective is to provide European reinsurers with a single European passport and “home state” control of the type long enjoyed by their direct insurance counterparts. This would allow EU reinsurers to trade throughout the European Community under one licence, whether through branches or by way of freedom of services. Such a regime would logically involve the removal of other barriers to free trade in reinsurance in Europe including the obligation to maintain local deposits and restrictive reserving requirements under national rules, and would allow European regulators to develop a co-ordinated approach to reinsurance security.

International

At the international level the ambition is to create a co-ordinated international regulatory structure under which the world's reinsurers will, through mutual recognition of their licences, be able to trade globally without having to comply with the uncoordinated regulatory demands of national and regional authorities.

In accessing international markets, both European reinsurers and direct insurers would benefit from the “gold standard” of their EU licence which would enable European authorities to negotiate access to other trading blocs such as the emerging markets and the removal of barriers to entry to developed markets such as multiplicity of licences required under the current state-focused US regulatory system.

Core requirements

In order to qualify for an EU reinsurance licence reinsurers must meet certain “core requirements” which follow in principle the regulatory requirements laid down for direct insurers under various life and non-life EU directives. Broadly these include the legal form of the reinsurer, satisfaction of minimum solvency requirements, maintenance of adequate technical reserves and reserving policies and the requirement that management be “fit and proper” with full reporting to a national insurance supervisor on at least an annual basis. Failure to meet these criteria would lead to the EU licence being withdrawn or suspended.

The accounting standards applicable to EU reinsurers will also require harmonization, most likely through an amendment to the Insurance Accounts Directive.

Conformity to replace diversity

The impact of this initiative and its scope can best be understood by comparing the proposals with the current European regulatory environment into which it has been launched.

Prior to the introduction of the single market for direct insurers, characterized by a single European licence and harmonization of regulation and supervision - a process that took 30 years to achieve - markets were regulated at national level and direct insurers were obliged to be licensed by each country in which they traded and were subjected to a variety of often discriminatory laws and requirements.

Tight national regulation led to comparative freedom from reinsurance regulation as it was in the interests of the state, and, more particularly, state-owned insurance companies, to have free access to the global reinsurance markets for the purposes of spreading risks assumed.

Accordingly, state supervision of reinsurers in Europe was checkered and continues to be so to this day. The Reinsurance Directive of 1964 (64/225/EEC) pre-dated the harmonisation initiatives of the 1970s and simply removed some of the longstanding national barriers employed by member states. Until now there have been no efforts at EU level to regulate the reinsurance sector which has been left to member states to determine. Reinsurance and retrocession did not feature in the European Commission's Single Market “White Paper” programme of 1985.

Domestic professional reinsurers are not subject to any reinsurance supervision in Belgium, Ireland and Greece. Germany, France and the Netherlands apply elements of their direct insurance supervisory regime to reinsurers while a reduced licensing regime exists in Austria, Italy, Spain and Sweden where only the latter two impose solvency margin requirements. This haphazard approach is repeated across the globe.

Only in the UK, Denmark, Finland and Portugal are reinsurers subject to the comprehensive regulation and supervision of the type applied to direct insurers under the single market regime, including licensing and thoroughgoing financial supervision.

This new Anglo-German initiative demands all of these national variations be swept away in favor of a common EU-wide regime and that regime, once established, should be used as a lever to open up overseas markets for European reinsurers.

The proposed framework does no more than start the debate, but the interest shown and the support it has received from the key European regulatory body in the form of the European Commission and the IAIS, representing insurance regulators from over 100 countries, indicates that it has realistic prospects of success in one form or another. Enhanced regulation of reinsurers is part of an inexorable trend towards regional and global coordination of the conduct of financial services business generally. Within Europe it is an anomaly that the retail (direct) insurance market should benefit from a level playing field while the wholesale (reinsurance) market which serves it remains subject to trading barriers within the EU contrary to the principles of free movement of capital and services upon which it is based.

Unanswered questions

The devil is in the detail and the details have yet to be addressed. The current Europe-wide regulatory regime for direct insurers cannot simply be applied in its entirety to the reinsurance sector. There are key differences between the regulation of retail and wholesale markets. What is the correct level of technical reserves for a reinsurer and how should they be calculated and accounted? How will the new regime apply to entities which carry on both direct and reinsurance business and will those two businesses be subject to separation of funds and different solvency margins? A motivating factor behind the initiative is the ongoing convergence of risk transfer mechanisms. Will reinsurers be allowed greater access to the capital markets than is currently permitted by direct insurers in the EU and will they be free to offer capital markets products such as derivatives under their new EU licence?

The success of this initiative and the shape of European reinsurance regulation will very much depend upon consultations with the industry itself.

It can be assumed that the UK and German reinsurance sectors broadly support the idea of regulatory reinsurance on a Europe-wide scale as it is their trade associations which have put this issue firmly on the agenda.

Experience of the single licence regime in place for several years for direct insurers teaches that there are a number of benefits of the pan-European regulatory approach. A single reinsurance licence will give reinsurers the right to trade cross-border and there will be savings on the costs of compliance with different legal and regulatory regimes.

Common standards of accounting and reserving will create a level competitive playing field in these key areas and will enhance competition. Increased transparency of licensing and supervision will contribute to security and will benefit direct insurers and their policyholders.

There may be a greater prize if, as is intended, the European reinsurance regime can be used as a tool to open up overseas markets and there will be competitive advantage for Europe's reinsurers when contesting for business against unsupervised and unregulated reinsurers from other countries. Regulators outside Europe cannot ignore developments of this type which can only add fuel to the fire in the debate in the US on state versus federal regulation of the insurance industry.

Patrick Devine is a partner and Andrew Crouchman is senior counsel at Akin, Gump, Strauss, Hauer & Feld, London. They both specialise in insurance and reinsurance law.