Rick Hodgdon argues that life reinsurers are being pushed into a new - possible undesirable - European regulatory regime

Life reinsurance - though largely invisible to the insurance-buying public - provides stability to the financial results of the primary underwriting company and enables more affordable life insurance protection. In the interest of policyholders, it is imperative that the distinct needs of the life reinsurance industry receive due consideration as new regulatory and supervisory rules are established for the European Union (EU) insurance industry.

The question is, "What does the life reinsurance industry want from the revised solvency and regulatory environment?" Quite simply, it should provide a level playing field across financial services sectors and jurisdictions, and it should encourage prudent management practices for our business.

Anything beyond this will restrict the life reinsurer's ability to effectively support the direct writer's business. The major focus should be consistent disclosure of the risk a company is carrying and the relative adequacy of capital and surplus to the risk, and consistency and transparency with regard to the handling of insolvency for both cedants and reinsurers.

However, on the journey to Solvency II, life reinsurers are being herded onto the train that is the fast-track Reinsurance Directive, the effort by the European Commission to integrate reinsurance regulation into existing EU insurance regulation. Fast-track at worst means 'non-life' or at best 'Solvency I,' and this is of concern to the life reinsurance market that has built its reputation on innovation and portfolio diversification.

Motivated by social and political forces as well as market imperfections, the push to fast-track this Reinsurance Directive could produce consequences for life reinsurers that are both unintended and undesirable from a regulatory perspective.

Life reinsurance transcends national and continental boundaries; it is not simply international, it is intercontinental in nature. Therein lies a major difference in considering regulation for life reinsurance as distinct from the direct life sector.

Consider Solvency I: it reinforces a system that is simple, robust, easy to understand and use, inexpensive to administer and has worked well in practice. The rules focus on implicit prudence, with prospective actuarial valuation based on principles. Solvency I increases the level of harmonisation, the level of minimum capital and ensures assets are prudently valued, diversified and adequately spread. These are all sensibly prudent measures but they are far from ideal, as is recognised by the Solvency II proposals.

However, they are designed for an internal market, and if everyone must compete on the same terms then there is a level (if sub-optimal) playing field. But, imposing these measures on a sector that is not an internal market, on a sector that generates massive exports from the EU and tax revenues for the EU, on a sector whose competitors are not subject to such levels of prudence, is tantamount to 'administering medicine that could kill the patient'.

Because the fast-track directive falls within the domain of the Internal Market Directorate-General of the European Commission, there is a risk that reinsurance will not be recognised as the intercontinental business that it is. To avoid such a mistake, we should look to and learn from regulatory efforts in the banking sector. The Basel Committee's rules concerning capital requirements form the basis for banking supervision worldwide and encourage a level playing field among players from all continents.

In the long-term, reinsurance (which has heretofore been under-regulated) needs the same co-ordinated, intercontinental approach. In the short-term, the EU needs to recognise that introducing regulation for an intercontinental sector like reinsurance requires a broader perspective than the 'internal market' approach.

The reinsurance industry recognises the need for some form of regulation, but the regulation must be practical and not punitive. In fast-tracking the formulation of the Reinsurance Directive, the EU must address the basic differences between direct insurance and reinsurance and, within reinsurance itself, the differences between life and non-life reinsurance.

Effective regulation requires a thorough understanding of the basic product principles, risk components and market dynamics with respect to life reinsurance.

Within the EU life reinsurance community, there are two schools of thought:

(1) since the fast-track directive is just a stopgap to Solvency II, there is little need to get it exactly right for life reinsurance, therefore concentrate on Solvency II; or

(2) that we should ensure that the fast-track directive is appropriate for life reinsurance because it forms the basis for Solvency II.

The reinsurance industry needs to embrace the latter way of thinking in order to ensure the appropriateness of both the Reinsurance Directive and Solvency II. Inappropriate regulation, even in the short term, can discourage sound management and produce unintended sub-optimal outcomes.

If deadlines preclude the opportunity to formulate appropriate regulation then whatever regulation is produced should leave reinsurers with the flexibility for good management practices.

It is very likely that regulators will want to simplify and apply rules broadly in order to lessen the burden and complexity of the supervisory authorities. Life reinsurance traditionally has been a small segment of the worldwide reinsurance business and an even smaller piece of the financial services industry. Therefore, there is a risk that in the regulatory effort to implement oversight, the needs of our specific industry will be compromised or subsumed by the larger elements of the financial services group. Another potential risk stems from the uniqueness and complexity of the life reinsurance business. Policymakers must know how our business works or they may apply a politically expedient or overly cautious approach.