UK: The Everchanging Regulatory Regime

Last Updated: 11 August 2004
Article by Pollyanna Deane and Fiona Russell

No one could be blamed for thinking that the insurance regulatory regime in the UK and Europe is always changing. It can be a daunting task getting to grips with the changes which have occurred in the UK insurance industry over the last few years. However there are to be further changes to the reinsurance sector with the impending adoption of a new Reinsurance Directive.

In the background new international accounting rules are currently being developed and the solvency regime for insurers and reinsurers is also undergoing review. These developments cannot, however, be reviewed in isolation as they all impact on each other.

The Reinsurance Directive

The European Commission has now presented a proposal for a Reinsurance Directive (the "Directive") which will now go forward for discussion and adoption by the European Parliament and the Council of the European Union. After which EU Member States will have 18 (or possibly 24) months in which to implement the requirements of the Directive into their own national law.

Although reinsurance is one of the most international service industries there are still obstacles to the provision of crossborder services. Some Member States regulate reinsurance and others do not. Certain countries in the EU have monopolistic situations in reinsurance through one (often state-owned) company. Other EU countries require compulsory cessions in certain lines of business to a state company or to identified national insurers. Consequently there is no level playing field throughout Europe in which reinsurers can effectively compete. As a result Member States and the European Commission agreed in 2000 to start a project in order to assess the possibility of establishing a harmonised framework for reinsurance supervision in the EU. After discussions and hearings it was decided that focus should be given to a "fast track" approach which would lead to legislation being developed in a relatively short time.

The Directive is based on current direct insurance supervision rules, taking reinsurance specific aspects into account. The Directive applies to pure reinsurers and reinsurance captives. It does not apply to direct insurance undertakings already covered by current non-life and life directives which accept reinsurance business. The Directive does, however, contains provisions which amend the First Non-Life Directive (73/239/EEC) and the Life Assurance Directive (2002/83/EC) whereby the provisions concerning the solvency margin will be applied to direct insurance undertakings with respect to their reinsurance activities separately.

Prior official authorisation will be required of a new reinsurance undertaking which takes up the business of reinsurance from the relevant supervisor in its home Member State. In the UK this will be the FSA. That authorisation will distinguish between life and non-life activities. A reinsurance undertaking could therefore be authorised to conduct non-life activities, life activities or both.

Reinsurance undertakings will have to "limit their objects to the business of reinsurance and related operations". This wording is similar to the current framework for direct insurance undertakings; however it has been modified so that that the reinsurance undertaking "limits its objects to the business of reinsurance and related operations" rather than "operations arising directly therefrom". The modified wording clarifies that it is not intended to impede a reinsurance undertaking in carrying on activities such as the provision of statistical or actuarial advice or risk analysis, to its clients, or having a qualified holding in other insurance undertakings, or owning a direct insurance undertaking.

Reinsurance undertakings will have to establish adequate technical provisions in respect of their entire business. The solvency margin rules for non-life reinsurance activities are the same as the requirements for direct non-life insurance. The solvency treatment of life reinsurance activities is to be in line with the current rules for direct health insurance.

The Directive contains a "grandfathering" clause for existing reinsurance undertakings at the time of adoption of the Directive. These undertakings will be deemed authorised and will have to comply with certain requirements such as the conditions for authorisation and the rules on technical provisions. Member States will, however, be able to give these reinsurance undertakings a further two years in order to comply with certain provisions such as the solvency margin requirements.

The Directive is, however, dependant on the outcome of the Solvency II proposals and once these have been finalised it is likely that the reinsurance supervision regime will be adjusted accordingly. This will mean that certain aspects of the Directive, such as the solvency margin requirements, will be of a temporary nature.

Solvency II and the International Accounting Standards

The Solvency II project is being conducted by the European Commission in co-operation with EU Member States. The purpose of the Solvency II project is to review all the prudential rules in the insurance sector (including reinsurance) in order to devise a solvency system which is more sensitive to the risks incurred by insurance and reinsurance companies. The project is divided into two stages: the first (which was completed at the beginning of 2003) was to produce a decision on the general design of the solvency system and the second, more technical phase, focuses on developing the detailed rules which will form part of the overall system.

Solvency II will mean changes to the current directives on direct insurance and reinsurance. The prudential rules in the directives will need to be amended because new concepts will be introduced and the directives will have to be adapted to the new regulatory framework that is envisaged in the future.

Before Solvency II can be finalised, account will be taken of the underlying accounting environment. This includes the current work being carried out by the International Accounting Standards Board (the "IASB") to develop a single set of international accounting standards. The IASB has no authority to require compliance with its accounting standards, however in 2002, the European Commission adopted a Regulation (No 1606/2002/EC) of the European Parliament and Council on the Application of International Accounting Standards (the "IAS Regulation"). The IAS Regulation endorses certain international accounting standards. From 1 January 2005 companies governed by the law of an EU Member State must, prepare their consolidated financial statements in conformity with the standards endorsed by the IAS Regulation if, at their balance sheet date, their securities are admitted to trading on a regulated market of any Member State. Member States may also extend this to permit non-publicly traded companies to prepare their consolidated and/or separate financial statements in conformity with the IAS Regulation. The UK has taken this approach.

The European Commission has agreed that the Solvency II project should be compatible with the IAS Regulation in order to reach a greater level of harmonisation. However the IASB standards on insurance, such as International Financial Reporting Standard 4 ("IFRS 4") "Insurance Contracts", remain incomplete and will inevitably impact the timing of Solvency II.

IFRS 4 "Insurance Contracts" was issued by the IASB on 31 March 2004. It aims to establish for accounting purposes what is or is not to be considered an insurance contract and applies to both insurers and reinsurers. This is separate from what legally constitutes such a contract. In developing IFRS 4, the IASB has recognised that developing a global consensus on an approach to insurance contracts would require extensive consultation beyond the time limits available – in the EU’s case companies need to comply with the accounting standards endorsed by the IAS Regulation from January 2005. In the first phase, IFRS 4 is aimed at introducing improvements to recognition and measurement practices where accounting for insurance contracts. In the second phase, the IASB intends to address broader conceptual and practical issues relating to insurance accounting. Consultation on this will begin in the second quarter of 2004. In order to start the second phase, the IASB is to establish an international working party of about 15 members. Although the completion of any long-term consensus on the treatment of insurance contracts may take several years to complete, the IASB has stated that it is willing to revise IFRS 4 in the short term in the light of any immediate solutions arising from the working party’s discussions.

It will take some time before the accounting issues surrounding insurance contracts are finalised and as a result the knock-on effects to the solvency regime for insurers and reinsurers will not be felt for a while. Nevertheless there is still plenty for European reinsurers to be doing to ensure they are ready for regulation in 2005/2006. 

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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