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NEW REGULATIONS NEW REGULATIONS AFFECTING THE AFFECTING THE

INSURANCE MARKETINSURANCE MARKETElemér TertákPrincipal Advisor

European Commission

THE INSURANCE IN EU ON THE THRESHOLD OF THE THIRD MILLENNIUMTHE INSURANCE IN EU ON THE THRESHOLD OF THE THIRD MILLENNIUM

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Role of insurance in the EU Role of insurance in the EU

Between 2002 and 2007 the European share of the global market rose from 32% to 43% as premiums in Europe grew faster than total worldwide premium income. However, with the decline of European premiums in 2008 and 2009, Europe’s market share decreased to 40%.

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History of insurance and History of insurance and insurance regulationinsurance regulation

The concept of insurance date as far back as 3000 B.C.

However, it was during the 15th to 17th century, when modern types of policies began to develop for life, marine and fire insurance. Initially, small local and regional carriers primarily writing fire and life insurance dominated the industry which led to a state-based regulatory framework.

In the 19th century the incorporated insurers come to the front and took over from the mutuals and cooperatives the business. Major disadvantage of the mutual insurance companies is the difficulty of raising capital thus take more or large value risks. The mutual market share at the end of 2008 was 24% .

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History of insurance and History of insurance and insurance regulation insurance regulation (cont‘d) (cont‘d)

At the end of the 19th century, there was a shift in public sentiment towards increased regulatory oversight of large and concentrated industries that resulted from concern from potential monopoly harms. The regulatory oversight was justified as being in the public interest, and imposed on several industries, including railroads, telecommunications, trucking, airlines and insurance.

Another driver was that in the mid-19th century the prospect of quick gains led to proliferation of less reputable insurers. The call for a competent oversight was not long in coming. The first insurance supervision laws were adopted at the end of the 19th and beginning of the 20th century. The insurance supervisions were mandated to protect the insured against failure of insurance companies against fraud, to protect high premium burden and lack of general policy conditions.

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Theories of Regulation Theories of Regulation Public interest theory, The purpose is to protect consumers by

monitoring the solvency of insurers and their business practices. The idea is that consumers are not in an equal bargaining position with insurers, so it is necessary for the government to regulate the terms of insurance contracts.

Public choice theory. It rests on one major premise – that regulators concern themselves only about the needs of the citizens. requirement for full disclosure and setting reasonable standards are aimed at to overcome imperfect information

Insurance is also regulated for economic, social, and political purposes.

Further rationale is to regulate international insurers for financial soundness and transparency. Another macroeconomic purpose is to avoid regulatory arbitrage among financial sectors and to maximize efficiency of capital allocation.

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Regulation of insurance in the EURegulation of insurance in the EU

Competition Competition regulationregulation

Competition Competition regulationregulation

Prudential Prudential regulationregulation

Contract lawContract law TaxationTaxation

EuropeanEuropean

NationalNational

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1973 / 1979: publication of the first non-life and life directives of the EEC (European Economic Community)

- mainly based on the work by Cornelis Campagne / OECD 1961

Required solvency margin for life companies (EEC, 1979):

4% of the mathematical reserves (≡ investment risk) +

3‰ capital at risk (≡ technical risk)

Early warning signal, based on fixed ratios (wind-up barrier: guarantee fund)

2nd, 3rd directive: solvency margins left unchanged

Solvency in Europe: Solvency Solvency in Europe: Solvency „„0”0”

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Insurance Committee (IC) asked the European supervisory

authorities (from 2004: CEIOPS) to establish a working group

to investigate solvency issues chair of the group: Helmut Müller (BAV, Bundesaufsichtsamt

für das Versicherungswesen)

Presentation of the Müller Report: current solvency margin structure satisfactory amount of the minimum guarantee fund needs to be increased

(inflation) identification of three risk groups (technical, investment, non-

technical)

Solvency I project initiated

Committee of European Insurance and

Occupational Pension Supervisors

SolvencySolvency in Europe: Solvencyin Europe: Solvency II

1994

1997

1999

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Experience since the adoption of Directive 2002/13/EC for non-life insurers and Directive 2002/83/EC for life insurers: have worked well over the last decade have significantly increased the protection of the policyholders

Characteristics:

simple, robust easy to understand and use inexpensive to administer rule-based, and not explicitly risk-based (e.g. differences between asset and liability profiles are neglected)

However since the creation of these rules, significant changes have taken place in the insurance industry need to adapt the rules.

Experience with Solvency IExperience with Solvency I

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Why to change the rules?Why to change the rules? Current regime nearby 40 years old Lack of adequate risk sensitivity

No incentives for insurers to manage risks adequately or to improve & invest in risk management

Does not facilitate accurate & timely supervisory intervention

Supervision of groups sub-optimal Lack of convergence within the EU Lack of consistency with international

developments (IAIS, IASB)

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„In 1980 the life insurance industry was 150 years old, in 2010 it was 30 years old“

Equity markets experienced a strong bull run from 1996-2000 and in 2005-2007

Equity and corporate bond markets suffered falls in 2001-2002 and in the recent financial crisis

Interest rates stabilized on a low level - problems with (high) guaranteed returns

Increasing life expectancy / costs

More frequent extremes / catastrophes (e.g. 09/11, Tsunami)

Insurance environment since the 90iesInsurance environment since the 90ies

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delayed intervention of external institutions (supervisors, rating-

agencies, ...)

high (distribution) costs – only partially offset against policy-

holder benefits

slanted toward growth

insurance market of the 90ies

increase in the „equity culture“– weaknesses in risk management and

control

competitive environment – creating

high expectations of discretionary

bonuses

Five erroneous trends in the 90iesFive erroneous trends in the 90ies

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Global Risks 2011Global Risks 20111.1. Economic RisksEconomic Risks

• Fiscal crises• Global imbalances and currency volatility

• Infrastructure fragility

2.2. Environmental RisksEnvironmental Risks• Air pollution

• Biodiversity loss• Climate change

• Earthquakes and volcanic eruptions• Flooding

• Ocean governance• Storms and cyclones

3.3. Societal RisksSocietal Risks• Chronic diseases

• Demographic challenges• Infectious diseases

• Water security

4.4. Geopolitical RisksGeopolitical Risks• Organized crime

Terrorism• Weapons of mass destruction

5.5. Technological RisksTechnological Risks• Threats from new technologies

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Based on the Müller Report, it was agreed that a more fundamental review of the overall financial position of an insurance company should be done, including

- Technical provisions (non-life) - Reinsurance

- Asset / investment risk - Solvency margins (methods)

- ALM - Accounting systems

Launch of the Solvency II project by the European Commission - CEIOPS was asked to provide input and recommendations

Solvency in Europe: towards Solvency IISolvency in Europe: towards Solvency II

19991999

20012001

Committee of European Insurance and

Occupational Pension Supervisors

2002 Publication of the Sharma Report and of the KPMG Report

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The three phases of progress:

Phase 1Phase 1:

from 2001 to 2003

gathering knowledge

general design of the system (e.g. 3-pillar framework)

KPMG report, Sharma report

Phase 2Phase 2:

from 2003-2009

technical development of detailed rules

3 waves of Calls for Advice giving

structure of the framework, QIS

Phase 3Phase 3:

from 2009-2013 implementing phase

modeling, standard models, calibration of

models and parameters

implementing in national law

Solvency in Europe: towards Solvency IISolvency in Europe: towards Solvency II (cont‘d) (cont‘d)

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Benefits expected from the principles and risk-based capital standards of Solvency II (Directive 2009/138/EC):

More transparent / better risk allocation between insurers, policyholders and capital markets

Better pricing, product innovation New asset management strategies Decrease in the cost of capital Better capital allocation (commensurate with risk profile)

improved financial stability

Solvency II – A great leap forward Solvency II – A great leap forward

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Securing the benefits of the policyholders*

* Note: this does not necessarily require the continued existence of a company. Zero-failure will not be the aim of prudential supervisory systems. In a free market, failures will occur!

ObjectivesObjectives

Minimum financialrequirements

Supervisory reviewprocess

Market discipline via disclosure requirements

1 32

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Improved risk management: o matched to the true risks of an insurance company

total balance sheet approach

sending out early warning signals

ensuring a smooth run-off of the portfolios in case of financial distress

Stability of the financial market

Consistency with other sectors (e.g. Basel III)

International comparability, compatibility and convergence

Objectives (cont‘d) Objectives (cont‘d)

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Solvency II TimetableSolvency II Timetable

Directive development (Commission)

CEIOPS work on technical advice necessary for implementing measures / supervisory convergence / preparation for implementation / training & development

2006 2007 2008 2009 2010 2011 2012

Directive adoption(Council & Parliament)

Implementation(Member States)

QIS2

July 2007 Solvency II Directive proposal

QIS3

Commission preparatory work implementing measures (IM)

Adoption of IM

QIS4

January 2013 Solvency II enters into force

QIS5

December 2009 Solvency II Directive published in OJ

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State of PlayState of Play

Around 40 implementing measures being prepared based upon advice from CEIOPS / EIOPA

Public hearing held in May 2010Discussion of drafts with MS experts and with

stakeholdersFirst consolidated version of drafts prepared by

Commission staff in October 2010

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State of Play State of Play (cont‘d) (cont‘d)

Implementing measures to be adopted by Commission as delegated acts in June / July 2011

Council and Parliament can voice objections during period of 3 or 4 months

Entry into force: 1 January 2013

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EU Financial Supervision Architecture EU Financial Supervision Architecture Reform and level 3 rulesReform and level 3 rules

CEIOPS became on 01/01/2011 EIOPA (European Insurance and Occupational Pensions Authority)

Preparation of level 3 rules

Possibility to write Binding Technical Standards, or issue guidance

The Solvency II Directive will be revised to allow these changes (so called « Omnibus 2 »)

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Thanks for your attention!Thanks for your attention!