Although Solvency II should considerably reduce the risk of insurers failing, the European Commission is concerned the absence of a uniform system of guarantee schemes across the European Union remains a serious shortcoming. Jeremy Woolfe reports on the Commission’s move to rectify this.
With over a quarter of life insurance policies in Europe lacking any kind of protection if companies fail, the European Commission (EC) has plans to bring in pan-EU coverage. New legislation would introduce a harmonised insurance guarantee system (IGS), with minimum parameters, but organised on a country-to-country basis.
To illustrate the need for an IGS, the EC noted that more than 130 insurers went insolvent in the EU from 1996 to 2004, while the 2009 failure of a Greek insurance group affected around 800,000 policyholders.
Based on preliminary assessments, the EC suggests that funding of the IGS should work to a target level of 1.2% of gross written premium income per year.
In a white paper, entitled On Insurance Guarantee Schemes, the EC writes it is taking into account an appropriate transition period, particularly in those EU member states where no IGS have been established so far. The EC adds it will take a number of years to establish the system, and overall costs will have to be balanced against the expected benefits.
The EC is giving all interested parties until 30 November to provide their views and comments on the white paper. It will then evaluate the feedback and take it into it account when coming forward with a detailed legislative proposal, that may be tabled during 2011. This proposal will be accompanied by a new impact assessment.
Early reaction from Brussels-based industry body the Comité Européen des Assurances (CEA) recognises “the European Commission’s objective of safeguarding consumers even in the most extreme circumstances”.
But CEA director general Michaela Koller adds: “We are convinced Solvency II, being a risk-based regulatory regime, [already] increases the level of consumer protection.”
The CEA continues that, should the EC decide to go ahead with a legislative initiative, the CEA would support a minimum of harmonisation of national schemes.
The CEA adds: “This would accommodate existing national systems that function well and are adapted to local conditions and consumer needs.”
However, the CEA, which represents undertakings of €6.9trn ($8.8trn) – approximately 94% of total European premium income and investments – “questions pre-funding of IGSs… [believing] that the decision on how to fund schemes should be left to individual EU member states provided that equivalent protection is given to policyholders.”
Koller stresses: “Attention must be paid to ensure an IGS, combined with the other initiatives envisaged by the Commission, does not place a disproportionate compliance burden on the insurance sector, which would be to the ultimate detriment of consumers.”
On the Solvency II issue, the EC noted that once Solvency II becomes operational on 31 December 2012, it expects to see a reduction in the incidence of failures.
However, it argues, neither the current nor a future solvency regime will be able to create a zero-failure environment in the insurance sector. Solvency II requires insurance and reinsurance companies to hold sufficient capital to cover their obligations for one year, subject to a 99.5% confidence level. This is intended to ensure no more than one insurer in 200 goes bankrupt in any one year.
Despite the low probability of it occurring, in the event of the insolvency of an insurance company, the lack of appropriate insurance guarantee protection for consumers may trigger harmful effects, stressed the EU. These include financial hardship incurred by consumers, an unlevel playing field for the industry, and a loss of consumer confidence in the market.
The EC’s overall position is that of the 30 EU-European Economic Area countries, only 12 at present operate one or more general IGSs and that some 26% of all life insurance policies and 56% of all non-life insurance policies are unprotected. Those countries with IGS are: Bulgaria, Denmark, France, Germany, Ireland, Latvia, Malta, Norway, Portugal, Romania, Spain and the UK. Taking in both long-and short-tail insurance, one third of the entire market in the EU 27 countries and the three European Economic Area countries (Iceland, Liechtenstein and Norway) lacks any kind of coverage by an IGS.
In contrast, said the EC, guarantee schemes are in force in other sectors of the financial services industry. For instance, such provisions do apply to investor compensation arrangements. These give minimum protection standards, which are enforced under the EU’s Deposit Guarantee Scheme Directive of 1994 and the Investor Compensation Scheme Directive of 1997.
The EC added that when ISGs are in place for insurance, under national rule books, policyholders get different levels of protection from member state to member state. According to a descriptive text introducing the EC’s white paper, the schemes also differ in operational procedures and funding arrangements.
Impeding the market
The lack of harmonised IGS arrangements in the EU may be impeding the functioning of the internal insurance market, by distorting cross-border competition. In its white paper, the EC proposes that any future directive should ensure IGSs across the EU should comply with certain basic criteria (such as definitions of the kind of insurance policies to be covered, geographical scope, funding etc).
The white paper suggests member states may provide for a higher than minimum level of protection “if they believe this is necessary and appropriate for their markets”. The EC believes its proposed moves will “enhance confidence in the financial sector and thus have a positive impact on the economy”.
However, the EC agrees that while a single, pan-EU guarantee scheme, could present advantages, “it would seem very difficult at this stage and pose complicated legal issues”. Hence, at present, the most realistic and useful approach is to establish relevant schemes at national level.
It insists the schemes would have to be able to deal with cross-border operations, citing, for example, the buying of life assurance in Belgium from a local branch of an insurer whose headquarters are located in Germany. The EC said it has identified “a considerable proportion” of cross-border insurance business lacks any kind of IGS protection.