Insurance Regulation in the European Union

Insurance is traditionally a regulated industry because of the insurance business’s peculiarities. Since the 2007–2008 financial crisis, however, insurance has been experiencing a level of regulation that is not comparable to the previous one in several respects. This chapter aims to identify the key drivers of the regulatory activity on insurance carried out by the European Union (EU). However, the chapter will take into account the transnational dimension of the sources of this regulation, the different binding authority of the rules issued by the EU, and the involvement of the stakeholders in the decision-making process, rather than focusing on the detailed contents of such a regulation.

Even in times of spectacular developments in the regulatory framework of the insurance business, it remains instructive and revealing to examine the slow but equally remarkable changes of insurance contract law. These changes illustrate the evolution which insurance itself, its image and its role in society have undergone. The present chapter focuses on five major developments: the emancipatory move of insurance from a marginal operation to a fully regular financial transaction and an indispensable ingredient of modern economic and social life; the changing concept of risk and the expanding notion of insurability; the evolution of insurance law from business law to consumer law; the integration of insurance and its regulation into the financial services area; the difficult quest for harmonization of insurance contract law in the EU context.

The objective of this chapter is to describe how the IDD contributes to greater (and/or better) consumer protection and what the main differences are with the IMD. It is also the intention to give a flavour of the EU regulatory process and some indications on the interaction of IDD with other regulations. In this respect, the author hopes that this chapter will also contribute to the identification of the areas in which the sector can start preparing for the practical consequences of the IDD. This chapter refers to the IDD as published in the Official Journal of the EU (OJEU) on 2 February 2016.

How far will Solvency II and the IDD continue to form the substantive content of UK insurance regulation after Brexit? The stated preference of the UK government and of many UK insurers is for UK insurers and intermediaries to be able to continue to operate in the single European market with as close an approximation to the current passporting rights as can be negotiated. It is widely assumed that the retention of much of the substance of Solvency II in UK domestic legislation will be necessary to achieve this. The current “equivalence” provisions are not enough. Whether Solvency II-based capital requirements would continue to be appropriate for UK life insurers focused on North American or Asian markets and with no significant European business is a debated point.

Around the turn of the twenty-first century, the UK Life Insurance and General Insurance sectors had been beset by reputational and solvency problems. In response, the Financial Services Authority (FSA) made fundamental changes to the prudential regulation of insurers. It enhanced existing requirements and introduced an entirely risk-based Pillar 2 capital regime—Individual Capital Adequacy Standards (ICAS)—in many ways anticipating changes introduced later by Solvency II. This chapter documents the UK’s journey from those difficult beginnings through to Solvency II, drawing out how the prudential regime changed, and the challenges along the way.

Under Solvency II, corporate governance requirements are a complementary, but nonetheless essential, element to build a sound regulatory framework for insurance undertakings and also to address risks not specifically mitigated by the sole solvency capital requirements. After recalling the provisions of the second pillar concerning the system of governance, the chapter is devoted to highlighting the emerging regulatory trends in the corporate governance of insurance firms. Among others, it signals the exceptional extension of the duties and responsibilities assigned to the Board of Directors, far beyond the traditional role of both monitoring the chief executive officer and assessing the overall direction and strategy of the business. However, a better risk governance is not necessarily built on narrow rule-based approaches to corporate governance.

The aim of this chapter is to determine whether the Solvency II rules and implementing measures have had any influence on the maturity level of organisation’s risk management. In fact this study sought to understand the status of the organisation’s risk management maturity prior to and after the introduction of Solvency II and the relevant implementing measures.

 To answer this question, the authors used a questionnaire, which was sent out to targeted controllers (risk managers/consultants/officers, auditors and compliance managers/officers) and managers (CFOs, CEOs, COOs, directors and investment managers) within European insurance firms located in the UK, Italy, Holland, Spain, Belgium, Luxembourg, Czech Republic and Malta.

 The findings provide empirical evidence that the organisations’ risk management maturity improved with the introduction of Solvency II regulations and the relevant implementing measures.

This chapter examines the supervision of insurance groups in the European Union (EU), highlighting the evolution from the Insurance Groups Directive to the Solvency II Directive. Solvency II deviated from supplementary supervision, turning to a system of consolidated supervision that rests on the concept of the insurance group as a single economic entity rather than a collection of entities. The chapter discusses the changes made by Solvency II and argues that the system is based on a clear and appropriate allocation and division of responsibilities between the group supervisor and the other supervisory authorities, to the benefit of enhanced accountability in the exercise of group supervision. The concentration of powers and responsibilities in the group supervisor is conducive to both more efficient and effective group supervision. Further centralization of supervisory responsibilities for the oversight of systemically significant insurance groups, however, would be sensible. The chapter suggests the prospect of the centralization at the EU level of the supervision of groups that are systemically risky as the next step of the evolutionary process of insurance group oversight.

Solvency II Directive introduced a new framework in order to develop new risk management practices to manage risk and to define a minimum capital requirement. To this aim, Commission Delegated Regulation provided the final version of the standard formula. Capital requirement is obtained via a modular structure where each source of risk must be first measured and then aggregated under a linear correlation assumption. As the results of main Quantitative Impact Studies have shown, premium and reserve risks represent a key driver for non-life insurers. In this regard, we focus here on the valuation of the capital requirement for this specific sub-module. Some inconsistencies of the approach provided by Solvency II will be highlighted. We show that some assumptions of the standard formula may lead to an underestimation of the capital requirement for small insurers.

Quantification of capital requirements is a critical issue for any insurer. Solvency is assessed through the regulatory capital, but, in practice, insurance companies usually hold higher levels of economic capital assessed using risk-based models that allow for any type of risk the institution deals with. Once the economic capital of a company is determined, it should be allocated down to lower levels, such as business units, lines and products for a number of purposes and this allocation of capital has crucial importance. This chapter deals with some key aspects related to risk quantification and capital allocation in life insurance. Portfolios composed by different insurance contracts, with both life and death benefits, are investigated. The numerical results obtained explain that the features and benefits of a contract influence not only the assessment of the total risk but also its allocation to single factors, showing that such a risk measurement methodology could be a useful tool for new products improvement and management, in adherence to the principles stated by the Solvency II directive, specifically with respect to the own risk and solvency assessment (ORSA) and the implementation of internal models.

The third pillar of Solvency II consists of supervisory reporting and market disclosure. This chapter focuses on market disclosure, the most innovative part of the Solvency II Pillar 3. In the author’s view, the pros—principally, market discipline and the European Union (EU) comparability of solvency public information across insurers—override the cons—principally, possibly window-dressing practices and comparability between solvency and the International Financial Reporting Standards (IFRS) financial statement data. However, the European Insurance and Occupational Pensions Authority (EIOPA) and national authorities should monitor the existence of side effects and, if they are judged relevant, suggest some improvement in the regulation. Insurers should introduce an integrated reporting system in order to make solvency and financial information more clear and comparable to the public, avoiding duplication of costs, and avoiding inconsistences in the reporting system.

The introduction of Solvency II new regulatory framework in the European Economic Area strongly impacts on adequacy activities required from insurance companies which are now facing a tighter and more demanding scenario in terms of capital requirements, availability of own funds, which are very sensitive to economic balance sheet assessment, a more robust system of governance and a largely standardized set of data and information to be disclosed. Different aspects of balance sheet evaluation and performance measurement are common with the new international accounting standards that will be effective in the next years (International Financial Reporting Standards [IFRS] 9 in 2018 for financial instruments, 2021 if deferral option will be applied by the entity, and IFRS 17 in 2021 for insurance products.). To avoid any misunderstandings on communication and transparency with financial markets, a clear explanation and reconciliation of figures from these two frameworks will pose a great challenge to the insurance sector which must undertake huge efforts for fully implementing both regulations in the next years.

Solvency II required many years and a lot of discussions to acquire its present form. The final text was also heavily influenced by the financial crisis. This chapter looks at key aspects of the negotation of Solvency II. It then looks at the implementation of the new risk based solvency framework. It concludes by looking at likely future developments.

This chapter focuses on the role of insurers as providers of funds for long-term investment in the real economy, with an examination of the European market. The thesis is that financial regulation, and prudential insurance regulation in particular, crucially affects insurers’ investment behaviour and therefore their contribution to financial stability and economic growth, which for many reasons will be increasing in the near future. Accordingly, careful assessment of the effects of Solvency II on the insurance industry is required, bearing in mind the regulatory reviews planned for 2018 and 2020.

The captive concept—in its most basic form—is that of forming an insurance company to insure the risks of its owners. A captive insurer’s owner and the ultimate insureds are, in most cases, one and the same. When the insured is the owner of the insurance company, policyholder protection, as a key principle of insurance regulation, may take a different emphasis.

The Solvency II framework is structured through three separate but complementary pillars which are applicable to captives in like manner as they are applicable to insurance and reinsurance undertakings. The principle of proportionality which is threaded through the Solvency II Directive is indeed identified as a fundamental concept applicable also to captives.

The three broad objectives of the Solvency II Regime—to improve policyholder protection, to improve international competitiveness of EU insurers and to deepen the integration of the EU insurance market—have been argued to have limited applicability to captives.

This notwithstanding, there is a growing appreciation of the opportunities afforded to captives under Solvency II through better governance, added value to the risk management process as well as increased intellectual capital.

Against a backdrop of evolving insurance regulation, captives have maintained a steady growth and remain key as part of the risk management programme of their owners. As captives adjust, they innovate and look for opportunity in change. On a going forward basis, coping with the challenges associated with a change in regulatory culture, mind-set and skill set have been identified as the main lessons being learnt.