European Commission releases final report on business insurance sector inquiry

Insurance Update. European Commission releases final report on business insurance sector inquiry The Commission has published the final report of its competition inquiry into the business insurance sector. The Commission identifies two key areas of potentially anti-competitive practice; one in the field of coinsurance and reinsurance, and another relating to intermediaries. Although not ruled out, enforcement action does not seem to be imminent and further analysis is expected of both issues. The report also examines the Block Exemption for insurers, which is due to expire in 2010. The Commission has yet to be convinced as to why it ought to be renewed after that date. The report s findings Harmonisation of terms and conditions in coinsurance and reinsurance The Commission is exclusively concerned about the two-stage procedure used in coinsurance and reinsurance, where a lead insurer is selected and the remaining risk attributed to insurers who then conclude agreements on identical terms to those of the lead insurer. The report states that this practice may fall foul of Article 81(1) because it often results in an alignment of premiums and other conditions. The Commission recognises that the process has long been considered normal practice in certain markets, but is nonetheless calling for a critical reappraisal by market participants. Concerns relating to intermediaries The Commission feels that the remuneration of insurance brokers is insufficiently transparent and results in inflated prices and reduced choice, particularly for small and medium sized enterprises. The Commission is also concerned that brokers are often exposed to conflicts of interest that could jeopardise the objectivity of their advice to clients. This concern is expressed with particular regard to practices which aim to incite brokers to place business with particular insurers. The report notes that such conflicts of interest may need to be better supervised or Contents European Commission releases final report on business insurance sector inquiry Linklaters advises on authorisation of first UK insurance special purpose vehicle (ISPV) 3 Increased activism from the FSA on Part VIII Transfers New Permitted Links rules 5 1 3 November 2007 1

regulated. The Commission will follow up these findings in its review of the Insurance Mediation Directive. Horizontal co-operation amongst insurers The Block Exemption Regulation ( BER ) currently exempts certain agreements between insurers from Article 81. It will however lapse in 2010, and insurers should be prepared for the possibility that the BER might not be renewed. Although the Commission notes that there are many pro-competitive forms of cooperation between insurers, such as sharing historical data on claims, the Commission does not feel that the BER is necessary in order to protect these practices. Market participants can instead conduct their own selfassessment of the application of Article 81(3) as they would in other sectors. Moreover, the report argues that there is a risk that the BER inadvertently exempts some restrictive conduct. The Commission will review the matter definitively in a report to be published by 31 March 2009. Financial aspects of the industry The report found that profit ratios vary by a factor of one to three across the EU-25 for the same insurance line and by up to double within the same country for different insurance lines. It is felt that this may be a sign that the industry is not as competitive as it might be. The Commission also states that there is a large degree of market fragmentation and significant scope for saving from further integration. The Commission may decide to look further at this fragmentation and propose additional measures to encourage greater market efficiency at the pan-eu level. Duration of business insurance contracts The Commission expressed concern regarding certain networks of long term insurance contracts in Austria. It is not concerned by long-term agreements as such, but will have cause for alarm when they form cumulative networks which foreclose the market or when they are carried out by a dominant company. The Commission s concerns have been resolved in other such cases previously examined in the Netherlands, Slovenia and Italy. Comment After a lengthy inquiry, the Commission has produced a thorough and informative report, indicating various issues for the industry to consider. It inevitably means that the insurers will continue in close dialogue with the Commission on these and on the renewal of the BER, which will, itself, lead to a further Commission report in Spring 2009. This approach has advantages for both sides: allowing the business insurance industry to address the Commission s concerns by justifying or, where required, reforming current market practices, without the need for potentially time consuming and damaging enforcement action by the Commission. Nonetheless, the Commission, on the basis of the Report, is going to take some persuading that the practices it has identified and/or BER renewal are 2 November 2007

necessary for, or conducive to, a competitive insurance or reinsurance market. The Commissions final report can be viewed here: http://ec.europa.eu/comm/competition/sectors/financial_services/inquiries/bu siness.html Linklaters advises on authorisation of first UK insurance special purpose vehicle (ISPV) Linklaters has advised Legal & General on the conversion of Legal & General Pensions Limited (LGPL), into an insurance special purpose vehicle (ISPV) with effect from 1 November 2007. It is the first ISPV to be authorised by the Financial Services Authority (FSA) in the UK. An ISPV is a type of insurance entity regulated by the FSA. It is neither an authorised insurer nor a pure reinsurer. ISPVs were introduced in the UK less than a year ago and were originally expected to be used primarily to allow insurers to access external finance from capital markets to support insurance liabilities. However, the conversion of LGPL has shown that ISPVs are also appropriate vehicles for use in a purely internal reinsurance arrangement. LGPL was established as a pure reinsurer in December 2006. Since that time, LGPL has reinsured its immediate parent company, Legal & General Assurance Society Limited (LGAS), in relation to all non-linked non profit pensions and annuity business. LGPL s conversion into an ISPV largely reverses the capital inefficiency previously created by the need to hold regulatory capital within both LGAS and LGPL. The FSA has granted the necessary waivers which enable LGAS to take credit for the reinsurance to LGPL. For further information please speak to Victoria Sander (victoria.sander@linklaters.com) or Tim Scott (tim.scott@linklaters.com). Increased activism from the FSA on Part VIII Transfers The Financial Services Authority (the FSA ) has mooted proposals for undertaking a more substantial reporting role on insurance business transfers ( Part VII Transfers ) under the Financial Services and Markets Act 2000 ( FSMA ). Insurance Update. 3

Traditional Role The FSA has always played a significant role in Part VII Transfers especially prior to the final court hearing for example, in approving the appointment of the independent expert and the form of his/her report, reviewing drafts of the scheme and paying a particular interest in policyholder communications. Fundamentally, the FSA has viewed its role more akin to that of a facilitator - not so much as approving Part VII Transfers but rather in ensuring that consumers have appropriate information and not to set its judgment over theirs. Limited interaction with the courts Consistent with this approach, the FSA would rarely, if at all, be present at the final court hearing although it was entitled to be heard by the court under section 110 of Part VII of FSMA. Similarly, the FSA would normally make its views known of any Part VII Transfer by a succinct confirmation that it did not object to matters rather than furnishing the court with any detailed underlying analysis. Increased twin track interaction with the courts Under the FSA s proposals its historic approach to these matters is likely to change and it appears that the FSA will (i) issue a more detailed report setting out, amongst other things, the basis on which the FSA did or did not object to the transfer going ahead and (ii) with increasing frequency, seek to be represented at the final court hearing. Wider considerations In principle, this increased activism from the FSA might be welcomed as it would assist the court in its decision making process and in some ways the proposed report simply represents a formalisation and consolidation of informal practices undertaken to date. Cleary increased FSA activism on Part VII transfers ought to be guided by the need for the FSA to have regard to the need to use its resources in the most efficient and economic way (section 2(3) FSMA) hence we would not anticipate the FSA instructing counsel on the more simple transfers of insurance business. It is also unclear whether formal reporting is necessary or appropriate for all Part VII transfers or would be better limited to schemes involving complex matters or substantial bodies of policyholders. Further, there will need to be careful consideration of some of the collateral implications from this new approach. Should the FSA s report be made available to policyholders? If so, might the mere fact of the FSA issuing its own report lead to undue reliance upon it by policyholders at the expense of the independent expert s report? Will there be implications for (an already congested) the court timetable as a result of this additional reporting regime? To what extent will the FSA be amenable to modifications raised by applicants to any draft report it circulates? 4 November 2007

The FSA has recently held a roundtable discussion in relation to its role on Part VII transfers with representatives from the legal, actuarial and accountancy professions routinely involved in such transactions. We await further feedback from the FSA in the light of these recent discussions. New Permitted Links rules The Permitted Links rules for long term insurance business changed on 6 October 2007 and became COBS 21 on 1 November 2007. The rules were last updated in 1994 and the new rules are intended to reflect the changes in the linked life assurance market that have taken place since then. The updates also aim to reflect the FSA s move towards more principles-based regulation, and the most significant change is one of structure the rules now feature a list of principles to which long term insurers must have regard. Amongst these principles is that assets should be judged based on their economic effect rather than their legal form. Key changes The previously detailed readily realisable requirement for certain asset types has been replaced by a high-level rule, based on whether the linked assets are capable of being realised in time for the firm to meet its policy obligations. Interests in land can now be held in any functioning market rather than only listed countries. The definition of permitted land and property includes indirect holdings through structures that do not create a materially greater risk to linked policyholders than a direct holding would. Permitted scheme interests now vary according to whether the firm s business is in respect of institutional linked policyholders or other policyholders. A firm must notify the FSA as soon as it becomes aware of any failure to comply with the rules. Guidance in COBS 21.2.9 states that in considering its response, the FSA will have regard to the reasons for that failure, including any exceptional or temporary circumstances. Insurance team Name Telephone E-mail Duncan Barber 020 7456 3356 duncan.barber@linklaters.com Victoria Sander 020 7456 3395 victoria.sander@linklaters.com Anna Tipping 020 7456 3533 anna.tipping@linklaters.com Madhu Jain 020 7456 4700 madhu.jain@linklaters.com Ravinder Masaon 020 7456 5685 ravinder.masaon@linklaters.com Tim Scott 020 7456 4447 tim.scott@linklaters.com Insurance Update. 5

6 November 2007

Insurance Update. 7

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