UK: The Reinsurance Directive - Creating A Level Playing Field?

Historically, there has been no common regulation of reinsurance in the European Union (the "EU"), and Member States applied their own rules in relation to the conduct of reinsurance business. At one extreme, Belgium and Greece, for example, chose not to regulate reinsurers at all. At the other, in Member States including Denmark, Finland, Portugal and the UK, reinsurers have been regulated on essentially the same basis as primary insurers (save for those insuring consumers) for years.

However, a new EU system of regulation has been introduced under the Reinsurance Directive (the "Directive") in order to remedy this lack of common regulation. The Directive was approved by the European Parliament in June 2005, adopted by the Council in October 2005, and must be implemented by each Member State into its national law by 10 December 2007.

The aim behind the Directive is to put in place a minimum level of harmonised prudential supervision of reinsurers across the EU, with the wider Directive applying to all insurers - Solvency II - following. Further, the Directive sets out provisions relating to finite reinsurance and Insurance Special Purpose Vehicles ("ISPVs"). It also is anticipated that the Directive will persuade the US to change its rules regarding collateral requirements for non-US reinsurers.

Quick off the mark with regard to implementation has been the UK which has opted for early adoption and has already implemented all parts of the Directive. The FSA has considered the required standards and made the necessary amendments to the FSA Handbook. It seems clear, however, that the legislation will have little obvious impact in the UK, where reinsurance has been regulated for many years.

At the opposite end of the spectrum, Belgium is a Member State well known for its lack of reinsurance regulation. One of the obvious risks associated with the absence of regulatory control is the opportunity for fraud to be perpetrated.

In this regard, you may recall the Brussels based insurance company Dai Ichi Kyoto and its reinsurance units Kobe Reinsurance Co SA and North American Fidelity & Guarantee which collapsed amid fraud allegations in the mid 1990s, owing millions of dollars to US and UK insurers and brokers. Dai Ichi Kyoto set up in Belgium and began collecting premiums during the first half of the 1990s, claiming that they were backed by Japanese pension funds and a US bank, but the former did not exist and the latter was secretly owned by Dai Ichi Kyoto. Belgian authorities had to call in the help of both the UK's Serious Fraud Office and the USA's Federal Bureau of Investigation to assist with subsequent enquiries. The implementation of the Directive in Member States, including Belgium, hopefully should put an end to such events.

One significant effect of the harmonised prudential supervisory framework put in place by the Directive is that it enables "passporting" of reinsurance business across the EU. Once an EU reinsurer is authorised in a Member State, it will be able to conduct reinsurance business in all of the 27 Member States. An EU reinsurer will be supervised by one regulatory authority in its home Member State, whilst able to transact business in all Member States. Also, EU reinsurers will be able to transfer portfolios of business across EU borders.

No doubt the Directive will have a significant impact on the EU reinsurance market, with EU reinsurers considering which Member State should be their home Member State and whether they should restructure themselves in order to take full advantage of the "passporting" possibilities. Several EU reinsurers, including Munich Re, have been preparing for major restructuring. Will other EU reinsurers follow suit? The impact of the Directive could not only affect EU reinsurers but also non-EU reinsurers. Non-EU reinsurers, who under the Directive cannot be treated more favourably than EU reinsurers, may consider whether they should have an entity regulated by a Member State in order to obtain the "passporting" advantages.

As stated above, the Directive also sets out provisions relating to finite reinsurance and ISPVs. The Directive permits Member States to lay down specific provisions concerning finite reinsurance, including mandatory conditions for inclusion in all contracts, and provisions relating to sound administrative and accounting procedures. The Directive also provides Member States with the framework to allow ISPVs to be used to provide additional reinsurance capacity. It will be interesting to see how many Member States utilise these provisions and how finite reinsurance and ISPVs within the EU reinsurance market develop as a result.

It is recognised that a unified system of reinsurance regulation in the EU could also help in the battle to reduce barriers for EU reinsurers writing US business, in particular with regard to the requirement that they post collateral. The argument is that, if EU reinsurers are subject to a tough regulatory regime, the need for collateral becomes redundant. Countries such as France, Spain and Portugal abolishing their collateral requirements may encourage other non-EU countries, particularly the US, to continue to review their policies in respect of their collateral requirements for EU reinsurers. In fact, in December 2006, the National Association of Insurance Supervisors adopted a proposal which would allow state insurance regulators to assign a rating to individual reinsurers and which would then determine the collateral requirements. If this system is implemented, it would mean that ratings and collateral requirements would not be based merely on the origin or domicile of the reinsurer. Many will view this as a major step forward.

Clearly, as mentioned above, the impact of the harmonised prudential supervisory framework put in place by the Directive will vary between the Member States, with little or no impact in some or alternatively the creation of a whole new system in others. It is, however, the wider implications of this new framework that could be most significant. Will finite reinsurance and/or ISPVs become more widely available within the EU reinsurance market? Will there be the major restructuring of EU reinsurers as a result? Will the USA's collateral barriers fall as a consequence? Time will tell.

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