Insurance Regulation
by Anton K Schnyder and Christian Heierli
1. Object and function
Insurance regulation is the collection of all laws dealing with the regulation of insurance markets. First and foremost, it aims to protect the insured person (policyholder, other entitled persons and injured party), from insolvency (corporate) of the insurance company. In addition, it also aims to provide protection from abusive business conduct by the insurers. Insurance regulation is part of the broader law regulating the financial market.
Subject to supervision are primarily companies that insure (predominantly) domestic risks (cf Art 2(1)(b) Swiss VAG; § 1 No 1 in conjunction with § 105(2) German VAG). This implies two things: first, only companies that conduct ‘insurance activities’, ie direct insurance and reinsurance, are subject to supervision. However, other activities in relation to insurance can also fall within the scope of insurance supervision, eg insurance broking. Legal transactions that cannot be classified as ‘insurance’ are unaffected by insurance regulation (in the strictest sense). The characteristics of insurance are: (1) risk or danger to be insured (criterion of incertitude); (2) entitlement to the insurer’s performance in cases of occurrence of the insured event; (3) premium payment of the policyholder (criterion of compensation); (4) independence of the insurer’s transaction; (5) systematic business operations (according to the laws of statistics; balance of congeneric risks). Secondly, the applicability of insurance regulation not only requires compliance with the factual but also with the territorial area of application. The insured risks have to be within the geographical limits of the regulatory act, ie they have to be ‘domestic’. This ‘situs of the risk’ concept is unknown to UK law, where insurance business is considered to be carried out in the United Kingdom if insurance contracts are negotiated, concluded and/or executed there. Universally valid is the statement that it is not the domicile of the company that is determinative for insurance regulation but the ‘market’ affected by its activity (see Art 2(1), Art 11(3), (5) and Arts 28, 31 Liechtenstein VersAG).
In detail, insurance supervision in the proper sense can be subdivided into the following three areas: regulation of the commencement of an insurance company’s business; supervision of ongoing business activities; and supervision of the termination of a business. Before elaborating on these three aspects, it should be noted that competition regulation, which in the European Union (EU) is centrally administrated by the European Commission, is part of insurance supervision in a wider sense (competition law (procedure)). In this regard, the new regulation on insurance (Reg. 267/2010) is of specific relevance for the insurance sector.
2. Regulation of the commencement of the business
Insurance companies require an authorization (also permission, concession) to carry out insurance business; see s 19(1) British FSMA (‘general prohibition’): ‘No person may carry on a regulated activity in the United Kingdom, or purport to do so, unless he is an authorised person [...]’ (similar § 5(1) German VAG; Art L 321-1 French Code des assurances). EU directives stipulate the conditions under which a company is entitled to an authorization to carry on insurance business. Thereby, an EU-wide harmonization of approval standards is assured. Similar standards exist in countries that are not part of the Single European Market (European internal market).
Approval requirements are found in regulatory laws that have an array of detailed provisions on the subject matter (cf Parts III, IV British FSMA; §§ ff German VAG; Art L 321-1 ff French Code des assurances). These provisions concern, firstly, the legal form and the corporate purpose of a company. Compliance with structural and organizational standards is usually a condition for approval (see §§ 7, 120 German VAG). Accordingly, the articles of association (bylaws, constitution) of the company have to be submitted to the regulatory authority in the course of the approval procedure. Regarding the corporate purpose, companies are constrained to concentrate on insurance activity; so-called ‘non-insurance activities’ are not allowed. In particular cases, it can be difficult to draw a line between permitted and prohibited activities. Regulatory laws are more reserved regarding the appraisal of ‘indirect’ activities of insurance companies. Thus, there are fewer restrictions when an insurance undertaking wants to participate in companies that do not conduct insurance activities themselves.
From a regulatory point of view, the supervision of the capitalization of a company—from the very beginning—is crucial. Insurance undertakings need a minimum equity capital to meet their obligations. A distinction has to be made between requirements of capitalization at the moment of commencement of business, on the one hand, and the monitoring of the consecutive accumulation of risks and their effects on the building up of reserves, on the other hand. The respective EU insurance directives and national laws implementing these requirements stipulate absolute amounts of money that must be at a company’s disposal as a minimum guarantee fund at the moment of formation of the company. This fund has to be substantiated before authorization.
The company has to provide a detailed description of its business activity in a scheme of operations. With regard to approval, the company has to disclose to the regulatory authority in which business areas (classes of insurance) it wants to operate and by which organizational measures it intends to meet the forthcoming challenges. With regard to indemnity insurance as well as life insurance, the individual insurance classes have been systematized by EU directives. If an undertaking has not received approval for a certain class of insurance, it is not allowed to operate in this field. With regard to the correct operation of an insurance activity, further information has to be provided about the intended reinsurance policy as well as about the expected costs for the establishment and the administration of the company, including the planned distribution network. Generally, statements about financial means—revenues and expenditures—have to be made for the first three business years.
Surveillance of the quality of management is becoming more and more important. The company has to demonstrate that it has the required competence at its disposal. It must satisfy both the criteria of professional qualification, on the one hand, and the character of the involved persons, on the other hand (cf § 7a German VAG; § 11a(3) Austrian VAG; Art 13(1)(g) Liechtenstein VersAG). These qualities are particularly required from the organs of the insurance undertaking; but more and more, they are also requested from the (controlling) shareholders of the company. Transparency regarding a company’s human resources increasingly plays an essential role in the approval procedure.
Additional special requirements can be imposed depending on the insurance class in which an activity will be started. This applies, for example, to liability insurance for motor vehicles. Several regulatory laws stipulate that insurers intending to operate in this field have to join the national bureau of insurance (as it can be engaged to cover damages caused by foreign motor vehicles) as well as the domestic guarantee fund (which in particular covers damages caused by unknown vehicles). Other examples are the accumulation of special assets in life insurance or the appointment of a responsible actuary.
If the regulatory requirements for approval as an insurance undertaking are fulfilled, the company is entitled to obtain authorization. In the EU and in the European Economic Area (EEA), the approval (awarded as a single licence) is, in general, also valid for activities in other countries of the EU or EEA. The authorization awarded in the home country allows the insurance undertaking to act in other Member States or contracting countries either on the basis of the freedom of establishment or within the scope of the free movement of services. The company does not need an additional approval in the foreign country of activity. Insurance companies from third countries are excluded from this freedom, unless a special treaty with the EU exists (as is the case, to some extent, with Switzerland).
Future changes to the approved business plan have to be sanctioned by the regulatory authority.
3. Regulation of operating activities
Supervision of insurance companies does not end with the permission to pursue the business activity. In fact, companies must continually comply with the approved business plan and maintain the required capitalization.
As regards ongoing supervision, a paradigm shift has occurred over the last decades—away from intensive substantive insurance supervision towards specific solvency supervision. The effect is that the individual conditions of contracts and the price fixing for individual products are no longer the main focus of regulation. Thus, Member States of the EU and the EEA (as well as in other legal systems) are not allowed to demand from insurers previous approval or systematic conveyance of provisions, tariffs (tariff structure), forms and other documents of the insurance contract (Art 29(1) and Art 39(2) Dir 92/49 (Third Non-life Insurance Directive); Art 6(5) and Art 34 Dir 2002/83 of 5 November 2002 concerning life assurance (recast)). Exceptions remain only for some classes of compulsory insurance. Hence supervision of content—ie supervision of individual insurance products—has been reduced to a supervision of abuse. Therefore, supervisory authorities are only allowed to intervene against terms of insurance contracts and other provisions of the insurer if those form an abuse, notably in the light of consumer protection (see on this eg the UK Insurance Conduct of Business Sourcebook (ICOBS)).
Today the emphasis of supervision lies on the monitoring of capitalization as well as on—and in connection with—the insurance companies’ obligations to report and maintain the books. The starting point of regulatory law for supervising capitalization is the solvency margin. It ‘shall consist of the assets of the insurance undertaking free of any foreseeable liabilities, less any intangible items’ (Art 16(2) Dir 73/239). An insurance undertaking is obliged to maintain the (available) solvency margin with respect to the entire scope of its business activity. The solvency margin is complemented by the guarantee fund, which is a proportion of the former. The guarantee fund constitutes the core of the equity capital, so to speak, that has to be at an insurance company’s disposal. To ensure the availability of the necessary capital, companies are obliged to set aside actuarial reserves. At the same time, the means and assets permitted for the creation of those reserves are specified. Tightened requirements on reporting and auditing should then lead to a better appraisal of the asset situation of insurance companies. The increasing cooperation between national supervisory authorities can contribute to this.
4. Regulation of termination of business activity
Supervision over a company ends when the latter withdraws from the insurance business. In these situations, supervision occurs during the liquidation of the insurance company and the dissolution of the existing contractual relationships (see § 86 German VAG). A cessation of the entrepreneurial activities occurs when business operations are prohibited or ceased voluntarily or the permission to operate business is revoked. The cessation of the business can be caused by the winding-up or merger of a company or the transfer of the business by force. In all these cases, the supervisory authority accompanies the liquidation of the business and takes all necessary measures that are appropriate to protect the interests of the insured. Provisions regarding special procedures for financial restructuring and liquidation are increasingly relevant (see §§ 81b, 89b German VAG; § 104a Austrian VAG; Art 52 ff Swiss VAG; Art 59a ff Liechtenstein VersAG; see also Dir 2001/17 on the reorganization and winding-up of insurance undertakings).
5. The Community acquis
(European) Insurance regulation is formed to a great extent by the framework directives that have been developed within the Single European Market in the field of insurance (internal market (insurance)). The elements of regulation briefly described above can all be found in the directives and—in detailed form—in national legal rules implementing the former in the individual member and contracting states. Thus, insurance regulation law can no longer be discussed without referring—in a qualifying respect—to the process of European regulation. European regulation in this field does not possess an overall regulatory power in the general sense but rather focuses on the functioning of the competence for supervision within the EU and EEA. Thus, concerning which regulatory authority has competence, European regulatory law implies the state of origin principle by requiring the Member State of an undertaking’s seat to supervise all business activities of subordinated companies as well. The concentration of supervisory power in the approval authority reduces (substantially) the regulatory competences of the authorities in the (foreign) country of establishment or activity. Only rarely do the latter authorities retain control competence. Moreover, the specific constitution of European insurance single market law (internal market (insurance)) results in third country companies not profiting to the same extent from the freedoms realized in the EU and EEA. Hence, the specific allocation of competences does not apply to them, so that—apart from special agreements in treaties—they encounter the risk (and the costs) of multi-supervision in several EU and EEA countries.
6. Enhancements and future prospects of insurance regulation law
A first important trend of insurance regulation is that it is being consolidated and integrated, especially in relation to the supervision of other financial service companies. First of all, group specific problems and questions can arise when an insurance undertaking is part of a corporate group. It has been realized that as regards regulation such entities have to be viewed in a general context and can (no longer) be analysed in an isolated way, following the individual, artificial persons that belong to the company. Thus, increased group supervision has been established in the EU in the last years, as can be seen in the Insurance Group Directive (Dir 98/78). This directive does not establish consolidated supervision but extends regulation by putting transactions within the group under supervision in certain aspects. The main objective of the Group Directive is enhancing the overview of the (primarily) responsible supervisory authority over the supervised undertaking and its affiliated associations (see the implementation in §§ 104a ff German VAG concerning additional supervision of insurance undertakings that are part of an insurance group; in the United Kingdom the requirements of the Group Directive have been included in the Handbook of the Financial Services Authority (FSA)). Group supervision is completed and enhanced by the supervision of financial conglomerates consisting of companies belonging to different financial sectors (banks, insurers, investment firms and others). Thereby, from the perspective of regulation, intersectoral and integrating aspects have to be met by special instruments of supervision. In the EU, the foundation for this has been laid by the special Dir 2002/87 on the supplementary supervision of credit institutions, insurance undertakings and investment firms in a financial conglomerate, and in the future special attention will be given to the supervision of groups and conglomerates, particularly regarding the further development of European regulatory law. These changes are being accompanied by an integration of regulatory authorities that has become visible in several countries. The necessity of an expanded supervision of company groups and the need for conglomerate supervision has, with regard to organization, hastened the establishment of an integrated supervisory authority in several countries in order to overcome the one-on-one technical supervision split up into supervision of banks and of insurers. One expects an increased use of synergetic effects and increased transparency in the regulated markets from the integration of individual authorities. This has been successful in many cases but does not eliminate the persistent need for subject-specific one-on-one supervision. It was the United Kingdom that paved the way for integrated supervision of financial markets (based on the FSMA 2000). Germany, Austria, Liechtenstein, recently Switzerland (since 2009) and other countries followed.
On the European scale, at present and in the foreseeable future, the focus is on a top-to-bottom reform of all the hitherto existing directives governing direct insurance and reinsurance, which will be updated and given a new basis. This consolidation will be implemented by means of the new Dir 2009/138 of the European Parliament and of the Council, becoming applicable beginning 2013. This framework directive is known as ‘Solvency II’. Firstly, it is aimed at establishing new criteria and provisions regarding the requirements of capitalization and solvency, subsequent to the existing solvency regulation. At the same time, the supervision of insurance groups and the collaboration of state regulatory authorities will be deepened and intensified. It is probably the broadest and most far-reaching project that insurance regulation has ever faced and one that will engage legislatures, supervisors and insurance companies intensively in the coming years (see as one of the first implementation projects, the Liechtenstein draft of 24 May 2011 for a general revision of the VersAG). One of the primary goals of Solvency II is to form—to an (even) greater extent—a risk-based capital in the undertakings. Apart from the risks resulting for the insurance companies from incurred liabilities, more reference will be made to the coverage of those liabilities by company assets. The risk analysis will be based on models developed and formulated by the undertakings and approved by the regulatory authority. This creates a kind of ‘dialogical’ system of supervision in which it is primarily up to the companies to judge their risk exposure under the aspects of quantity and quality and to produce suggestions for risk coverage (risk management). In the future, the required capital will be subdivided into minimum capital requirements that have to be fulfilled by a company at all times, and additional requirements in excess of the required minimum capital. In case of their loss, these additional assets form a kind of early warning for the controlling institutions and for their possible intervention. It can be expected that, over the years, standard models will develop out of the applied models, so that insurance companies will no longer have to create own appraisal catalogues for the entirety of their risks. In Switzerland, risk-based capital requirements as a model of regulation have been implemented in the shape of the Swiss Solvency Test (SST; see Art 9(2) Swiss VAG).
In line with Solvency II, collaboration between supervisory authorities will be improved and intensified. It has been identified that for a proper functioning of insurance markets and, notably, supervision processes regarding insurance groups, collaboration of authorities is crucial. The supervisory authority of the home country of the parent company needs to be given a stronger role as a ‘group supervision authority’. In this context, as well as in the overall course of the further development of insurance regulation, the new European Insurance and Occupational Pensions Authority (EIOPA), replacing the former Committee of European Insurance and Pensions Supervisors (CEIOPS) in 2011, is gaining central importance. Against this background, it has to be considered in the future whether—at least in the EU and EEA—a (supranational) European authority might some day supersede the national regulatory authorities. The establishment of a European System of Financial Supervisors (ESFS), consisting of a network of national financial supervisors working ‘in tandem’ with the new European Supervisory Authorities (ESAs; thereunder the EIOPA), as intended in the proposal for the so-called ‘Omnibus II’ Directive, might turn out as a step into this direction.
Literature
Anton K Schnyder, Internationale Versicherungsaufsicht zwischen Kollisionsrecht und Wirtschaftsrecht (1989); Helmut Müller, Versicherungsbinnenmarkt—Die europäische Integration im Versicherungswesen (1995); Peter Braumüller, Versicherungsaufsichtsrecht (1999); Heinrich R Schradin, ‘Entwicklung der Versicherungsaufsicht’ (2003) Zeitschrift für die gesamte Versicherungswissenschaft 611–64; Michael Blair and others, Butterworth’s Annotated Guide to the Financial Services and Markets Act 2000 (2nd edn, 2005); Anton K Schnyder, Europäisches Banken- und Versicherungsrecht—Eine systematisch-vergleichende Darstellung (2005); Rolf H Weber and Patrick Umbach, Versicherungsaufsichtsrecht (2006); Johan van der Ende, Rym Ayadi and Christopher Obrien, The Future of Insurance Regulation and Supervision in the EU—New Developments, New Challenges—Report of a CEPS Task Force (2007); Ulrich Fahr, Detlef Kaulbach and Gunne W Bähr, Versicherungsaufsichtsgesetz Kommentar (4th edn, 2007); Etay Katz (ed), Financial Services Regulation in Europe (2nd edn, 2008); T Henry Ellis and James A Wiltshire (eds), Regulation of Insurance in the UK, Ireland and EU (2009); Manfred Wandt and David Sehrbrock, ‘Regelungsziele der Solvency-II-Rahmenrichtlinie’ in Festschrift Schweizerische Gesellschaft für Haftpflicht- und Versicherungsrecht (2010) 689.
