Insurance updater - Europe

Welcome to our insurance updater. We will highlight key legislative and regulatory developments. We will also review court judgments and insurance market publications that are likely to be of interest to you.  

On 7 May 2012, the European Insurance and Occupational Pensions Authority (EIOPA) published an opinion, addressed to supervisors, regarding the process for approving the use by insurers of external models and data to calculate the solvency capital requirement (SCR) using a full or partial internal model, under the Solvency II Directive.

In the opinion, EIOPA states that an insurer should provide the specific information required to enable its supervisor to assess whether an internal model approval to calculate its SCR should be granted. The supervisor should reject an insurer’s application if it fails to provide the specific information or documentation required for a proper assessment. The opinion further provides that any insurer seeking to obtain approval of an internal model application, which includes the use of an external model or data (that is, external models or data an insurer has obtained from a third party vendor), must demonstrate to its supervisor that it has complied with all the requirements for internal model approval.

Applications which include the use of an external model or data must be assessed by the supervisor on the appropriateness of each individual application. EIOPA states that particular attention should be paid to how the external model or data has been adapted to take into consideration the insurers risk profile and specificities. In these cases, the supervisor may request additional information about either the external model or data in order to assess whether the requirements have been complied with. Again, failure to provide such information will result in the application being rejected. The opinion states that contracts between insurers and third party vendors of models or data should specify how to deal with providing information to supervisors for approving an internal model application. The contract terms cannot be used to justify an insurer's refusal to demonstrate that its external model or data fulfils the necessary requirements.

In order to address confidentiality concerns raised by some vendors of external models and data, the opinion emphasises that confidentiality provisions are already in place under Solvency I, and these provisions extend to confidential information received by supervisors during the pre-application process.

Gabriel Bernardino, EIOPA Chairman, confirmed that EIOPA intends to make use of opinions as a “tool” to promote common supervisory approaches and practices in the EU.

For further information: EIOPA opinion on external models and data

On 11 May 2012, EIOPA published a speech by Gabriel Bernardino, EIOPA Chairman, on the work carried out by EIOPA, how Solvency II can contribute to the improvement of risk management, and the loss adjusting profession and its relevance for the insurance market.

Bernardino begins his speech by explaining that EIOPA is an independent Union body with legal personality, accountable to the European Parliament and the Council. EIOPA’s mission, Bernardino explains, is to protect the public interest by contributing to the short, medium and long-term stability and effectiveness of the financial system. In order to fulfil their objectives, EIOPA has some important powers which include: developing technical standards that are binding for all insurance undertakings in the EU; issuing guidelines and recommendations on a “comply or explain” basis; settling disagreements between national supervisory authorities; monitoring the correct application of EU law in Member States, and coordinating crisis situations. 

Bernardino goes on to explain EIOPA’s involvement in a number of regulatory issues. In relation to Solvency II, EIOPA has been advising the EU Commission on the Level 2 implementing measures and developing draft technical standards and guidelines on around 40 different areas of Solvency II. In addition, EIOPA has contributed to the Commission’s revision of the Insurance Mediation Directive (IMD) by conducting an extensive survey of national laws providing for sanctions for violations of the provision of the IMD. Bernardino explains that consumer protection and financial innovation are priority areas for EIOPA and notably, EIOPA has prepared Guidelines and a Best Practices Report on Complaints-Handling by Insurers, due to be finalised in the second quarter of 2012. In relation to financial stability, EIOPA had an active role in assessing the resilience of the EU insurance sector to major shocks through the EU-wide stress test exercise, and publishes bi-annual Financial Stability Reports.

Bernardino then discusses the Solvency II regime, and in particular risk management. He argues that insurers need to rely on strong risk management capabilities in order to deal with the various challenges they currently face. Solvency II, Bernardino explains, has transformed the view that risk management is not a relevant element of the insurance regulatory regime. He recognises that, in addition to the risk-based capital requirement calculation, the regime’s heavy reliance on robust risk management practices is a key element of Solvency II. Insurance and reinsurance undertakings are required, under Solvency II, to have in place an effective risk management system that comprises strategies, processes and reporting procedures necessary to identify, measure, monitor, manage and report, on a continuous basis, the risks to which they are or could be exposed. Bernardino notes that this is an ongoing process and risk management should not be viewed as a “point in time” procedure. In light of the financial crisis, Solvency II identifies a number of elements relevant for an effective and robust risk management system. The system should be documented and communicated to the relevant management and staff and integrated into the organisational structure of the undertaking and its decision-making process. Furthermore, it must cover all material risks the undertaking might be exposed to. Finally, the undertaking’s management body has ultimate responsibility for ensuring the system is suitable, effective and proportionate to the nature, scale and complexity of the risks inherent in the business.

In the final part of his speech, Bernardino concentrates on the loss adjusting profession and its crucial role for insurance business. He recognises the contribution of the European Federation of Loss Adjusting Experts (FUEDI) in maintaining high standards of professional conduct and competence, high educational standards and unified standards of customer services. Bernardino acknowledges the role of self-regulation in this area, however, he argues that some basic principles should be incorporated in the EU regulatory framework. This speech indicates the likelihood that the loss adjusting profession, currently outside regulatory scrutiny, may be subject to closer scrutiny in the future.

For further information: EIOPA, Solvency II and the Loss Adjusting profession

On 15 May 2012, the Financial Services Authority (FSA) published a letter from Julian Adams, FSA Director of Insurance Supervision, sent to firms involved in the FSA’s internal model approval process (IMAP) in preparation for the implementation of Solvency II. In addition, Adams gave a speech discussing specific feedback issues from the letter.

In his speech, Adams explains that firms will shortly be moving from the ‘pre-application’ to the submission phase of IMAP, with the FSA expecting the first submissions in May 2012. Submissions will be reviewed against the FSA’s current requirements and feedback on the model provided to the firm in question. The letter sets out the FSA's feedback on firms' IMAP work to date, including observations on the following issues where the FSA has observed weaknesses in its reviews of firms' work:

• Methodology and assumptions. Models should be pitched at an appropriate level, adequately reflecting the risk a firm is exposed to but avoiding unnecessary complexity.
• Aggregation and dependency. The FSA expects firms to be able to explain and validate the choices and assumptions made in relation to the amount of diversification credit a firm seeks to take, and in particular whether it presents a capital number which is adequately reflective of risk.
• Validation. The FSA expects decisions about materiality thresholds to be clearly articulated and justified. Adams states that many of the validation policies already seen are too vague, and that the level of detail should reflect the materiality of the elements of the model.
• The use test. Firms are expected to demonstrate how the internal model has been embedded, and where it will be used within the business.

The FSA has also identified model change policy, un-modelled risk and documentation requirements for Solvency II as further areas of weakness.

The date at which the FSA can begin accepting formal applications is dependent on when it assumes formal legal powers under Solvency II, which in turn is dependant on the finalisation of the Omnibus II Directive, however, Adams suggests it will be “some time in 2013”.

For further information: 

Feedback from our IMAP work to date

Solvency II and the London Market

The FSA has fined Mitsui Sumitomo Insurance Company (Europe) Ltd (MSIEu) £3,345,000 and imposed a ban and fine of £119,303 on its former executive chairman, Mr Yohichi Kumagai for serious failings of corporate governance and control arrangements.

MSIEu is a London-based subsidiary of the Japanese insurance firm Mitsui Sumitomo Insurance Company Ltd (Japan), which is part of one of the world’s largest non-life insurance groups. Historically MSIEu had only supplied wholesale insurance cover to Japanese firms operating in Europe and the Middle East, however, in 2007 MSIEu began expanding into non-Japanese business, with a particular focus on the French and German markets.

In April 2009 Mr Kumagai was seconded from the Japanese parent company and appointed as executive chairman of MSIEu. Soon after his appointment, the FSA wrote to MSIEu and Mr Kumagai stating that MSIEu’s expansion into European markets would require careful and focussed oversight from an appropriately skilled and experienced board. The FSA also advised that MSIEu’s systems and controls would need to be improved to identify and address the risks in this new area of business.

Despite these warnings, however, the FSA found that MSIEu had breached Principle 3 of the FSA’s Principles for Businesses by failing to take reasonable care to organise and control its affairs responsibly and effectively. Further, Mr Kumagai was found to have breached Statements of Principle for Approved Persons 5 and 7 by failing to ensure that MSIEu’s business, for which he was responsible, was organised in such a way that it could be controlled effectively and comply with the relevant regulatory standards.

On 8 May 2012, the FSA published the final notices issued to Mr Kumagai and MSIEu. Among other things, the FSA found that Mr Kumagai and MSIEu had failed to:

• Take prompt and effective action to ensure appropriate governance and control arrangements were established. This meant MSIEu was poorly organised and managed across the business as a whole and board effectiveness was weak.
• Ensure that key posts at MSIEu were filled with staff who had the necessary experience, knowledge and time to fulfil their roles effectively. Mr Kumagai, for example, failed to appoint a chief underwriting officer, therefore hindering the firm’s ability to control the expansion of the business.
• Implement a new IT administration system, across the firm, in an effective and timely manner. This led to shortcomings in management information available to the board.

Tracey McDermott, acting FSA director of enforcement and financial crime, commented that Mr Kumagai failed to respond adequately to the changing risks facing MSIEu’s business, even after the FSA had pointed these out. The FSA requires firms to have effective corporate governance and controls which, McDermott added, must be adapted appropriately to reflect changes in a firms risk profile, particularly regarding growth into new areas.

Following this case, insurers should take away a lesson that they must review corporate governance procedures and processes, if they had not done so before, and should update them where necessary, particularly since corporate governance was an underlying theme of Solvency II. Heeding regulatory warnings arising out of Advanced Risk Recognition Operating FrameWork (ARROW) visits will be critical for firms. If the FSA or its successors identify a problem and suggest how it should be remedied, firms should do what the regulator says or they may find themselves in trouble.

For further information: 

Final Notice: Mitsui Sumitomo Insurance Company (Europe) Ltd

Final Notice: Yohichi Kumagai

On 11 May 2012, the FSA published final notices for Donald McKee Morgan and his wife Janet Morgan. Donald Morgan, a partner in the firm of Donald Morgan Insurance Services (DMIS) based in Ayrshire, Scotland, has been fined £335,204 for committing insurance fraud, whilst Janet Morgan, the only other partner at DMIS, has been publicly censured. Both have been banned from carrying out any regulated financial services activity in the future.

The FSA found that Donald Morgan had deliberately kept insurance premiums payments from a number of DMIS’s clients which should have been paid to a broker network (Network A). Donald Morgan concealed his fraudulent conduct from Network A by falsifying monthly reports and manipulating DMIS’s computer systems. The premium monies were then used by Donald Morgan to pay staff salaries and to fund his lifestyle. In August 2010, upon realising that the financial situation of DMIS would not improve and that he would be unable to repay the misappropriated funds, Donald Morgan informed the FSA of his misconduct. The FSA investigation found that Janet Morgan had not taken an active part in the firm’s affairs and had failed to notice Donald Morgan’s fraudulent activity.

Tom Spender, FSA head of retail enforcement, explained that Donald Morgan’s actions were unacceptable and resulted in significant financial loss for Network A. Donald Morgan abused both his position as an approved person and the trust clients and business partners placed in him. Spender warned that insurance brokers “must adhere to our rules, ensure customers are treated fairly and trust in the industry maintained.”

For further information: 

Final Notice: Donald Morgan

Final Notice: Janet Morgan

On 8 May 2012, Insurance Europe published its response to the European Commission’s call for evidence relating to its review of Financial Conglomerates Directive (2002/87/EC) (FICOD). This review is frequently referred to as FICOD II. For the insurance and reinsurance industry, financial conglomerates legislation is currently based on Insurance Groups Directive (98/78/EC). This Directive will be repealed by the Solvency II Directive when it comes into force on 1 January 2014.

Insurance Europe explains that, in its view, the Solvency II regime is sufficiently risk based and therefore, any additional requirements at financial conglomerate level should not result in duplicate or contradictory requirements.

In its response, Insurance Europe comments on supervision of financial conglomerates and the use of waivers allowing Solvency II requirements to be deemed equivalent for financial conglomerate supervision. Further, in light of EIOPA’s recent proposals for annual stress testing, Insurance Europe calls for EIOPA and the  European Banking Authority (EBA) to coordinate on stress testing of their respective sectors to avoid further overburdening insurers and reinsurers.

For further information: Insurance Europe response to European Commission Call for Evidence on Financial Conglomerates Review

In January 2012, the Italian Government enacted a new legislative provision regulating sales of life insurance contracts linked to loans and other types of financing. The provision states that banks and financial intermediaries which require a life policy to be taken out as a condition on the grant of a mortgage or a consumer loan must provide the customer with at least two quotes for life policies from insurance companies not “linked” to the bank supplying the loan. In order for these policies to be easily compared by the customer, the new provision requires that policies must comply with some “minimum requirements”, to be established by the Italian market authority (ISVAP).

In addition, customers should be provided with the opportunity to purchase a life policy available on the market which, as long as it is more favourable to the customer and complies with the minimum requirements, must be accepted by the lender when granting the loan.

Immediately after the provision was ratified by Parliament, ISVAP opened a public consultation on what the minimum requirements should be. Following this consultation, which ended on 3 May 2012, ISVAP issued Regulation 40 which, among the other minimum requirements, provides that any life policy that the customer is required to purchase in order to obtain a mortgage or consumer credit must not exceed the duration of the loan. In answering the questions of the market during the consultation, ISVAP has clarified some areas of uncertainty and provided guidelines on the practical implementation of the new legislative provision:

• Regulation 40 applies to Credit Protection Insurance (CPI) policies, which includes both life and non-life insurance and policies that are compulsory by law;
• Customers are free to purchase products which provides wider coverage than provided by the minimum requirements, should they choose to do so;
• The two quotes to be provided by the bank or financial intermediary shall not be from either insurers belonging to the same group as the bank  or financial intermediary, or to any insurers who have distribution agreements with the relevant bank or financial intermediary. Quotes should be procured by the bank online, where insurers are obliged to publish their products and allow the calculation of the estimated premium.

Regulation 40 also includes certain obligations, on the bank or financial intermediary, relating to the negotiation stage with the customer including: an obligation to inform the customer in writing of the minimum required coverage; a requirement to use a specific template form when providing quotes; an obligation to inform the customer of their right to “shop around” for the best price and conditions for the minimum required policy. This right can be exercised by the customer for a period of at least 10 working days after providing the quotes.

This new legislative provision is the latest in a number of provisions enacted by the Italian Government in recent months in the bancassurance market. One such example is the regulatory provision, enacted in December 2011, preventing banks from assuming the role of both intermediary and beneficiary in the same insurance policy. Collectively, these provisions are expected to increase competition in favour of the customers. Doubts have been raised, however, as to the capacity of these provisions to open-up the market and provide greater cost efficiencies, also taking into consideration the relevant investments which will be required to convert to the new system.

For further information please contact Nicolò Juvara in Milan.