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THE LANDSCAPE OF INSURANCE

REGULATION:

A EUROPEAN VIEW

Professor Chris Parsons

Cass Business School, City of London

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TOPICS

A look backwards …

1 Origins of insurance and its evolution in

Europe

2 Different insurance models – ‘Alpine’ and

‘Maritime’

3 Harmonisation of regulation in Europe

A look forwards …

1 Regulation after the financial crisis

2 The interplay of social insurance and private

insurance

3 New sources of regulation and control

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A LOOK BACKWARDS ….

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EARLY DEVELOPMENT OF INSURANCE

Risk sharing by Chinese merchants (2,500 B.C.)

Early (marine) ‘bottomry’ contracts (Babylon, Mesopotamia, 2,500 B.C.)

Roman burial societies

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EVOLUTION OF INSURANCE IN EUROPE

Two ‘cradles’ (birthplaces) of insurance

1 The Alpine Mountains Early mutual fire and livestock

insurance schemes

2 The sea Marine insurance in Italian sea

ports then, increasingly, in London

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EVOLUTION OF INSURANCE IN EUROPE

Two ‘models’ of insurance*

1 The ‘Alpine’ model

Mutuality, community solidarity, risk

spreading without fine segmentation

‘Spiritual home’: Munich, Zurich, Trieste

2 The ‘Maritime’ model

Entrepreneurial, competitive, profit-

oriented, with maximum segmentation of risk

‘Spiritual home’: Lloyd’s of London

* Michel Albert, ‘Capitalism against capitalism’

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EVOLUTION OF INSURANCE

European insurers ‘exported’ these two models through colonialism and the influence of their overseas trading companies

In the late 19th century a third model emerged with the first social insurance systems (beginning in Germany, 1880s)

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THE SINGLE EUROPEAN INSURANCE MARKET

The aim was to allow insurance to be bought and sold freely in Europe, and not affected by differences in national laws and regulatory systems

But there were two different models of regulation …

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THE ‘ALPINE’ MODEL (e.g. FRANCE , GERMANY)

Tight regulation. The approach was more compulsory than discretionary, for example

State control of premium levels or guidelines for the calculation of premiums

Compulsory notification of changes in premiums

Prior approval needed for the wording of insurance contracts, and/or standardisation of clauses

Some insurance monopolies

Some compulsory specialisation of insurers

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THE 'MARITIME’ MODEL (e.g. UK, IRELAND, NETHERLANDS)

Lighter regulation. And preference for self – regulation.

No price control, provided insurers have set up the necessary actuarial reserves against their liabilities

No specific restriction on policy wordings

No prior approval required - no standardisation of insurance contracts or clauses

No monopolies or compulsory specialisation

Supervisory authorities have wide discretionary powers and self-regulation was often preferred

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THE EUROPEAN COMPROMISE

Stronger prudential regulation – leading

eventually to Solvency II (unified European

regime for capital adequacy and risk

management standards, coming into force in

2013)

Abandonment of all (state) regulatory

controls over insurance prices and policy

terms

Market regulation (consumer protection

rules) set at national level

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A LOOK FORWARDS ….

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INSURANCE AFTER THE FINANCIAL CRISIS

The 2007-9 financial crisis in Europe and the US has intensified the debate on a number of issues, e.g.

1 The benefits, or otherwise, of convergence in financial services

2 The adequacy, or otherwise, of systems of prudential regulation for insurance

3 Indirectly, the wider social role of insurers

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BANKINGINDUSTRY

SECURITIESINDUSTRY

INSURANCEINDUSTRY

CONVERGENCE IN FINANCIAL SERVICES

Regulators oncekept thesecirclesapart .....

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THE CIRCLES HAVE CONVERGED .....

BANKING INSURANCE

SECURITIES

Bancassurer

Investment bank

Asset Manager+

Risk Manager(ART structures)

Financial conglomerateGerry Dickinson

Cass Business School

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CONVERGENCE IN FINANCIAL SERVICES

The literature on convergence presents a mixed picture, claiming:

Benefits: e.g. economies of scale and scope, diversification benefits, enhanced innovation, better consumer choice and convenience

But also:

Drawbacks: e.g. increase in risk (especially systemic risk), consumer harm through monopoly power, management problems, lack of transparency, additional complexity of regulation

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WHICH INSURERS SUFFERED MOST IN THE FINANCIAL CRISIS?

1 Companies which dabbled in risky areas of structured finance (e.g. AIG, Swiss Re)

2 ‘Bancassurers’ – integrated financial services providers and insurers having close affiliations with banks

3 Specialist financial guarantee insurers (e.g. US monolines)

4 Firms writing various forms of credit insurance

5 Insurance firms holding a high proportion of risky assets (some US life insurers especially)

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REGULATORY AND MARKET ISSUES

Will the circles ‘move apart’ again – and will regulators push them apart?: - restrict convergence within financial services?

To what extent is insurance activity compatible with banking – what models of bancassurance are most viable?

Is there a case for stronger regulation of ‘quasi-insurance’ products such as credit default swaps (CDS)?

How should financial conglomerates be regulated – what form should the regulator take?

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SOLVENCY II

New, unified European system for capital adequacy and risk management standards, coming into force in 2013)

Three ‘pillars’ (Capital adequacy, Risk management and corporate governance, Transparency and reporting standards)

Solvency II is principle-based rather than rules-based

Solvency II is dynamic and model-based, not static and volume/factor based

Emphasis on risk management and corporate governance not found in many other systems (e.g. US RBC regime)

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IMPACT OF SOLVENCY II IN EUROPE

Heavy short-term compliance and development costs, especially for small insurers

Longer-term benefits include better policyholder protection, lower cost of compliance (especially for pan-European firms), more competition?

Solvency II may bring about some changes in market structure and also in the relative cost of some lines of insurance

Possible knock-on effects on other financial markets (e.g. further shift of insurers’ investments away from equities, less liquid assets and banks generally)

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IMPACT OF SOLVENCY II BEYOND EUROPE

Size of European insurance market (about 40% of world market) will make Solvency II influential

Solvency II may ‘export’ its principles because insurers wishing to enter the EU will undergo mutual recognition assessment

A number of major markets (e.g. US, China) are re-evaluating their own systems and observing

Europe

Academic approval for Solvency II (generally)

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SOCIAL INSURANCE AND PRIVATE INSURANCE

Europe has developed extensive (and expensive) social insurance systems over the last 130 years

Historically, many risks have been shared with private insurers

For some risks there has been the option to insure privately or through a state system

For other risks has been provided through a combination of private and public insurance

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SOCIAL INSURANCEAND OTHER PUBLICPROGRAMMES

PRIVATE INSURANCE

Risks wholly ormainly insured undersocial insurance or otherState programmes

Risks wholly ormainly insured under

private insurance programmes

Shared risks:e.g. accidents,sickness, disability,unemployment,pension provision

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SOCIAL INSURANCE AND PRIVATE INSURANCE

Social insurance systems in Europe are under extreme pressure

Main source of pressure is demographic – e.g. ageing populations, increased longevity

The financial crisis has increased this pressure (need to cut public spending and reduce budget deficits)

Result is a shift away from social insurance towards private insurance (especially

pensions, health insurance, work accident insurance)

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SOCIAL INSURANCEAND OTHER PUBLICPROGRAMMES

PRIVATE INSURANCE

Risks wholly ormainly insured undersocial insurance or otherState programmes

Risks wholly ormainly insured under

private insurance programmes

Shared risks

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SOCIAL INSURANCE AND PRIVATE INSURANCE

The shift to private insurance presents opportunities for insurers and potential benefits to consumers (more competition, greater efficiency?)

It also presents challenges ….

Because social insurance schemes are normally ‘open access’ (no right to decline applicants) ….

And social insurance schemes are normally not ‘underwritten’ (no right to vary premiums according to risk)

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SOCIAL INSURANCE AND PRIVATE INSURANCE

Private insurers that assume previously ‘socialised’ risks will have to accept stricter control of pricing, policy terms and risk selection

Regulators will have to find the right balance ….

Consumers must be protected, but insurers must be allowed to use their skills and given incentives to participate

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THE EFFECT OF EQUALITY LAWS

Europe is extending the scope of its equality laws

Basic proposition: people should not be treated differently because of things which they did not

choose and cannot change

This includes factors such as race, gender, age and health condition

Originally equality laws applied mainly to areas such as employment – they are now being extended to financial services, including insurance

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CASE STUDY – THE EU GENDER DIRECTIVE

Gender may be a relevant risk factor in many forms of insurance – e.g. life insurance, pensions and annuities, health insurance, motor insurance

The EU Gender Directive (law) forbids sex discrimination in financial services, but

originally had a limited exception which Member States could apply…

‘Member States may … permit proportionate differences in individuals' premiums and benefits where the use of sex is a determining factor in the assessment of risk based on relevant and accurate actuarial and statistical data’

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CASE STUDY – THE EU GENDER DIRECTIVE

The limited exception allowing ’proportional differences in premium based on accurate statistical data’ was difficult to apply

Some European states did not adopt the exclusion (so had ‘unisex’ premiums, for at least some lines), some European states adopted it, allowing insurers to charge different rates for men and women

The European Court has now declared the exception illegal ….

So Europe will have ‘unisex’ premiums for all lines of insurance – including, life, pensions/annuities, health insurance, motor insurance etc.

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THE EFFECT OF EQUALITY LAWS

The next battle-ground in Europe may be

other forms of discrimination (e.g. age or

disability)