The single European insurance market

3. The single European insurance market

3 . 1 . Treaty of Rome, directi6es, EU Commission The objective of the Treaty of Rome, signed in 1957 by six founding Member States, was the establishment of a common market. Several provisions of the Treaty had important implications for the establishment of an integrated European insurance market. Article 52 called for the abolition of restrictions on nationals of one Member State from establishing themselves in another. Article 59 provided for the abolition of restrictions on Member State nationals who are established in one Member State from providing services in another. However, the realization of these provisions has been far from immediate. A series of Directives followed the Treaty of Rome and is targeted at harmoniz- ing regulatory requirements across Member States. A further major step was the enactment of the Single European Act in 1986. This act amended the Treaty of Rome and set forth a deadline of December 31, 1992 by which the single market was to be achieved. The goals of the single market in insurance defined by the EU Commission 4 were: 1. the freedom for consumers to choose any insurance policy from any insurer authorized in any Member State; 2. the freedom for insurers authorized in any one Member State to market policies throughout the EU under the principles of freedom of establishment and freedom to provide services; and 3. the freedom for insurers to compete equally on price, product and service, all unnecessary barriers to competition being removed. The EU legislation covering direct insurance can be divided into three genera- tions: freedom of establishment; freedom of services; and introducing both free- doms on the basis of home country control. Each of these generations has been matched by a specific Directive see Dickson and Bardwell, 1991, pp. 10 – 11: 1. First Life Insurance Establishment Directive adopted: March 5, 1979; right for any EU insurer to establish itself in any foreign Member State; freedom from more onerous restrictions than those applied to local competitors; common solvency margins to apply throughout the EU; 2. Second Life Insurance Services Directive adopted: November 8, 1990; freedom to provide services cross-border under the ‘cumul’ rule 5 ; 4 See Clifford Chance 1993, pp. 2. The EU Commission in Brussels is the community’s executive arm. 5 Cumul is based on the Latin ‘accumulare’, which means ‘to accumulate’. It refers to a situation where an insurer, established in a host Member State and able through its branch there to insure risks in that State, can also cover the same risks from an establishment in another Member State. The cumul rule has been abolished under the Third Directive. Therefore, insurers are allowed to provide their services in another Member State both through a local establishment or directly from the home Member State. 3. Third Life Insurance Framework Directive adopted: November 10, 1992: introduces concept of a single license; abolition of ‘cumul’ rule; home state supervision of financial soundness. 3 . 2 . EU sol6ency requirements Guarantee funds are allocated net worth accounts. They correspond most closely to the minimum capital and surplus requirements imposed by US state insurance statutes Hogan, 1995, pp. 353. 6 Under Article 20 of the First Life Insurance Directive, the guarantee fund is established to be one-third of the minimum solvency margin as specified in Article 19, but not less than the following: 1. 800 000 units of account ECU; 2. 600 000 units of account ECU in the case of mutual associations and mutual- type associations. 7 Although the guarantee fund may be higher based on the calculations described in Article 19, the minimum level for any insurer is that described above. Hence, these amounts are used in censoring the data set for the insolvency analysis in this study. Article 24 details the provisions for regulatory action should an insurer fail to maintain the required minimum guarantee fund. Specifically, Article 24 states: If the solvency margin falls below the guarantee fund as defined in Article 20, or if the latter is no longer constituted as laid down in that Article, the supervisory authority of the head-office Member State shall require the undertaking to submit a short-term finance scheme for its approval. It may also restrict or prohibit the free disposal of the assets of the undertaking. It shall inform the authorities of other Member States in whose territories the undertaking is authorized of any measures and the latter shall, at the request of the former, take the same measures. A Member State can set more stringent solvency requirements. However, these higher standards can be applied only to the Member State’s own domestically based insurers. Also, Member States cannot require prior approval of rates and forms for any insurer selling in their market see Hogan, 1995, pp. 342. 6 The term ‘guarantee fund’ as used here should not be confused with the state guaranty funds that exist in each state in the US. The state guaranty funds are mechanisms for covering the financial loss that policyholders and claimants sustain when an insurer fails. No uniform guaranty fund system like that in the US has been established in the EU. In most Member States no such system exists presently. 7 Based on exchange rates on March 1, 1996 ECU 1 = US 1.25, the requirements would be 1 million and 750 000, respectively. 3 . 3 . Responsibility for regulatory o6ersight Under the Third Life Insurance Directive, a single license regime is established. An insurer’s home Member State license is valid whether business is carried on through a branch, agency or through the provision of cross-border services. The insurer must simply notify the host Member State authorities that it intends to write business in that Member State and file required documents. Sole responsibility for the financial supervision of an insurer’s entire business within the EU rests with the insurer’s home Member State. However, it also obliges any host country to notify the home Member State’s supervisory authorities if it suspects that the insurer’s activities might affect the insurer’s financial solvency. It is left up to the home Member State to decide whether any action is necessary. The home Member State is solely responsible for withdrawing authorization. The EU Insurance Committee was established by the Insurance Committee Directive 91675EEC. The Committee consists of the supervisory authorities of each of the Member States and is chaired by a Commission representative. The Committee began work January 1, 1992. The Insurance Committee has two main functions. First, it acts in a regulatory capacity to assist the EU Commission in exercising its powers under the Directives. Second, it acts in an advisory capacity to the EU Commission on the application of the Directives. The Committee seeks to achieve coordination between the insurance supervisory authorities of the Member States. Particularly important is the coordination of actives related to the financial oversight of insurer operations. The committee has proposed an ‘early warning system’ to supervise life insurers. This system would be similar to the IRIS Insurance Regulatory Information System approach used by the NAIC see Hogan, 1995, pp. 343. Although the framework for a single insurance market in the EU was completed in July 1994, barriers still remain to the realization of this single market. Two of these barriers which have relevance to insurer solvency include: 1. it is unclear to what extent host Member States will be able to intervene in the control of insurance operations in their country; 8 2. it is uncertain to what extent home Member State regulators will be able to effectively monitor non-domestic business and to take any necessary remedial action see Clifford Chance, 1993, pp. 56 – 67. A proposal for a Council Directive for winding-up or liquidation procedures was introduced in 1989, but is not yet adopted. This proposal sets out common procedures for the compulsory winding-up of insurance activities in the case of both solvent and insolvent insurance operations. 8 Also of concern is the relative ability of some Member States to monitor effectively the operations of their domestic insurers operating in a variety of host Member States. Do the supervisory authorities have the requisite expertise and financial resources to do their jobs effectively? Differential accounting practices across Member States also present monitoring problems for supervisory authorities. Finally, a uniform definition of financial distress is yet to be established. Analysis by the Commission reported in the early 1980s showed that if insurance products were sold throughout the EU at the average prices of the four lowest cost producer countries, consumers would save ECU 2.45 billion US 3.08 billion. Prices would need to fall by 51 in Italy, 32 in Spain, 31 in Belgium, but by a minimal amount in Holland and Britain to achieve similar price levels Dickson and Bardwell, 1991, pp. 5. This type of situation clearly suggests that harmonization of requirements and the general deregulation resulting from the EU Directives is likely to create significant competitive pressures in some of the EU countries, thus increasing the likelihood of insolvency for life insurance companies. The virtual absence of insolvencies among EU life insurers precludes a direct analysis of insolvency risk based on a large sample of insolvent European insurers. Yet, the dramatic insurance market changes described are likely to have a signifi- cant impact on life insurer solvency in the EU. Postponing solvency research until a sufficient number of insurer failures occur in the EU does not appear prudent.

4. Prior research