NEW REGULATIONS AFFECTING THE INSURANCE MARKET

1. THE INSURANCE IN EU ON THE THRESHOLD OF THE THIRD MILLENNIUM NEW REGULATIONS AFFECTING THE INSURANCE MARKET Elemér Terták Principal Advisor European Commission

2. Role of insurance in the EU Between 2002 and 2007 the European share of the global market rose from 32% to 43% as premiums in Europe grew faster than total worldwide premium income. However, with the decline of European premiums in 2008 and 2009, Europe’s market share decreased to 40%.

3. History of insurance and insurance regulation • The concept of insurance date as far back as 3000 B.C. • However, it was during the 15th to 17th century, when modern types of policies began to develop for life, marine and fire insurance. Initially, small local and regional carriers primarily writing fire and life insurance dominated the industry which led to a state-based regulatory framework. • In the 19th century the incorporated insurers come to the front and took over from the mutuals and cooperatives the business. Major disadvantage of the mutual insurance companies is the difficulty of raising capital thus take more or large value risks. The mutual market share at the end of 2008 was 24% .

4. History of insurance and insurance regulation (cont‘d) • At the end of the 19th century, there was a shift in public sentiment towards increased regulatory oversight of large and concentrated industries that resulted from concern from potential monopoly harms. The regulatory oversight was justified as being in the public interest, and imposed on several industries, including railroads, telecommunications, trucking, airlines and insurance. • Another driver was that in the mid-19th century the prospect of quick gains led to proliferation of less reputable insurers. The call for a competent oversight was not long in coming. The first insurance supervision laws were adopted at the end of the 19thand beginning of the 20thcentury. The insurance supervisions were mandated to protect the insured against failure of insurance companies against fraud, to protect high premium burden and lack of general policy conditions.

5. Theories of Regulation • Public interest theory, The purpose is to protect consumers by monitoring the solvency of insurers and their business practices. The idea is that consumers are not in an equal bargaining position with insurers, so it is necessary for the government to regulate the terms of insurance contracts. • Public choice theory. It rests on one major premise – that regulators concern themselves only about the needs of the citizens. requirement for full disclosure and setting reasonable standards are aimed at to overcome imperfect information • Insurance is also regulated for economic, social, and political purposes. • Further rationale is to regulate international insurers for financial soundness and transparency. Another macroeconomic purpose is to avoid regulatory arbitrage among financial sectors and to maximize efficiency of capital allocation.

6. Regulation of insurance in the EU Competition regulation Prudential regulation European INSURANCE Contract law Taxation National

7. 1973 / 1979: publication of the first non-life and life directives of the EEC (European Economic Community) - mainly based on the work by Cornelis Campagne / OECD 1961 Required solvency margin for life companies (EEC,1979): 4% of the mathematical reserves (≡ investment risk) + 3‰ capital at risk (≡ technical risk) Early warning signal, based on fixed ratios (wind-up barrier: guarantee fund) 2nd, 3rd directive: solvency margins left unchanged Solvency in Europe: Solvency „0”

8. Insurance Committee (IC) asked the European supervisory authorities (from 2004: CEIOPS) to establish a working group to investigate solvency issues chair of the group: Helmut Müller (BAV, Bundesaufsichtsamt für das Versicherungswesen) Presentation of the Müller Report: current solvency margin structure satisfactory amount of the minimum guarantee fund needs to be increased (inflation) identification of three risk groups (technical, investment, non-technical) Solvency I project initiated Committee of European Insurance and Occupational Pension Supervisors Solvencyin Europe: SolvencyI 1994 1997 1999

9. Experience since the adoption of Directive 2002/13/EC for non-life insurers and Directive 2002/83/EC for life insurers: have worked well over the last decade have significantly increased the protection of the policyholders Characteristics: simple, robust easy to understand and use inexpensive to administer rule-based, and not explicitly risk-based (e.g. differences between asset and liability profiles are neglected) However since the creation of these rules, significant changes have taken place in the insurance industry need to adapt the rules. Experience with Solvency I

10. Why to change the rules? • Current regime nearby 40 years old • Lack of adequate risk sensitivity • No incentives for insurers to manage risks adequately or to improve & invest in risk management • Does not facilitate accurate & timely supervisory intervention • Supervision of groups sub-optimal • Lack of convergence within the EU • Lack of consistency with international developments (IAIS, IASB)

11. „In 1980 the life insurance industry was 150 years old, in 2010 it was 30 years old“ Equity markets experienced a strong bull run from 1996-2000 and in 2005-2007 Equity and corporate bond markets suffered falls in 2001-2002 and in the recent financial crisis Interest rates stabilized on a low level - problems with (high) guaranteed returns Increasing life expectancy / costs More frequent extremes / catastrophes (e.g. 09/11, Tsunami) Insurance environment since the 90ies

12. delayed intervention of external institutions (supervisors, rating- agencies, ...) high (distribution) costs – only partially offset against policy- holder benefits slanted toward growth insurance market of the 90ies increase in the „equity culture“– weaknesses in risk management and control competitive environment – creating high expectations of discretionary bonuses Five erroneous trends in the 90ies

13. Global Risks 2011 Risks with impact on insurance • Economic Risks • Fiscal crises • Global imbalances and currency volatility • Infrastructure fragility • Environmental Risks • Air pollution • Biodiversity loss • Climate change • Earthquakes and volcanic eruptions • Flooding • Ocean governance • Storms and cyclones • Societal Risks • Chronic diseases • Demographic challenges • Infectious diseases • Water security • Geopolitical Risks • Organized crime Terrorism • Weapons of mass destruction • Technological Risks • Threats from new technologies

14. Based on the Müller Report, it was agreed that a morefundamental review of the overall financial position of aninsurance company should be done, including - Technical provisions (non-life) - Reinsurance - Asset / investment risk - Solvency margins (methods) - ALM - Accounting systems Launch of the Solvency II project by the European Commission - CEIOPS was asked to provide input and recommendations 1999 2001 Solvency in Europe: towards Solvency II Publication of the Sharma Report and of the KPMG Report 2002 Committee of European Insurance and Occupational Pension Supervisors

15. The three phases of progress: Phase 1: from 2001 to 2003 gathering knowledge general design of the system (e.g. 3-pillar framework) KPMG report, Sharma report Phase 2: from 2003-2009 technical development of detailed rules 3 waves of Calls for Advice giving structure of the framework, QIS Phase 3: from 2009-2013 implementing phase modeling, standard models, calibration of models and parameters implementing in national law Solvency in Europe: towards Solvency II(cont‘d)

16. Solvency II – A great leap forward Benefits expected from the principles and risk-based capital standards of Solvency II (Directive 2009/138/EC): • More transparent / better risk allocation between insurers, policyholders and capital markets • Better pricing, product innovation • New asset management strategies • Decrease in the cost of capital • Better capital allocation (commensurate with risk profile)  improved financial stability

17. Securing the benefits of the policyholders* * Note: this does not necessarily require the continued existence of a company. Zero-failure will not be the aim of prudential supervisory systems. In a free market, failures will occur! Objectives 1 2 3 Minimum financial requirements Supervisory review process Market discipline via disclosure requirements

18. Improved risk management: matched to the true risks of an insurance company total balance sheet approach sending out early warning signals ensuring a smooth run-off of the portfolios in case of financial distress Stability of the financial market Consistency with other sectors (e.g. Basel III) International comparability, compatibility and convergence Objectives (cont‘d)

19. Solvency II Timetable 2012 2011 2007 2008 2009 2010 2006 Directive development (Commission) Directive adoption (Council & Parliament) Implementation (Member States) CEIOPS work on technical advice necessary for implementing measures / supervisory convergence / preparation for implementation / training & development Commission preparatory work implementing measures (IM) Adoption of IM July 2007 Solvency II Directive proposal December 2009 Solvency II Directive published in OJ January 2013 Solvency II enters into force QIS2 QIS3 QIS4 QIS5

20. State of Play • Around 40 implementing measures being prepared based upon advice from CEIOPS / EIOPA • Public hearing held in May 2010 • Discussion of drafts with MS experts and with stakeholders • First consolidated version of drafts prepared by Commission staff in October 2010

21. State of Play (cont‘d) • Implementing measures to be adopted by Commission as delegated acts in June/ July 2011 • Council and Parliament can voice objections during period of 3 or 4 months • Entry into force: 1 January 2013

22. EU Financial Supervision Architecture Reform and level 3 rules • CEIOPS became on 01/01/2011 EIOPA (European Insurance and Occupational Pensions Authority) • Preparation of level 3 rules • Possibility to write Binding Technical Standards, or issue guidance • The Solvency II Directive will be revised to allow these changes (so called « Omnibus 2 »)

23. Thanks for your attention!