Insurance undertakings are exposed to a range of risks, which can lead to failure if inadequately managed and controlled. Although infrequent due to the prudential requirements applying to EU insurers under the insurance framework directives, the question remains as to what will happen if the assets of an insurer fall short of what is needed to meet policyholder claims in full.
In a bid to combat risks of insurance failures and in the light of the recent turmoil in the financial sector, the European Commission recently published a White Paper proposing a framework that would require EU member states to establish or maintain insurance guarantee schemes to minimum standards. There is currently no harmonisation at EU level on insurance guarantees, leading to varying consumer protection standards in the different member states.
The objectives of the proposal are laudable. In particular, the White Paper endeavours to ensure comprehensive and even protection for policyholders and beneficiaries irrespective of the member state in which they reside or whether they purchase policies from domestic or incoming EU insurers. The proposal also aims to avoid distortions of competition by creating a level playing field between insurance companies and by ensuring that domestic companies and incoming EU insurers can compete on equal terms.
The EU Commission proposal ensures that protection will be provided to policyholders and beneficiaries when insurance undertakings are unable to fulfill their obligations arising out of an insurance contract. Protection may be provided by paying compensation to claimants or else by securing continuation of the insurance policies through transfer of the insurer’s portfolio to another insurance company. The White Paper does not indicate to what proportion policyholders would be compensated in the event of an insurer’s bankruptcy, although compensation limits may be imposed compelling policyholders to bear a share of any loss. In any case, the Commission strongly encourages portfolio transfer where reasonably practicable and justified over compensation.
The schemes will cover both life and non-life insurance policies, including those which offer both types of products. Non-life insurance policies are nevertheless considered to expose the policyholder to a smaller degree of financial hardship than life insurance policies, since loss of the latter may prove devastating to policyholders who may have purchased life-insurance to provide, for instance, for their retirement. Eligible claimants will include both persons and selected companies, the latter being required to satisfy certain qualifying criteria.
The EU Commission, in its proposal, is recommending that these schemes should be pre-financed by contributions collected from the insurance industry, thereby accumulating funds for future insolvency cases.
This may need to be complemented by retroactive contributions in the event of lack of funds to cater for an insolvency case. The Commission is proposing a target level of 1.2 per cent of gross written premiums. This system ensures that the insurer which becomes insolvent will have made prior contributions to the scheme. However, the European Insurance and Re-Insurance Federation has already questioned the pre-funding mechanism, favouring instead the decision on the mode of funding of guarantee schemes to be left to each member state’s determination.
The proposed directive will apply a minimum harmonisation regime, which means that member states may, if they so desire, provide greater protection than is provided for in the relevant EU legislation.
At this stage, the EU Commission is inviting interested parties and stakeholders to provide their views and comments on the proposed directive. The consultation process will run until November 30, while a legislative proposal is expected to be tabled next year.
jgrech@demarcoassociates.com
Dr Grech is an associate with Guido de Marco & Associates and heads its European law division.