Out-Law Guide | 28 Jul 2010 | 10:36 am | 6 min. read
This guide was last updated on 17th February 2011.
The European Commission wants every member state to set up a national insurance guarantee scheme to protect policyholders if an insurer fails.
Each scheme would have to meet minimum requirements set out in a new Directive, although member states would be able to include increased protections if they wished.
Insurance guarantee schemes provide last-resort protection to policyholders and beneficiaries against the risk that their insurer will be unable to pay claims under their policies. When an insurer fails and no other protection mechanisms are available, these schemes step in to pay compensation or, where possible, secure the continuation of insurance contracts by transferring policies to another insurer (known as a portfolio transfer).
In the UK, the Financial Services Compensation Scheme (FSCS) performs this role for both general and life insurance. But of the 30 EU/EEA countries, only 12 operate insurance guarantee schemes, leaving about 26% of all life insurance policies and 56% of all non-life insurance policies unprotected.
The European Commission is concerned that, where guarantee schemes are in place, they often differ in coverage, design, operational procedures and funding arrangements so that the protection offered is inconsistent. Existing national schemes do not always cover cross-border activity, a market that the Commission expects to grow in the future.
Solvency II, the harmonised EU insurance solvency regime due to come into force by the end of 2012, should reduce the number of insurance insolvencies, but it cannot guarantee a zero-failure environment.
In a White Paper published on 12th July 2010, however, the European Commission has ruled out a fully-harmonised, EU-wide insurance guarantee scheme – at least for now. "At present […], there does not seem to be sufficient political support for this idea. It may be considered at a later stage," the paper states.
Instead, the preferred option is for a Directive setting out minimum requirements that member states would implement in their national schemes. Member states would have to achieve a certain result, but how they did so would be left up to them.
Responses to the proposals are now available on the Europa website. These include a joint paper from HM Treasury and the Financial Services Authority (FSA) and comments from the Committee of European Insurance and Occupational Pensions Supervisors (CEIOPS - whose role was taken over at the beginning of 2011 by EIOPA - the European Insurance and Occupational Pensions Authority).
Both responses broadly support the Commission’s proposal for a minimum harmonisation regime, although the HM Treasury/FSA paper emphasises that national schemes should be able to ensure continuity of cover via portfolio transfers where appropriate. For life insurance, in particular, continuity of cover should be the “preferred outcome”.
The Commission is due to publish a legislative proposal in December 2011.
Under the Commission's outlined proposals, national insurance guarantee schemes would be required to cover all life and non-life insurance companies, but not pension funds or reinsurance.
Each scheme would be run on a "home country" principle, covering not only those policies issued by domestic insurers but also policies sold by branches of domestic insurers established in other EU member states.
CEIOPS agreed with the home country approach but suggested member states should have the option of excluding or limiting certain insurance classes. It believed that including full coverage for some classes, such as marine and aviation, would increase running costs and that others, such as credit insurance, could increase the risk of moral hazard. On the other hand, it said motor insurance should be included.
HM Treasury and the FSA suggest all member states should be required to incorporate the home country principle into their insurance guarantee schemes. They also "strongly encourage" the Commission to include compulsory motor cover within scope, but support the view that marine, aviation and transport risks should be excluded.
The White Paper envisages some sort of eligibility criteria so that schemes would cover small businesses as well as individuals. The Commission will be considering further whether compensation caps and other limits on benefits would be appropriate.
In the UK, the FSCS assists private individuals and (mainly) smaller businesses. Since January 2010, it is able to pay up to 90% of the claim with no upper limit as regards life insurance and non-compulsory insurance policies. Claims for compulsory insurance (such as third party motor claims) are covered in full.
In their joint response, HM Treasury and the FSA suggest the Directive should require member states to cover individuals, at a minimum, but that they should be able to extend their national schemes to businesses if they wish.
HM Treasury and the FSA also believe compensation limits should be harmonised so that policyholders in the same member state have the same levels of cover. Specifically, they want to maintain existing levels of compensation under the FSCS scheme.
The paper does not include proposals for the timing of payments. CEIOPS suggested schemes should be required to make payments as soon as practicable after the claim has been assessed, taking into account that different payout times will be appropriate for different types of cover.
HM Treasury and the FSA suggest a reasonable time would be three months from the date insurers’ liability and the amount of the claim have been established. But, again, they emphasise that this should not override national schemes’ ability to ensure continuity of cover by portfolio transfer.
The Commission's current preferred option is for national schemes to be pre-funded by a series of industry levies based on a pre-estimate of possible bankruptcies. This follows the pattern of similar guarantee schemes in the banking and securities sectors.
The Commission's argument is that, in a pre-funded scheme, an insurer who becomes insolvent will already have contributed to the fund. Industry levies could be weighted according to each insurer's risk rating. The fund could also be topped up if necessary by additional contributions.
In a post-funded (or pay-as-you-go) scheme, levies would not be raised until a failure took place. Set-up and operational costs would be less, but the failed insurer would have made no contribution in advance.
In its response, CEIOPS said funding arrangements should be left to member states. But it suggested more research needs to be done on possible funding mechanisms and how the funding of a minimally harmonised insurance guarantee scheme should work in practice.
The UK's FSCS currently operates a pay-as-you go scheme, charging an annual levy based on the amount of compensation actually paid, plus an estimate of the amount of compensation that will be required in the year ahead.
Additional levies can be made during the year if necessary, but the overall amount the FSCS can levy is subject to a cap on each of the five broad classes of business covered by the scheme. For general insurance, this is currently £970m and for life and pensions £790m.
These broad classes are divided into two "sub-classes" based on provider and intermediation activities. If compensation costs attributable to a sub-class exceed the amount in the sub-class "pot", they will be met by the broader business class and, if that is still not enough, by a general retail pool to which all the broad business classes contribute, up to the overall limit of £4.03bn.
This funding arrangement, introduced in April 2008, remains controversial, particularly among general insurance brokers, whose sub-class has to meet the compensation costs of payment protection insurance (PPI) mis-sold by failed firms, even though most general insurance brokers do not sell PPI. As a result, many brokers are facing significant increases in their FSCS levy.
The FSA has, however, postponed its own review of FSCS funding, originally planned for November 2010, until the impact of the proposed changes to the UK regulatory landscape becomes clearer.
In their response to the Commission, the FSA and HM Treasury say it is too early to decide on funding mechanisms:
"There are wider and more fundamental debates going on at a European level on funding currently. We consider that we should not pre-empt these debates and draw any definitive conclusions on the financing of [insurance guarantee schemes] before knowing the exact role of insurers within any new resolution framework and the framework by which other compensation schemes are to be funded."
Contact: Bruno Geiringer ([email protected] / 020 7418 7306)