World IP Day 2021: Biotech investors must open their mind to different IP strategies
Out-Law Guide | 09 Apr 2008 | 10:23 am | 6 min. read
On 10th December 2007, a series of statutory instruments completed the implementation of the Reinsurance Directive into UK law.
In particular, the Reinsurance Directive Regulations 2007 amend the schedules to FSMA (the Financial Services and Markets Act 2000) to give effect to the passporting regime and new rules on transfers of business by reinsurers.
Before the Directive there was no EU-wide supervisory regime governing reinsurance business. Each member state had its own localised requirements. The UK had a well-established regulatory regime for reinsurers. But in many states, provided a reinsurer was considered to be suitably solvent, it was generally left to its own devices.
Poorly capitalised reinsurers, however, put reinsureds (and ultimately insurance policyholders) at risk. The Directive was introduced to increase confidence in the market, avoid unnecessary regulatory duplication and remove barriers to cross-border trade.
Its key provisions include authorisation and financial supervision by a reinsurer's "home" state regulator, mutual recognition of such authorisation between member states, the abolition of collateral requirements (funds pledged to cover a reinsurer's liability) and the harmonisation of minimum standards across the European market.
The European Commission also hopes the Directive will strengthen its negotiating position in persuading non-EU jurisdictions to lift their collateral requirements, notably the US, which requires "alien" reinsurers to provide collateral equivalent to 100% of gross liabilities for US risks.
The Directive applies only to "pure" reinsurers - reinsurers who only carry out reinsurance business. This includes captives – entities set up solely to provide reinsurance cover for the undertakings to which they belong.
"Reinsurance business" includes related activities, such as providing claims management services or actuarial advice.
The Directive does not apply to direct insurers who also carry on reinsurance business ("mixed" insurers) or to Lloyd's market underwriters. These continue to be regulated under the Non-Life and Life Insurance Directives. Nor does it apply to reinsurers which have stopped accepting new business and are in run-off.
Territorially, the Directive covers the European Economic Area (which covers all the EU member states plus Iceland, Liechtenstein and Norway). All EEA member states were due to implement the Directive by 10th December 2007.
The prudential requirements in the Directive were implemented in the UK on 31st December 2006 by amendments to the Financial Services Authority's Handbook.
The new measures include changes to the rules governing technical provisions (the funds allocated to meet the reinsurer's future liabilities), solvency margins (broadly, the excess of assets over liabilities) and the minimum guarantee fund (below which the solvency margin must not fall).
In addition, the FSA broadened its "prudent person" investment principles and removed other restrictions on admissible assets for pure reinsurers, in line with the Directive requirement that member states should not require reinsurers to invest in particular categories of assets.
The Directive gives member states the discretion to develop their own rules on the setting up of Insurance Special Purpose Vehicles – entities set up by (and taking on specific risks from) an insurer or reinsurer.
In the UK, the FSA Handbook applies a light regulatory touch to ISPVs proportionate to the lower risks posed by such vehicles, including a "fast-track" authorisation procedure.
Member states are also free to draw up their own rules on finite (or financial) reinsurance contracts, which transfer risk to a reinsurer but only to a limited extent.
The main concern with finite reinsurance contracts is that they may sometimes be used to distort the reinsured's balance sheet because of the way reinsurance (as opposed to, say, a loan) is treated in financial accounts and in the calculation of regulatory capital. If in reality there is little or no actual risk transferred, the contract should properly be accounted for as a loan.
To address this issue, the FSA has adopted a principles-based approach that balances any benefit to the reinsured's balance sheet against the extent to which there has been actual risk transfer. This principle applies to all types of reinsurance arrangements, including finite reinsurance and ISPVs.
By harmonising standards and ensuring the mutual recognition of those standards, the Directive sets up a regime that allows a reinsurer authorised in its "home" member state (where it has its head office) to carry on reinsurance business anywhere in the EEA.
Armed with this "single passport", a reinsurer can set up a branch in another member state (the right of establishment) or provide reinsurance services there from its home or another member state. The host state cannot impose any additional regulatory or supervisory requirements.
The passporting provisions were implemented in the UK on 10th December 2007 by the Reinsurance Directive Regulations.
Unlike the passporting regime for direct insurance, there is no requirement for information about the reinsurer to be provided to and by regulators in the host state.
In March 2008, however, CEIOPS (the Committee of European Insurance and Occupational Pensions Supervisors) published a revised protocol on collaboration that provides that the home state regulator should provide information to the host state where the reinsurer intends to set up a branch within one month of being notified of the reinsurer's intention. The protocol has been adopted by all CEIOPS members.
In the UK, the FSA (which is a member of CEIOPS) has asked reinsurers with their head office in the UK to provide it with details of their branches in other EEA states.
The Directive provides that non-EEA reinsurers should not be given more favourable treatment than EEA reinsurers.
A non-EEA reinsurer can carry on reinsurance business in Europe either through a subsidiary company authorised in an EEA state, or via a branch in an EEA state.
A subsidiary incorporated and authorised in an EEA member state will be treated in the same way as an EEA reinsurer and so can take advantage of the passporting regime to carry on business in any member state. The subsidiary's home state regulator must, however, notify any host state that the company's parent is situated outside the EEA.
But a non-EEA reinsurer that sets up a branch in an EEA state will not benefit from the passporting regime and so will have to obtain authorisation from the member state and from any other member state where it wishes to do business.
As a result, many non-EEA reinsurers that have previously operated through branches in the EEA may prefer to set up an EEA subsidiary instead, obtain the necessary authorisation from the chosen home state and transfer any business carried on by the branches to the subsidiary.
The Directive provides that a reinsurer's home state regulator can authorise transfers of books of pure reinsurance business within the EEA, provided the transferee's home state regulator certifies that the transferee reinsurer will have the necessary solvency margin after the transfer.
In the UK, this has meant some changes to existing procedures for portfolio transfers under Part 7 of FSMA. These were implemented on 10th December 2007 by the Reinsurance Directive Regulations.
Part 7 requires all insurance and reinsurance business transfers to be approved by the court in what can be a lengthy and expensive process.
The amended rules introduce a simpler alternative for pure reinsurance business transfers from the UK into the EEA. If all the policyholders affected by the transfer consent to the proposal, there is no need to obtain court sanction. Instead, the transferring reinsurer simply needs a solvency certificate from the transferee's regulator.
One of the main aims of the Directive is to create a level playing field for reinsurance across the EEA. Whether this can wholly be achieved when member states are still given the option to develop their own rules in relation to ISPVs and finite reinsurance is questionable.
The new regime, however, is likely to have the greatest impact on those member states that previously imposed few regulatory requirements on reinsurers.
In the UK, the immediate effect will be limited as there was already a fairly stringent regulatory regime in place. If anything, the new rules are a relaxation. Eligible reinsurers, however, will benefit from the new freedoms brought by the single passport and the streamlined Part 7 procedure.
In the long term, the intention is that all the prudential supervision provisions in this Directive and the Life and Non-Life Insurance Directives will be consolidated into Solvency II, the EU-wide, risk-based solvency regime planned to come into effect in 2012.
Contact: Charlotte Hooper ([email protected] 020 7418 8214)
See also: Recent changes to the Part 7 transfers of insurance business, an OUT-LAW Guide.
World IP Day 2021: Biotech investors must open their mind to different IP strategies