1. Introduction

The European insurance industry is currently preoccupied with the Solvency II project as companies plan their participation in QIS5 and carry out their gap analysis in relation to Pillar II requirements. However, there are other major initiatives that will also affect the insurance industry which insurers and risk managers should not allow themselves to be blindsided by. Some of these developments emanate from the overhaul of the financial regulatory regime in Ireland while others emanate from the overhaul at a European level. Some of these developments are of general application but the focus of this article is to examine them from the perspective of the insurance sector.

The aim of the initiatives is to improve financial regulation, compliance, stability and enforcement. Whilst these are admirable aims, insurers and reinsurers might rightly argue that the insurance sector is different to the banking sector and that policy makers may not be sufficiently taking this fact into account.

2. Ireland’s New Regulatory Framework

Following a number of developments documented recently in the media, we are beginning to see how the new Central Bank of Ireland Commission (the “Commission”) will be structured and some key executive appointments have also been announced.

The new framework will replace the current board structures of the Central Bank and the Financial Regulator and will be responsible for both the supervision of individual firms and the stability of the financial system generally.

Two top-level posts will be established within the Commission, namely, the Financial Supervision Directorate, who will report to the Commission on regulatory and supervisory functions, and the Central Bank Directorate, who will report to the Commission on the performance of the central banking functions.

The role of prudential director of the Financial Regulator will be divided into four Assistant Director General roles: special advisor to the head of financial supervision; enforcement; markets supervision; and policy and risk. All four Assistant Director Generals will report to the Director General of the Financial Supervision Directorate.

The following is a link to a diagram of what we understand the new Irish regulatory framework will look like.

The insurance industry in Ireland has broadly welcomed the appointment of Mr Elderfield as the Director General of the Financial Supervision Directorate. It is hoped that Mr Elderfield’s experience, most recently as the head of financial regulation in Bermuda, a jurisdiction with such strong insurance credentials, will assist to underpin confidence in the Irish insurance industry and cement Ireland’s position as a major global centre for insurance activity.

Increased Regulation and Enforcement

In his speech on the future of financial regulation in Ireland delivered to the financial services sector on 1 December 2009, Governor Honohan stated that the Financial Regulator will continue to be much more hands-on than in the past and is determined that there will be a renewed emphasis on enforcement. In view of those comments, it is likely that insurers, as well as firms in other sectors, can expect to be subject to more regular on-site supervisory visits and may also expect to have more challenging supervisors whose assertions will be backed by a credible threat of enforcement action.

Increased Levies

Changes in the national regulatory structure will also likely see the charging of regulated firms for 100% of the operating costs of the Commission. Most companies budgets for 2010 have already been set so they will be hoping that the increased levies will not be rolled out until 2011 and insurers should maintain a watching brief on this issue.

3. The EU’s New Regulatory Framework

The aim of the European Commission’s package of draft legislation is to correct, in a two pronged attack, at both a macro and micro level, the weaknesses in the EU supervisory framework and to reinforce financial stability throughout Europe.

European Systemic Risk Board (“ESRB”)

The ESRB’s function will be to monitor and assess risks in the financial system at a macro level and to provide early warnings of systemic risks that may be building up. Where it feels it is necessary the ESRB will issue recommendations to manage these risks. While these recommendations are not legally binding, recipients who choose not to comply with the recommendations must explain their reasoning to the ESRB. Decisions by the ESRB to make a recommendation or warning public will be made on a case-by-case base, balancing the benefits of publication with any possible adverse market reactions.

The ESRB will be composed of all the Governors of the national Central Banks in the EU, the President and Vice-President of the ECB, a member of the European Commission and the Chairpersons of the three new supervisory authorities (see below). National supervisors and the President of the Economic and Financial Committee will also form part of the General Board, but without voting rights. Accordingly, the ESRB will be comprised primarily of central bankers and forsees only one representative of the insurance industry being the Chairman of EIOPA (see below). The risk here for the insurance sector is that ESRB recommendations on systemic risks may be made with only the banking sector in mind and that these may have unintended consequences for the insurance sector given the fundamental differences in their respective business models. Insurers do not generate the same kind of systemic risk that arises in the banking sector and there should arguably be greater representation and insurance expertise on the ESRB to ensure that recommendations made promote the stability of the entire financial services sector not just the banking sector. Furthermore, with approximately sixty members there may be some concerns as to whether the ESRB may become overly bureaucratic, thereby impacting on its effectiveness.

European System of Financial Supervision (“ESFS”)

At a micro level the ESFS will comprise of three new European Supervisory Authorities that will replace the current level three committees (CEIOPS, CEBS and CESR) with the more powerful European Insurance and Occupational Pensions Authority (“EIOPA” which this article focuses on), the European Banking Authority and the European Securities and Markets Authority, respectively.

The aim of the ESFS will be to supervise individual financial institutions and will consist of a network of national financial supervisors working in tandem with the three new authorities while the day-to-day supervision of the national financial institutions will remain at national level.

It is proposed that these new supervisory structures will be introduced during the course of 2010 which is somewhat ambitious in that even after the draft legislation is finalised both the ESRB and ESFS will have to be fully resourced.

EIOPA

EIOPA will have an enhanced legal status. As an authority, as opposed to a committee EIOPA will have the power to issue binding decisions, whereas in the past CEIOPS could only issue recommendations. EIOPA’s mains tasks will include the following:

• Developing proposals for technical standards and ensuring consistent application

Although CEIOPS issued technical standards, they were not binding. This role is part of a wider aim of moving towards a common European rulebook. As a body with highly specialised expertise it is certainly arguable that EIOPA is best placed to draft standards that are genuinely necessary and technical, do not involve policy decisions and advance financial stability and policyholder protection by having a consistent approach.

A stakeholder group representing in balanced proportions Community insurance and reinsurance firms as well as occupational pension funds, their employees and consumers of their services will be established for consultation purposes in areas relevant to the tasks of EIOPA. Obvious by its absence is a similar stakeholder group in the context of the ESRB.

• Settlement of disagreements between national supervisory authorities

EIOPA will try to facilitate conciliation between national supervisory authorities but in the absence of an agreement EIOPA will have the final word. In addition to this, EIOPA will in some instances have the power to directly instruct individual companies to take certain necessary action to comply with its obligations under Community law including the cessation of any practice. This is a significant development and although this power may only be used in limited circumstances and where the national authority has first failed to comply with a decision of EIOPA, it is one that will likely generate much debate in the months ahead.

• A coordination role in emergency situations

EIOPA’s powers will be enhanced in emergency situations, the existence of which will be declared by the European Commission. It will have a co-ordinating role between national supervisors, and will also be able to adopt decisions requiring supervisors to take action. The main issue here will be making it acceptable to Member States to have decisions made at a European level that may have financial implications at a national level.

Europeanisation of Financial Supervision?

A challenge to the insurance sector is that these proposals will mark a new era of regulation with the balance between national and EU authorities being shifted such that the latter will clearly have a greater influence over the form and content of the rules governing the insurance industry.

The EU’s draft legislation on the new regulatory framework does however stop short of creating direct European supervision. The Q&A accompanying the draft legislation provides that day-to-day supervision is best done at national level and that the proposed system is a “hub and spoke” type of network of EU and national bodies. It also provides that “the new authorities will only act where there is clear added value such as the development of technical standards “and settlement of disagreements between national supervisors”.

4. Conclusion

Whether we are crossing a regulatory rubicon remains to be seen. It may be impossible to prevent all future crises, however it should be possible to prevent the kind of systemic and interconnected vulnerabilities that occurred and which have resulted in the current global economic difficulties. Here’s hoping that these new structures achieve their goals and that the benefits of the new regulatory landscape, including reputational benefits, outweigh the inevitable increased costs of regulation and create a platform for sustainable growth. In this context the insurance industry needs to be cognisant of the regulatory developments as they evolve and has to make its voice heard to ensure that policy makers understand the distinctive features of the sector.