Introduction

We take pleasure in introducing our spring 2011 insurance update – an overview of key trends in insurance law and regulation over the coming year.

Stop press 1 March 2011

European Court applies unisex premiums and benefits to insurance from December 2012

The Court of Justice of the European Communities made a ruling on 1 March 2011 on the use of gender as a factor in the calculation of insurance premiums.

Directive 2004/113/EC prohibits discrimination based on sex in the access to and supply of goods and services.

By way of derogation, however, as from 21 December 2007, under the directive member states may permit exemptions from the rule of unisex premiums and benefits, so long as they can ensure that the underlying actuarial and statistical data on which the calculations are based are reliable, regularly updated and available to the public.

The Court has ruled that the lack of any temporal limitation on the derogation works against the achievement of the objective of equal treatment between men and women. It must be considered to be invalid on the expiry of an appropriate transitional period. The Court accordingly determined that the derogation should cease to have effect from 21 December 2012. The effect is that ‘the rule of unisex premiums and benefits’ in, for instance, motor insurance and annuities will apply from that date.

A copy of the Court’s press release on taking the gender of the insured individual into account is available. The judgment itseitself was not available on the Court’s website at the time of going to press.

1. New regulatory framework

1.1 EU

A new regulatory framework came into force in the EU on 1 January 2011. It establishes a European Systemic Risk Board (ESRB), which will provide macro-prudential oversight across the European financial system. It also creates the following new regulatory authorities:

  • the European Banking Authority (EBA);…
  • the European Insurance and Occupational Pensions Authority (EIOPA); and
  • the European Securities and Markets Authority (ESMA).…

The ESRB and the EIOPA are located in Frankfurt, the EBA in London and the ESMA in Paris. See Freshfields briefing, The new EU framework for financial supervision. Their influence has begun to be felt over 2011. In particular, EIOPA will have stronger powers in shaping and developing the Solvency II regime (see below) than its predecessor, the Committee of European Insurance and Occupational Pensions Authority (CEIOPS).

The chief executive of the FSA, Hector Sants, recently commented on the expanded role of EIOPA: ‘EIOPA’s core responsibilities are to support stability of financial system, the transparency of markets and financial products and protection of policyholders, it is also envisaged EIOPA will conduct pan-European analysis of trends in the insurance sector. This mandate is wide-ranging but initially, its principal feature will be as the rule making body in Europe. Going forward, the FSA and successor authorities will thus essentially be a supervisory arm of an EU policy setting body.’

1.2 UK

In 2010, the UK government proposed a new framework for financial regulation. See Freshfields briefing, The new structure for UK financial regulation. A new Financial Policy Committee will be created within the Bank of England. The FSA’s current functions will be split between a Prudential Regulatory Authority (PRA) and a Financial Conduct Authority (FCA; previously designated as the Consumer Protection and Markets Authority).

An update on the government’s plans was published in February 2011. See Freshfields note, Treasury update on new structure for UK financial regulation. This is to be followed by further details in spring 2011, including a draft of the necessary bill to be presented to parliament. In the meantime, the FSA is restructuring internally to anticipate the proposed changes.

Hector Sants has indicated in a recent speech on the future of insurance regulation how the FSA is adapting to the new regulatory structure and how it is likely to be developed in the future. Mr Sants is due to be the chief executive of the PRA when it is created. Martin Wheatley, managing director of the FSA’s consumer and markets business unit, is due to be appointed chief executive of the FCA.

2. Prudential regulation

2.1 Solvency II

Firms will need to continue to prepare for the new regime coming into force at the end of 2012. Major priorities are likely to include:

  • getting approval for the use of internal models;…
  • updating governance arrangements, including arrangements for remuneration, to comply with the new standards;
  • ensuring that group structuring takes advantage of the new standards; and
  • focusing on how the regime will affect operations outside the EEA, including determining whether specific non-EEA jurisdictions (including Switzerland) are considered to be equivalent.

Draft level two measures reflecting the outcome of QIS5 are due in June 2011. For further details see our recent client briefings:

Since these briefings were published, the Commission has published a draft proposal for an ‘Omnibus II Directive’ proposing extensive amendments to the Solvency II Directive, including:

  • expanding the scope for level two measures to accommodate, for instance, the expanded powers of EIOPA;
  • providing for the adoption of binding technical standards to support the level two measures; and
  • providing for transitional measures that may allow many aspects of the new regime to be introduced over an extended period and thus ease the burden of adapting to the new regime.

2.2 Capital issues

In CP11/01, the FSA proposed new rules requiring advance notice from insurers of the issue of capital instruments that will be counted towards regulatory capital and group regulatory capital. If adopted, these rules are likely to come into force later in 2011. See Freshfields alert, Capital instruments: pre-issuance notification.

2.3 Corporate governance of financial institutions

Following an EU green paper on corporate governance in financial institutions, published on 2 June 2010, a formal Commission legislative proposal is expected in 2011. The Commission initiative focuses on:

  • functioning, composition and skills of boards of directors (including prohibiting the combined role of CEO and chairman, and compulsory evaluation of the board by an external evaluator);
  • strengthening risk management-related functions (mandatory board risk committees);
  • expanding the role of external auditors (greater duty to make disclosure to the board and/or supervisory authorities);
  • strengthening the role of supervisory authorities in the governance of financial institutions;
  • the place and role of shareholders (mandatory code of best practice); and
  • remuneration of directors of listed companies (it invites views whether stock options and golden parachutes should be prohibited).

See Freshfields bulletin, EC green paper on corporate governance in financial institutions.

2.4 Financial Conglomerates Directive

The Financial Conglomerates Directive applies prudential requirements to mixed financial groups that satisfy minimum requirements as to, on the one hand, insurance business operations and, on the other hand, banking and investment operations. In this context, ‘insurance’ refers to the writing and carrying out of insurance operations and not insurance mediation.

These requirements are applied in addition to solo prudential requirements and in addition to sectoral requirements that may apply to sub-groups within the conglomerate. A conglomerate may also be a sub-group within an insurance or banking group or another financial conglomerate. Under the Directive, financial conglomerates must be notified by member states and a list of them maintained by the Commission.

The Commission has carried out a review of the operation of the Financial Conglomerates Directive. As a result, in August 2010 it proposed a further directive to amend the Financial Conglomerates Directive. The main purpose of this proposed amending directive is to equip national financial supervisors with new powers. These powers will enable supervisors better to oversee the conglomerates’ parent entities, such as holding companies.

Agreement on the new directive may be reached in the coming year.

2.5 Insurance guarantee schemes

The Commission published awhite paper on insurance guarantee schemes (IGSs) in 2010 concerning a possible new European regime requiring them to be adopted by member states. They would be required to comply with a minimum set of design features. The Commission has published the responses to its IGS proposals.

The UK Treasury and the FSA have published a joint response to the white paper, supporting the Commission’s proposal. In particular, the joint response considers that: provisions relating to geographical scope, compensation limits and time limits should be harmonised to the maximum level; the function of an IGS should be as a mechanism of last resort that offers continuity of insurance cover and payment to policyholders of an insurer in default; and that IGSs should be required to perform stress tests that include a peer review process.

This white paper may be followed by further more detailed proposals in 2011.

3. Insurance law

3.1 Reform of insurance law

The Law Commission and Scottish Law Commission are conducting a joint review of insurance contract law. In July 2007, the Commissions published an issues paper that set out proposals for the reform of insurance law in the areas of pre-contractual information and warranties. Other issues have been covered in subsequent issues papers, including damages for non-payment of insurance claims, insurable interests, whether micro-businesses should be treated in the same way as consumers, the broker’s liability for premiums and the insured’s post-contract duty of good faith.

The Law Commission has also published a final report on ‘Consumer Insurance Law: Pre-Contract Disclosure and Misrepresentation’. The two Commissions recommend new legislation on what a consumer should tell his insurer before taking out insurance. The current law requires consumers to volunteer information about everything that a ‘prudent insurer’ would consider relevant. It is recommended that this duty should be abolished. Instead, insurers should be required to ask questions about what the insurer wants to know. It is expected that this bill may be passed by parliament under an accelerated procedure designed for non-controversial legislation. Subject to restraints on parliamentary time, it is possible that this bill may be presented to parliament in 2011.

Implementation of the Law Commission’s recommendations is expected to redress what is seen as an imbalance in insurance contract law between insurers and intermediaries on the one hand and policyholders (the latter both in the retail and wholesale sectors) on the other.

The Law Commission’s work on this project is expected to continue into 2011 and after. Further proposals to reform business insurance law are expected in 2011.

3.2 Jurisdiction in insurance disputes

The European Commission proposed in December 2010 significant amendments to the Brussels Regulation on jurisdiction in civil and commercial disputes. These new rules will affect how courts and arbitration tribunals in the European Union assume jurisdiction. They will, if adopted, extend to cases involving defendants outside Europe. The proposals are also aimed at supporting the use of jurisdiction or arbitration clauses. They may need to be taken into account in drafting of future documentation. The timeline for implementation is not clear.

4. Conduct of business issues

4.1 European Court applies unisex premiums and benefits to insurance from December 2012

The Court of Justice of the European Communities made a ruling on 1 March 2011 on the use of gender as a factor in the calculation of insurance premiums.

Directive 2004/113/EC prohibits discrimination based on sex in the access to and supply of goods and services.

By way of derogation, however, as from 21 December 2007, under the directive member states may permit exemptions from the rule of unisex premiums and benefits, so long as they can ensure that the underlying actuarial and statistical data on which the calculations are based are reliable, regularly updated and available to the public.

The Court has ruled that the lack of any temporal limitation on the derogation works against the achievement of the objective of equal treatment between men and women. It must be considered to be invalid on the expiry of an appropriate transitional period. The Court accordingly determined that the derogation should cease to have effect from 21 December 2012. The effect is that ‘the rule of unisex premiums and benefits’ in, for instance, motor insurance and annuities will apply from that date.

A copy of the Court’s press release on taking the gender of the insured individual into account is available. The judgment itself was not available on the Court’s website at the time of going to press.

4.2 Data protection

Under the Data Protection Act 1998 (DPA), the Information Commissioner has always been able to conduct audits, serve information notices requiring organisations to provide specified information within a certain time period, serve enforcement notices where there has been a breach of the DPA and prosecute those who commit offences under the DPA. Since April 2010, the Information Commissioner has had a new power to issue monetary penalties of up to £500,000 for serious breaches of the DPA. The European Commission has since asked the UK government to strengthen further the power of the Information Commissioner to bring the UK into line with the EU Data Protection Directive 95/46/EC.

A more stringent enforcement of standards in data protection may follow.

An EU review of data protection is also planned in summer 2011.

4.3 Commission review of the Insurance Mediation Directive

This review was initiated in 2007 because of concerns about the Insurance Mediation Directive (IMD). The IMD was implemented in January 2005 and has led to fragmented insurance markets in the EU, in particular regarding the information requirements imposed on sellers of insurance products. It is thought that in some areas the IMD requires regulation where there is no adequate justification and that in others it has gaps in its coverage. It is likely that the Commission’s ultimate proposals will include applying the Directive requirements to direct sales by insurers and common rules on dealing with conflicts of interest.

CEIOPS provided the Commission with initial advice on the IMD review in the summer of 2010. The Commission has consulted on reforms to the IMD, with industry participants having until February 2011 to respond. A proposal for an amending directive is expected, possibly as early as later this year.

4.4 Legal expenses insurance

In July and August 2010, insurance companies received a letter from the FSA on legal expenses insurance, following a European Court decision on the interpretation of the Legal Expenses Insurance Directive 87/344/EEC (the Erhard Eschig decision). The letter applies a new interpretation to the freedom of a policyholder to choose his own legal representative in any inquiry or legal proceeding.

Under the Directive and relevant UK implementing regulations, the freedom to choose a lawyer arises in the following areas:

  • principally, where recourse is had to a lawyer to represent the insured in any inquiry or proceedings;
  • whenever there is a conflict of interest; and…
  • where the insured is afforded the right to entrust the defence of his interest to a lawyer of his choice, then the freedom to choose a lawyer exists as soon as the right to claim under the policy arises, and cannot be curtailed.

It follows that any terms that detract from, or qualify in any way, the freedom to choose a lawyer as explained above will not be compliant with the Directive and will be in breach of the regulations.

This interpretation is more favourable to the policyholder than that previously applied by the FSA. It may require changes to standard form motor and household insurance policies among others. Compliance issues may arise in the course of 2011.

4.5 Packaged retail investment products

Work has been going on for some time at the EU level on the regulation of packaged retail products. The concern is that the regulation of economically similar products (in areas such as product transparency, and advice) differs depending on the legal form of the product and the distribution channel. Products based on insurance, deposits, or non-deposit investments are treated quite differently.

The European Commission is working on proposals for a ‘horizontal’ directive dealing with mandatory disclosures and selling practices for these products, irrespective of their form or distribution channel. A consultation on packaged retail investment products was published in November 2010, to be followed by a formal proposal in spring 2011, with adoption expected by the end of 2011.

4.6 Payment protection insurance

The FSA has issued new rules on sales of payment protection insurance (PPI) (PS10/12) and handling of complaints relating to such products. The rules and guidance:

  • oblige firms to handle complaints in line with the FSA’s expectations and offer redress where appropriate;
  • require firms to analyse past complaints to identify if there are serious flaws in sales practices that may have affected complainants and even non-complainants; and
  • set out common sales failings to help firms identify bad practice when selling PPI and handling complaints.

The complaint handling rules are the subject of a judicial review by the British Bankers Association, for whom Freshfields is acting. Judgment in the case is expected in March 2011. If the application is successful, changes to the new FSA rules may need to be made.

Separately, the Competition Commission (CC) confirmed a ban on selling PPI (other than ‘retail PPI’) at point of sale in October 2010. The CC is now moving to implementation of a fuller package of reforms. An Order is intended to be made by early March 2011, with measures on mandatory information in marketing materials and to third parties likely to come into force by October 2011 and all other elements in April 2012.

4.7 Retail distribution review

The FSA launched the Retail Distribution Review (RDR) in June 2006 to address problems in the retail investment market (which includes some long-term insurance products).

In CP09/18, the FSA set out three measures that it regards as most fundamental to delivering the desired market outcomes. These are to:

  • improve the clarity with which firms describe their services to consumers;
  • address the potential for adviser remuneration to distort consumer outcomes; and
  • increase the professional standards of investment advisers.

In March 2010, the FSA published PS10/6, which contained its final policy for the first two elements. In June 2010, it published CP10/14 containing its latest proposals for the third element, professional standards of advisers. It has set out its final rules on group personal pensions in PS10/10 and pure protection products in PS10/13. It has published CP10/29, which consults on the RDR implications for platforms and other related issues. The policy statement on this CP is expected in the first quarter of 2011.

The new framework will come into effect at the end of 2012 and will apply to all advisers in the retail investment market, regardless of the type of firm they work for (eg banks, product providers, independent financial advisers or wealth managers).

4.8 With-profits regulation

The FSA published in February 2011 CP11/5, addressing how proprietary and mutual firms writing with-profits business manage the following issues:

  • conflicts of interest;…
  • the fair treatment of with-profits policyholders in mutually-owned funds;
  • the terms on which new business is written;…
  • material reductions in new business;…
  • market value reductions;…
  • strategic investments;…
  • charges made to with-profits funds;…
  • excess surplus;…
  • re-attribution of inherited estates; and…
  • corporate governance.…

The proposals fulfil a commitment we have made to the House of Commons Treasury Committee regarding the With-Profits Regime Review (WPRR) and in the FSA’s Business Plan 2010/11. The proposed new rules are expected to be adopted in the third quarter of 2011.

A further CP that concerns with-profits business will be published later in 2011. This will relate to changes arising from the implementation of Solvency II. It will also address issues about firms’ communications with their with-profits policyholders.

4.9 Unit-linked products

The current requirements for unit-linked products to be linked only to ‘admissible assets’ will be abolished under Solvency II. However, member states may continue to impose requirements on products sold to individual customers. More information about these rules may emerge in 2011.

5. Enforcement

5.1 Bribery Act 2010

The government has announced that the UK Bribery Act will come into force in 2011. The Act:

  • introduces a corporate offence of failure to prevent bribery by persons performing services for or on behalf of a business. A business can avoid conviction if it can show that it has adequate procedures in place designed to prevent bribery;
  • makes it a criminal offence to give, promise or offer a bribe and to request, agree to receive or accept a bribe either at home or abroad. The measures also cover bribery of a foreign public official; and
  • increases the maximum penalty for bribery from seven to 10 years imprisonment, with an unlimited fine.

In September 2010, the government launched a Bribery Act consultation exercise, looking at the guidance on procedures that commercial organisations can put in place to prevent bribery on their behalf. Publication of the final guidance has been delayed, with no firm date being given, although there will be a three-month period between publication of the guidance and the Act being implemented.

Concerns have been expressed that the Act may impose undue burdens on business. The government has responded by including the Act in its Coalition Growth Review, but it is unclear whether this will lead to any amendments. In the insurance sector, there is concern that certain market practices, such as the use of contingent commissions, could be caught by the Act.

5.2 Collective redress

Proposals for a new form of collective actions for financial services claims were omitted from the Financial Services Act 2010. Currently, there is no further draft legislation for reforms of collective actions in the UK. However, the government is working on fresh proposals, which are anticipated in the near future.

Section 14 of the Financial Services Act 2010 contains revised provisions for the FSA to impose consumer redress schemes under s404 FSMA. The FSA has published informal guidance on how consumer redress schemes will be used in the future (July 2010).

The FSA is also considering consumer complaints/claims methods of redress for consumers in a holistic way. The FSA’s feedback statement to discussion paper DP10/1 ‘Consumer complaints (emerging risks and mass claims)’ may be published in 2011.

5.3 Financial Ombudsman Service

In CP 10/21, the proposal has been made to raise the Financial Ombudsman Service (FOS) jurisdiction limit to £150.000. Other changes have been proposed to complaint handling rules, among other things to require firms to take account of previous decisions by the FOS.

The FSA is expected to publish a policy statement with final rules in Q2 2011.

5.4 Financial penalties regime: proposed changes

In March 2010, the FSA adopted a new penalties policy. This could see enforcement fines treble in size.

Under the new framework, fines are linked more closely to income and are based on:

  • up to 20 per cent of a firm’s revenue from the product or business area linked to the breach over the relevant period;
  • up to 40 per cent of an individual’s salary and benefits (including bonuses) from their job relating to the breach in non-market abuse cases; and
  • a minimum starting point of £100,000 for individuals in serious market abuse cases.

The impact of the new regime will continue to make itself felt over 2011.

5.5 Sanctions

The European Commission has published a proposal to introduce a common framework for regulatory sanctioning regimes across the EU. The aim is to ensure a consistent and effective application of financial services rules in all member states, at a time when there is increasing convergence and a stronger regulatory framework at European level.

These proposals could lead to significant changes in enforcement powers and procedures in some EU jurisdictions. Comments are sought by 19 February 2011. The legislative timetable is tight, with adoption expected in November 2011. See our newsletter on this topic, Bank of the future: EU sanctions.

6. Tax

6.1 Taxation of insurance companies

The EU Solvency II Directive will supersede the current regulatory reporting requirements for insurance companies. The taxation of life companies is at present based on the regulatory reporting, so changes will be needed to the life company tax code. Solvency II will also impact on the taxation of non-life insurance companies. These changes will occur against the background of anticipated new accounting standards for insurance companies. Further information about proposals for a new tax regime may emerge in 2011.