1. Amendments to the Law on Insurance and other laws

Before turning to the most recent amendments to the Law on Insurance dated 23 July 2013 it is necessary to note that in August 2012 Russia joined the World Trade Organisation. The insurance industry was one of the areas in relation to which Russia made specific commitments. The majority of the changes to the local legislation that are required pursuant to these commitments will be developed later as the Accession Protocol provides for transition periods depending on particular commitments (see our previous Alert “The Russian insurance market and the World Trade Organisation: first impressions” for details). However, some of these changes are already in force.

Foreign investment

One of the changes that Russia had to introduce immediately pursuant to the WTO requirements was the increase of the foreign investment quota from 25% to 50%. This was implemented in December 2012. As of 1 January 2013, according to official statistics (published annually), foreign investment represented 17.41% of the aggregate amount of charter capitals of the Russian insurers.

Other WTO requirements that needed immediate action included lifting of residency requirements for managers of insurance companies and cancelling preferential treatment for foreign investors originating from the EU. In July 2013 these requirements were met by passing a significant piece of legislation amending the Law on Insurance and other related laws. These amendments are so detailed and voluminous that it would take some time to describe and analyse them all. Some of them have already been mentioned in Part 1 of this Alert (e.g. provisions on total loss, deductible, etc.). This Part 2 focuses further on some other important changes that may re-shape the Russian insurance market in the near future. The amendments have been drafted as a rather complex document and will generally come into force in January 2014. However, certain amendments, for example, provisions on the new regulator, will come into force earlier (1 September 2013), while other provisions have different effective dates (e.g. 1 January 2015).

According to the amendments to the Law on Insurance, in addition to state funded insurance and life insurance, Russian insurance companies with more than 51% of foreign investment cannot participate in compulsory motor liability insurance. This is a temporary ban which will come into force on 1 July 2014 and will be lifted on 22 August 2017 when the transition period established by the Accession Protocol comes to an end.

As mentioned above, the amendments cancelled more favourable terms that Russia provided for EU investors. General limitations on foreign investors in the Russian insurance sector apply regardless of the country of their origin. However, the amendments introduced a grandfathering clause, according to which those subsidiaries that had licences as of 22 August 2012 may continue to be engaged in life and compulsory motor liability insurance.

Another provision of the amended Law may serve as an additional “soft” limitation on foreign reinsurance companies. Paragraph 2 of amended Article 13 of the Law provides that “reinsurance is carried out on the basis of the reinsurance contract concluded between the reinsurer and the reinsured in accordance with the legislation of the Russian Federation”. It is not entirely clear what exactly must be governed by Russian law - the reinsurance contract itself or the way it is formed?

On the other hand, the amendments lift the restriction applicable to cross-border provision of insurance services. The scope of these services is defined by the WTO Accession Protocol, according to which cross-border supply of insurance services will be possible in cases of cross-border marine insurance (hull and liability), insurance of carriage by air, commercial space launch and cross-border transportation of passengers and cargo including liability.

Transparency

It is important to make a general note that as of 1 September 2013 the Central Bank of Russia will take over the regulation of the insurance industry as well as private pension funds and the securities markets (see below). As a result it is likely that the standard of supervision in relation to insurance companies and other non-banking financial institutions will increase to the level of supervision applicable in the banking sector.

The recent amendments introduced new disclosure requirements for insurance companies. They are now obliged by the law to have a corporate website. The domain name and/or the address of the website must be communicated to the regulator. Insurers will have to publish detailed information about their corporate governance, managers, shareholders, annual reports and auditors’ statements, ratings, membership in various insurance unions, transfer of insurance portfolio, etc. Most importantly, they will have to publish general terms and conditions of insurance (rules of insurance) and insurance tariffs. Insurance companies will also be required to keep records of all insurance agents and insurance brokers that they work with and publish these lists on their websites.

The amendments provide that the information has to be published within five working days from the date it becomes available or has changed. The regulator is entitled to define the procedure for publishing this information.

Another amendment which relates to transparency, as well as solvency (see below), was adopted in June 2013. It provides that any person with direct or indirect control over 10% of voting shares in a Russian insurance company must notify the regulator. The regulator may also request information on shareholders holding more than 10% from the insurance company at any time.

Solvency

The amended Law introduced a very important requirement related to solvency and financial stability of Russian insurance companies. Insurance companies engaged in pension insurance, annuities or investment types of life insurance and compulsory insurance must engage a specialised depository (custodian) to control their investment of capital and insurance reserves into securities. One of the most radical provisions of the amended Law provides that the custodian must exercise permanent (daily) control over the compliance with the investment guidelines set out by the law and the regulator. This requirement comes into force on 1 July 2015. The regulator will have a right to develop ad hoc tailored investment guidelines depending on the types of business that insurers are carrying out or if circumstances so require (e.g. to deal with a global financial crisis). It is totally prohibited to invest capital and reserves into promissory notes.

The amended Law requires a compulsory actuarial assessment of the activities of the insurance company to be carried out annually by an independent actuary (see below). The results of such assessment must be submitted to the regulator.

Other amendments related to solvency include a right of the regulator to monitor the activities of insurance companies based on various risk factors in a similar way that the Central Bank monitors the performance of banks. It is intended that the Central Bank will develop the procedure for this monitoring and one would expect that it will require, at the least, daily reporting from insurance companies, which will include key financial indicators.

Furthermore, the regulator has a right to define procedures and methodology for calculating tariffs and their indexation. These must be based on statistical data and the loss ratio for the previous three years in the case of non-life insurance tariffs, with this period being extended to five years for insurance tariffs of life insurers.

Finally, it is now possible to use subordinated loans for the purposes of the solvency margin calculation. The share of subordinated loans for these purposes cannot exceed 25% of the insurer’s capital.

The amendments also introduced a concept of an insurance group that is defined by reference to the IFRS. This concept is particularly important in the context of solvency requirements. The holding insurance company of the insurance group must comply with Russian solvency rules and other regulatory requirements on a consolidated basis. It must report to the regulator on a consolidated basis and runs a risk of losing its licence if it fails to meet the regulatory requirements or reporting deadlines. The details will be developed by the Central Bank as the new regulator. It is likely that the Central Bank will adopt the existing rules applicable to banking groups.

Another tool for securing solvency and the financial stability of insurance companies introduced by the amendments to the Law on Insurance is the concept of an insurance pool. While insurance pools exist in practice (e.g. the Russian nuclear insurance pool) there are no defined rules for their operation save for one sentence in Article 14.1 of the Law on Insurance, leading Russian competition authorities to, in some cases, regard insurance pools as cartels.

The amended Article 14.1 of the Law on Insurance provides that insurance (reinsurance) pool operates as a simple partnership without creating a legal entity. The pool must have the management structure, common underwriting and claims adjusting principles, acceptance and exit procedures, etc. It must reinsure risks of payment of insurance indemnity exceeding the aggregate capital of the pool members. Information on the pool including its members must be disclosed on the website of the pool or on the website of the leader of the pool.

Compliance

A large section of the amendments is dedicated to a completely new concept for the Russian insurance market, namely, internal audit and compliance. Technically, this statement is not entirely correct – subsidiaries of foreign insurance companies already have compliance systems and officers in place, but this has been driven by the requirements of their shareholders. Many Russian insurance companies also claim to have such systems, but they are usually focused on auditing the accounts and financial performance of the company. Now, every insurance company in Russia, regardless of the ownership structure, will be obliged to develop and implement a compliance policy and to appoint a compliance officer (an internal controller).

According to the Law, the purposes of the compliance system include ensuring efficiency and profitability of the insurance business, efficient investment and risk management, trustworthiness of the financial statements, compliance with ethical norms and professional standards, and preventing legalisation of crime proceeds and financing of terrorism.

Consequently, the amended Law provides that compliance functions are spread between various managing bodies and officers of the insurance company including its management, an internal auditor, a compliance officer (an internal controller), a chief accountant, an AML officer, an in-house actuary and other employees as defined by internal regulations of the insurer.

The Law describes, in some detail, what provisions the compliance policy must contain, as well as the procedure for the approval of the compliance policy, the appointment of the compliance officer, qualification requirements (see below), his authority and obligations, as well as reporting lines and procedures.

The compliance policy and information on the compliance officer form a part of the licensing pack that must be submitted to the regulator in order to obtain a licence.

Insurers have to adopt compliance policies and appoint compliance officers by 21 April 2014.

Licensing

The amended Law changes the approach to licensing. It distinguishes kinds of insurance activity and types (classes) of insurance. From now on the regulator will grant licences for the following kinds of insurance activity:

  • voluntary life insurance;
  • voluntary accident, health and medical insurance;
  • voluntary property insurance;
  • compulsory classes of insurance;
  • mutual insurance; and
  • inward reinsurance.

In contrast to the previous procedure, there is no need to submit rules of insurance, insurance tariffs and the rules for setting insurance reserves for licensing purposes. Once the licence for a type of insurance activity is granted the insurer has to submit these documents in relation to each class of insurance that it wants to underwrite. The list of classes has not changed and still includes 23 classes, including pension insurance, motor insurance, aviation liability insurance and so on. The only amendment to the list was the introduction of general class 24 covering various compulsory lines of insurance. Insurers must notify the regulator about any changes in these documents within the time frame and in accordance with the procedure to be set out by the regulator.

Perhaps this is an appropriate moment to mention another amendment that relates to the classification of insurance under Russian law. Until very recently there were difficulties classifying financial risk insurance. The Law on Insurance provides for this class of insurance, but the Civil Code does not recognise it. The amended Law defines financial risk insurance as insurance against unforeseen expenses and loss of income that does not relate to entrepreneurial activities. It is important to note that the Law on Insurance makes it possible to insure financial risk of a third party.

The amendments have also changed the qualification requirements for the management of insurance companies. To date, managers of insurance companies had to have a degree in finance or economics recognised in Russia. It is now only necessary to hold a higher education degree, regardless of the area. The degree must still be recognised in Russia. This resolves an issue of applicability of an MBA degree for the licensing purposes.

Another notable change is the eradication of a requirement for managers of insurance companies to permanently reside in Russia. This requirement did not apply to managers of subsidiaries of EU investors, but will now be completely abandoned. However, any foreign employee, including a manager of a Russian insurance company, must still hold a work permit. The two-year track record requirement has not changed.

According to the amended Law, the qualifications and experience required of the internal controller (the compliance officer) are also important for licensing purposes and are quite onerous compared to the requirements for the managers of insurance companies. The internal controller must hold a degree in economics, finance or law and have worked in insurance companies, financial institutions, auditing firms or state financial supervision authorities for not less than two years. To our disappointment, a track record in a law firm would not qualify!

The regulator will now have 30 working days to decide whether to grant a licence. This is a huge improvement comparing to the previous term of 120 calendar days!

There are other less significant and/or technical amendments related to the licensing procedure and suspension or revocation of the licence. The most radical of these is that the regulator can now withdraw the licence for a repeated failure to submit financial reports in time without prior notice.

Transfer of portfolio

Over the last few years the Russian insurance market has seen a number of voluntary exits as well as restructurings and bankruptcies of insurance companies. In all of these cases insurers or liquidators need to decide what to do with the existing suite of insurance contracts. Prior to recent amendments, the Law on Insurance only provided for a few basic provisions on voluntary insurance portfolio transfers and many insurance companies had to adopt a procedure based on the general principles of Russian civil law. Compulsory portfolio transfers have also not been specifically regulated by bankruptcy laws.

New Article 26.1 of the amended Law on Insurance incorporates a detailed description of the portfolio transfer process. It probably deserves a more thorough review so this article will only focus on a few of the main points and few new ideas such as the transfer of insurance portfolio with a premium or with a discount. The portfolio is transferred with a premium if it includes assets with a value exceeding the reserves under the policies comprising the portfolio. If their value is less than the reserves, the portfolio is transferred with a discount.

Regardless of the reasons for the transfer, insurers must enter into an insurance portfolio transfer agreement. The regulator will have to develop requirements as to the content of this agreement.

According to the amended Law, an insurer willing to transfer its insurance portfolio must publish a notice of the transfer in mass media and on its website, as well as send notice to the regulator to be published on the regulator’s website. The amended Law clarifies that there is no need to obtain written consents of policyholders to the transfer of the insurance portfolio. Policyholders have a right to say “no” but if they remain silent their policies are transferred to the new insurer. If a policyholder objects to the transfer, the policy is terminated and the policyholder entitled to the unearned insurance premium under a property insurance policy or the surrender value under a life insurance policy.

Intermediaries

Amended Article 8 of the Law on Insurance deals in much more detail with insurance agents and insurance brokers. Its provisions are further developed in other sections of the amended Law, for example, those related to licensing. Again, the format of this Alert does not provide scope to review all the changes that relate to insurance intermediaries, but it is worth mentioning a few very important developments.

Insurers are now obliged to keep record of all intermediaries they work with and publish the lists on their websites. The amended Law clarifies that insurance agents and brokers may collect insurance premiums from the insured and introduces a minimum capital requirement of three million roubles for brokers accepting insurance premiums from the insured. This requirement may be substituted by a bank guarantee for the equivalent amount.

A rather controversial change prohibits intermediaries from appointing themselves as beneficiaries under insurance policies concluded by them in favour of third parties. This provision is not the best example of legal drafting and it remains to be seen how it will be applied in practice. One could argue that only the insured can appoint the beneficiary and insurance agents (e.g. banks) do not usually conclude insurance contracts, but rather print out policies already signed by insurers. On the other hand, it may also result in a serious reconstruction of bank assurance arrangements and the ways insurers use other distribution channels (car dealers, retailers, etc.), pursuant to which insurance agents are also often named as beneficiaries in full or in part. This follows from the wording of another provision of the amended Law on Insurance which says that “the ban on insurance agents and brokers being beneficiaries under insurance contracts applies from 1 July 2014”. Clearly, this wording does not correspond to the main provision related to this restriction, which creates additional uncertainty and risks.

Another change that caused much surprise is the maximum limit of 10% on the commission an agent or a broker can receive for placing a compulsory insurance policy. This limit has been in place for quite some time in compulsory motor liability insurance, but the market players have generally found ways to overcome it. There is little doubt that they will be able to do so again, so it is unlikely that the introduction of this rule on a wider basis will achieve its intended purpose.

A further interesting provision relates to the definition of the insurance agent and the insurance broker. Previously, only Russian residents or Russian legal entities could act as insurance agents. Insurance brokers had to be Russian residents registered as individual entrepreneurs or Russian legal entities. The new version of Article 8 lifts this restriction, indicating that any individual or legal entity may act as an insurance agent or an insurance broker. However, an analysis of the section dealing with licensing of insurance brokers (insurance agents are not subject to licensing) indicates that only Russian residents and Russian legal entities can obtain a licence to act as an insurance broker. This is further supported by the provision only allowing foreign insurance brokers to act in reinsurance arrangements. As drafted, this provision does not distinguish (as it used to do) between domestic reinsurance and reinsurance to or from foreign (re)insurers. So, on the face of it, a foreign reinsurance broker may negotiate a reinsurance policy between a Russian insurer and a Russian reinsurer.

A very important change in the Law requires insurance agents and insurance brokers to publish a lot of information on their websites, including information related to the amount of their commission. It is not clear how this will be fulfilled as commission varies from policy to policy and many distribution (agency) agreements contain sophisticated formulas for calculating agency fees depending on the profitability of the insurance portfolio, etc. The Law also prohibits insurance brokers from receiving commission from both the insurer and the insured on the same policy.

Megaregulator

Together with the amendments to the Law on Insurance, the parliament approved amendments to various laws on the Central Bank of Russia. These amendments create a regulatory superpower on the Russian financial services market. As of 1 September 2013 the Central Bank will assume responsibility for regulating banks, insurance companies, insurance brokers, private pension funds, asset managers, investment funds and investment brokers.

Actuaries

The amendments to the Law on Insurance have been supported by a special draft law on actuaries. The purpose of this draft was to introduce a regulated actuarial profession and an independent actuary as opposed to an actuary employed by the insurer. The plan was that independent actuaries would assess reserves and obligations of insurance companies and pension funds and their reports would form a part of the reporting obligation of the financial services providers. However, the upper chamber of the Russian parliament, the Federation Council, vetoed the draft as it lacked internal consistency and proposed an excessive bureaucratic regulatory framework for the profession.

The conciliation commission has been formed by the State Duma and the Federation Council to try and overcome these issues. It is expected that the refined draft law on actuaries will be considered by the parliament this autumn.

Reinsurance

As detailed above, the amendments to the Law on Insurance mainly focus on regulatory issues. However, there are a few provisions dealing with certain civil law issues that have either been missing from the legislation or inconsistently applied by the courts. Some of these have already been mentioned in Part 1 of this Alert (e.g. the concept of the deductible). Others include important new rules for reinsurance and defining the sum insured under direct insurance contracts.

The amended Law on Insurance provides a general definition of reinsurance. This defines the concept as the insurance of the insurer’s interests related to his/her obligation to pay an insurance indemnity under a direct policy. This seems to confirm the position of the Civil Code: that the subject-matter of reinsurance is insurance of the insurer’s risk of payment of the insurance indemnity under the original policy. The amendments require insurance companies to reinsure the risk of payment of insurance indemnity that exceeds its own retention limit, as defined by the internal policies of the insurer.

The amendments introduce definitions of four different forms of reinsurance (facultative, obligatory, facultative-obligatory and obligatory-facultative) as well as two different types of reinsurance (proportional and non-proportional). This is the first time this has been done – as the Civil Code simply states that reinsurance is the insurer’s insurance while the court practice further suggests that the contract may provide otherwise. This development has been subject to some criticism as it seems to create more questions than answers. For instance, often in practice reinsurance slips and cover notes issued by foreign reinsurers or foreign brokers do not really indicate whether they are facultative or proportional, or otherwise categorised. Therefore, tax authorities or Russian banks acting as foreign exchange agents for the Government may take a view that a document that does not contain any of those words in its heading is not a reinsurance contract. This would probably not be an issue for domestic reinsurance as it would be easy to amend the policies if necessary. However, in the case of reinsurance with foreign reinsurers written on the basis of their standard reinsurance slips, the Russian reinsured may face a problem if it asks the reinsurer to amend its standard form reinsurance slip to include the relevant wording in the heading of the reinsurance contract.

In this context, one particular provision in the amended Law on Insurance stands out. As mentioned above, it stipulates that reinsurance is carried out on the basis of a reinsurance contract concluded between the reinsured and the reinsurer “in accordance with the requirements of the civil legislation of the Russian Federation”. As drafted, this provision seems to suggest that any reinsurance contract to which a Russian insurer or reinsurer is a party must be governed by Russian law. If this is the case, it could be a rather unexpected development for many market players…

Another civil law type amendment legalises a reinsurance profit commission (tantieme). Until now this was only mentioned in tax legislation, without a clear explanation of what it was. The amended Law on Insurance provides that the reinsurance profit commission is a part of the positive financial result of the reinsurer on one reinsurance contract or a group of reinsurance contracts over a certain period of time payable to the reinsured.

Returning to the subject of regulation of reinsurance, the amendments to the Law on Insurance prohibit reinsurance of compulsory motor liability risks from 1 July 2014. It is difficult to understand the logic behind this ban given the problems with capital and reserves facing many Russian insurance companies. By contrast, the ban on combining life insurance with non-life reinsurance is perfectly understandable. Finally, as explained above, Russian insurers must reinsure the risk of payment that exceeds their own retention.

Sum insured and investment income

Another civil law aspect addressed by the amendments is the long-awaited provision related to defining the sum insured. The Civil Code provides that a contract of insurance must contain the amount of the sum insured. Based on this rule, it has not really been possible to include flexible or varying sums. The amended Law on Insurance allows the sum insured to be defined in accordance with the procedure provided by the law or by the contract of insurance at its inception. This means various credit protection insurance products that have varying sums insured will now be easier to implement. Furthermore, the amended Law on Insurance makes it possible to conclude unit-linked insurance contracts where the parties define the method for calculating the sum insured by reference to the return on investment.

One final comment relates to the procedure of defining the investment income under life insurance policies that contemplate participation of the insured in the investment income of the insurer. The amended Law on Insurance provides that while the exact amount of such income is defined by the insurer, the method for calculating and distributing it among relevant life insurance policies must be developed by an association of insurers (e.g. by the All-Russian Insurers Association or by the Association of Life Insurers). The beneficiary has a right to see how the investment income attributable to him/her was calculated.

  1. Further afield

The magnitude of the recent changes to the legal framework for insurance in Russia is still to be realised. Even a broad review makes one wonder whether there can (or should) be more changes. It seems that policymakers have already got an answer, as the Government recently published the official version of the Insurance Market Development Strategy 2020. It is a long document establishing the road map for the insurance market development in various areas: political, business, social and legal. The Strategy indicates that there will be further amendments to the Law on Insurance, the Civil Code, tax laws and so on. Some of them will appear later, like legislation on insurance ombudsman, but a few will be implemented shortly, for example, the draft law on actuaries. However, most of the immediate changes will stem from the Central Bank as the new regulator.

It has been announced recently that there is a draft plan for developing the regulatory framework of the insurance market. This was prepared by the Federal Service for Financial Markets in anticipation of its takeover by the Central Bank and pursuant to the Insurance Market Development Strategy 2020. The draft plan suggests that insurance companies could not be organised as limited liability companies and should work on the basis of unified insurance standards and common terms and conditions, etc. The regulator would receive more powers to withdraw licences without warning, to block access to the market for those investors who have a tarnished business reputation and to appoint personal supervisors for big insurance companies similar to the supervisors overseeing big Russian banks. And this is just a short summary of the proposed changes!

Evolution goes on.