On February 8 2013 the European Commission published the long-awaited report commissioned by Ernst & Young (E&Y) into co(re)insurance pools and ad hoc co(re)insurance agreements on the subscription market.(1)
Co-insurance (whether offered by a pool or pursuant to an ad hoc agreement) involves multiple insurers entering contracts with the same insured for part of the same risk. Co-reinsurance allows very large loss exposures to be spread across international insurance markets in cases where individual insurers are unable to absorb the large losses that could result from a particular risk. The European Commission's 2007 sector inquiry into business insurance raised concerns that a number of features of ad hoc co(re)insurance might be anti-competitive. In 2010 the commission adopted the new Insurance Block Exemption Regulation (267/2010), which provides an exemption for the creation and operation of certain co(re)insurance pools.
Guidance issued at that time identified that ad hoc co-insurance arrangements which lead to rate alignment could be unlawful under Article 101(1) of the Treaty on the functioning of the European Union (TFEU), leading to substantial legal uncertainty in respect of a practice that has been the mainstay of the major insurance markets: "practices involving an alignment of premium (between co-(re)insurers through ad hoc co-(re)insurance agreements) may fall within the scope of Article 101(1) of the Treaty".(2)
The E&Y report was commissioned as an in-depth review of co(re)insurance pools and ad hoc co(re)insurance agreements across the European Union. The report considers:
- the differences between co(re)insurance pools and ad hoc co(re)insurance agreements on the subscription market; and
- whether the concerns raised by the commission's 2007 sector inquiry were still prevalent.
It is likely to feed into the regulation's revisions, which are due in 2017.
Overall, the report contains some helpful conclusions on the commission's purported concerns over ad hoc agreements (premium alignment and best terms and conditions clauses). With regard to co-insurance, the study hints at a perceived failure on the part of the industry to comply adequately with the regulation, particularly regarding assessment of market shares. There is a risk that the commission may use this conclusion to push for a rollback of the regulation as it applies to co(re)insurance.
As to ad hoc co-insurance (also known as subscription markets), the report does not signal any concerns - if anything, given the competitiveness of the market, the reverse. That said, the conclusions are based on the information provided by respondents and should thus be read with caution.
The report also identifies a gap in the commission's studies to date, in respect of line slips (or other broker facilitated arrangements between panels of insurers). This may be an area of follow up in the future.
The E&Y study hints at compliance issues with the regulation. Although most pools surveyed were aware of the regulation, response rates to questions relating to self-assessment, relevant market and market shares were said to be disappointing. The functioning of pools is heterogeneous and each pool requires assessment on its individual merits (Paragraph 315). It appears that while some pools reassessed their compliance following the entry into force of the current regulation (which altered how the applicable market share threshold was to be calculated), none of these pools reported a change in their compliance status. There is an outside risk that the commission will seize on this to further investigate the sector.
The sector inquiry report voiced fears that the alignment of premiums among co-reinsurers might be the result of agreements and concerted practices, but the E&Y study found no evidence of this (Paragraph 432, reflected on Page 3 of the executive summary).
Similarly, whereas the report focused on the harm posed by the use of best terms and conditions clauses (now discouraged by the European Federation of Insurance Intermediaries (BIPAR) principles), the E&Y study found that attempts by underwriters to impose such clauses are not regarded as acceptable practice and have been seen only rarely in the main four European markets in the past five years (Paragraph 435). More generally, the BIPAR principles were generally reported to be respected (Paragraph 433, reflected on Page 4 of the executive summary). This conclusion is perhaps unsurprising. Best terms were already on the wane in many major markets well before the EU sector inquiry, as they offended against contract certainty principles and were often negotiated away by intermediaries or clients.
The E&Y study's comments on premium alignment in the context of subscription markets are particularly helpful. They provide a strong riposte to the concerns voiced in the sector inquiry and Commission notice, that the alignment of premiums in a subscription market process - where the following market subscribes at the rate negotiated by the broker or client with the lead - could be seen as inherently suspicious:
"The present study indicates that in practice, premiums continue typically to align with the premium of the leader, notwithstanding that BIPAR principle 4 protects the right of parties to negotiate individual premiums. Based on respondents' views collected, the alignment reflects intensive competition in the market for the selection of the leader and hence for the corresponding initial determination of premiums, such that there is no further efficiency to be squeezed out of the following market. On this analysis, even though there is no constraint on seeking further reduction from individual (re)insurers in the following market, the marginal benefits that might be achieved are perceived to be less than the frictional costs of seeking them, and alignment of premiums reflects an equilibrium. Respondents emphasised that the market for large and complex risks is a global market with high capacity and that brokers and customers have strong negotiating power." (Paragraph 434, reflected on Page 4 of the executive summary).
The differences between co(re)insurance pools and ad hoc agreements are interesting, given the differing treatment between pools and ad hoc agreements under the regulation. The E&Y study's conclusions on these differences appear inconclusive and do not obviously support the differences in treatment under the regulation:
- While the majority of ad hoc agreements were found to take a similar form, pools are more diverse (Paragraph 485).
- There are many similarities between some pools and ad hoc agreements, mainly relating to the willingness of their members to take part, their expertise record and knowledge of risks and the capacity of the company (Paragraph 486).
- Whereas pools tend to be prompted by either government regulation or other external constraints, ad hoc agreements tend to be more market driven, with brokers (ie, agents of customers) playing a more active role than in pools (Paragraph 489). Again, this does not appear to support the more restrictive treatment of pools versus ad hoc agreements - if anything, the reverse.
- Pools tend to have been established to provide (often not for profit) types of insurance which it was felt that the market could not provide (Paragraph 487).
The report also identifies intermediary pools as an area potentially meriting further study. These arrangements - typically found in the Netherlands - as well as line slip type panel arrangements in the United Kingdom, cover the situation where brokers or authorised agents agree with insurers that the insurers will take pre-agreed percentages of business sold by the intermediaries, subject to acceptance by a lead insurer.
The E&Y study (Paragraph 149) notes that some respondents considered that this type of pool fell outside of the regulation, on the basis that it is not established "by insurance undertakings". However this seems open to doubt since the Insurance Block Exemption plainly foresees pools established by panels of insurers via a broker. This is something which the commission may consider warrants further guidance or investigation.
The commission has a workshop scheduled for March 12 2013, which will include a presentation by E&Y, followed by a discussion of its findings.(3)
For further information on this topic please contact Tom Jenkins or Bill Batchelor at Baker & McKenzie by telephone (+32 2 639 36 11 ), fax (+32 2 639 36 99 ) or email (firstname.lastname@example.org or email@example.com).
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(3) For registration details see http://ec.europa.eu/competition/sectors/financial_services/insurance.html#study.