The insurance industry is facing serious changes in market conditions and in the legal environment, especially due to the new Solvency II regulations. Here are some legal issues we see dominating 2012.
Implementing Solvency II into national legislation: Close monitoring advised
Solvency II enters into force on 1 January 2013. In 2012, national legislators and regulators will pass the necessary national implementation laws. There is ample room for national variations and insurers are strongly encouraged to closely monitor drafts of national legislators and regulators to safeguard the interests of the insured.
The introduction of Solvency II will be especially burdensome for small insurers. While Austrian market participants do not currently see a need for a market consolidation, several small carriers in the CEE/SEE market are seen as facing severe merger pressure, thus opening M&A opportunities. Cross-border mergers are one option for EU carriers.
New life insurance products – New legal issues in product design
Endowment life insurance is having hard times. Capital market and bond returns are at historical lows, which makes it difficult to sell the existing products. Only products with capital guarantees seem to be marketable in the current environment but guarantees trigger costs, further reducing returns. This triggers a series of new legal issues in the life insurance business.
First, the cost of third party guarantees must be passed on to the consumer. But cost efficient guarantee models are flexible; therefore, cost can neither be agreed on a fixed EUR-basis nor on a percentage of the premium. This fact might be a serious impediment for transparent agreements with consumers, depending on the national interpretations of the transparency requirement in the existing consumer directive and Art 5(1)b of the new consumer directive, which requires also insurers to provide the consumer:
in a clear and comprehensible manner [with] the total price inclusive of taxes, or where the nature of the goods or services means that the price cannot reasonably be calculated in advance, the manner in which the price is calculated, as well as, where applicable, all additional freight, delivery or postal charges or, where those charges cannot reasonably be calculated in advance, the fact that such additional charges may be payable.
Second, careful selection of a third party guarantor is a key prerequisite in keeping liability far from the carrier. The Lehman experience shows that an insolvency of a third party guarantor is no mere theory but a new reality that insurers must deal with. No explicit legislation exists as to the duty of care in the selection process, but it is questionable whether a mere rating check (eg, AA+ or higher) is sufficient. An own due diligence and additional fairness opinions are possible solutions to exercise maximum diligence.
Third, unit-linked products will be under pressure to offer low cost fund structures. ETFs seem to be a possible solution, but they bring additional counter-party risks that must be made transparent to the consumer to avoid inpractice surer liability. And removing existing funds from the offered portfolio just for cost reasons might not be possible if the insurer explicitly or implicitly agreed to offer those funds for the duration of the contract.
Fourth, the guarantee model should be described in detail in the GTC and agreed with the policy-holders. In particular, CPPI guarantee-models contain a potential conflict of interest. The guarantor wants to ensure that the guaranteed sum is secured at the end of the term. Individual policyholders, on the other hand, want to participate in the possible profits on the capital market during the whole term. This potential conflict must be addressed in the GTC.
All these issues – and many more – will have to be taken into consideration when designing new life products and drafting general terms and conditions.
The introduction of Solvency II will be especially burdensome for small insurers. While Austrian market participants do not currently see a need for a market consolidation, several small carriers in the CEE/ SEE market are seen as facing severe merger pressure, thus opening M&A opportunities.