Directive 2005/68/CE on reinsurance (the Directive) came into force on December 10, 2005. However, as is always the case for European directives, Members States were given time to implement it.The corresponding deadline for implementation was December 10, 2007.The main objective of the Directive was to introduce a minimum level of harmonised prudential supervision of reinsurers across the European Union, in advance of Solvency 2 which will apply to all insurers. Before the Directive, there was no European regulation addressing the prudential supervision of reinsurance business and the corresponding legal frameworks (if any) of the Member States were inconsistent and therefore inefficient from a single market perspective.

This is why the European Commission, through the Directive, intended to create a single European reinsurance market. Under the Directive, each reinsurer will be supervised by the competent authority in its home state and will be able to operate throughout the European Union.This is another application of the fundamental European principles of freedom of establishment and provision of services.Thanks to the Directive, European reinsurers will benefit from the same concept applicable to financial institutions know as ‘European banking passport’.

Insurance special purpose vehicles


Besides this corner stone principle, one of the most interesting provisions of the Directive is the introduction of a ‘special purpose vehicle’1 defined as “any undertaking, whether incorporated or not, other than an existing insurance or reinsurance undertaking, which assumes risks from insurance or reinsurance undertakings and which fully funds its exposure to such risks through the proceeds of a debt issuance or some other financing mechanism where the repayment rights of the providers of such debt or other financing mechanism are subordinated to the reinsurance obligations of such a vehicle”2.

National legal frameworks

The Directive leaves each Member State with the option to create an insurance special purpose vehicle (ISPV). For those Member States that decide to create an ISPV in their own jurisdiction, the Directive sets out minimum guidelines. In particular, Member States shall lay down their own legal framework regarding: 

  • the scope of the local official authorisation which is compulsory for the establishment of an ISPV on their territory; 
  • the mandatory conditions (if any) for inclusion in all contracts issued by the ISPV; 
  • the good repute and appropriate professional qualifications of the persons running the ISPV; 
  • the fit and proper requirements for the shareholders or members having a qualifying holding in the ISPV; 
  • the sound administrative and accounting procedures, together with the internal control mechanisms and risk management requirements applicable to the ISPV; 
  • the accounting, prudential and statistical information requirements applicable to the ISPV; and 
  • the solvency requirements applicable to the ISPV. Accordingly, the Member States may determine: 
  • the authorisation requirements; 
  • the solvency requirements; 
  • when amounts due from the ISPV can be counted as admissible assets to cover technical provisions; and 
  • when amounts due from the ISPV can be counted as reinsurance or retrocession in order to reduce the ceding firm's solvency requirements.

Alternative reinsurance risk transfer market

In substance, the Directive gives great flexibility to the Member States to encourage or limit the development of an alternative reinsurance risk transfer market.

Encouraging the development of such a market would certainly make sense in view of the conclusions of the ‘European Commission ART Market Study – Final Report’ published on October 2, 20003. According to this report, alternative risk transfer techniques and products such as securitisations provide solutions that would not exist in conventional insurance terms and it is to the benefit of the policyholders, together with the insurance companies and the reinsurance companies, that the latter be able to offer such techniques and products4. Furthermore, in an increasingly international competitive environment, it is in each Member State’s national interest to promote local legal tools and to avoid national blue chip companies taking advantage of foreign instruments.

On the other hand, nothing in the Directive prevents Member States from subjecting ISPVs to supplementary supervision within the scope of their national legislation, if they so wish; thus limiting the development of ISPVs established on their territory. This being said, Member States that choose not to allow the establishment of ISPVs within their territories still have to introduce rules setting the conditions for the use of amounts outstanding from an ISPV5 as assets admissible for covering technical provisions, since nothing prevents ISPVs from assuming risks from insurance undertakings established in other Member States6.

Implementation progress

As a result, each Member State has to implement all or part of the provisions of the Directive relating to ISPVs. Nevertheless, as at beginning of June 2008, not all Member State have done so. Accordingly, it is worth setting out where some countries stand in this process and which items are likely to create delicate discussions. Although it is always difficult to have a clear, exhaustive and up-to-date view of the implementation of a European directive across all Member States, it seems that7:

  1.  Austria, Bulgaria, Denmark, Estonia, Finland, France, Germany, Hungary, Italy, Ireland, Lithuania, Luxembourg, Malta, Slovakia, Spain and UK have implemented all or part of the Directive; 
  1. Belgium, Czech Republic, Cyprus, Latvia,The Netherlands, Poland, Portugal, Romania, Slovenia and Sweden are still working on the implementation of the Directive; and 
  1. amongst the Member States referred to in paragraph (1) above, France, Germany, Ireland, Luxembourg and UK, have provided for the existence on their territory of an ISPV. The following developments will focus on the main issues relating to the implementation of the ISPVs.

Supervision issues and discussions

Prior authorisation

As a general principle, the first paragraph of article 6 of the Directive states that the establishment of an ISPV requires prior official authorisation. Accordingly, there is no debate that the creation of an ISPV will require the prior authorisation from the competent authority determined by each Member State willing to accept the creation of ISPVs on its territory.

In some instances, the determination of such authority may have given rise to discussions – especially where the ISPV derived from an existing type of special purpose vehicle, as it is the case in France8. Ultimately, the competent authorities for France, UK, Ireland, Luxemburg and Germany are respectively the Autorité de contrôle de l’assurance et des mutuelles (ACAM), the Financial Services Authority (FSA), the Irish Financial Services Regulatory Authority (IFSRA), the Treasury and Budget Ministry (after investigation of the request by the Commissariat aux assurances) and the Bundesbank and German Financial Supervisory Authority (BaFin). In all cases, the establishment of the ISPVs is designed as a ‘light’ and ‘quick’ procedure compared to insurance companies. This is necessary to the extent that the Member States concerned want to encourage the European ISPVs to locate their operations on their territory.

Controlling powers

As the Directive only gives guidelines to Member States, once the competent authority has approved the establishment of an ISPV, the scope of powers of such authority over the life of the ISPV can vary from one country to another.The minimum power includes the right to have access, to request information and to withdraw its consent to an ISPV which does not comply with regulatory requirements. However, in some instances (such as in the UK), there is a greater emphasis on self-certification by the ISPV itself or supervision by the ceding insurer (or other insurer creditor) whereas, elsewhere (for example, in France), the competent authorities are willing to seek for a wider range of powers in between the two extremes: granting and withdrawing the ‘licence’ of the ISPVs.

Legal issues and discussions

Legal qualification

Before the Directive and other European regulations (in particular the European Directive 2004/47/CE dated June 6, 2002 on financial collateral9), implementing special purpose vehicles with the view to transfer insurance risks was quite delicate. One of the main questions was to determine whether the SPV was conducting regulated insurance or reinsurance activities.

The Directive is extremely helpful in this respect and provides clarity and certainty. According to its recital 32, ISPVs are not insurance or reinsurance undertakings. However, in some countries, further clarification is advisable as ISPV do conduct reinsurance-like activities and there is a risk that the agreements they enter to are re-qualified as ‘insurance contract’, therefore triggering unbearable regulatory constraints.This is why in France it is envisaged that the French insurance code expressly states that the agreements entered into by an ISPV do not qualify as insurance contracts.

Underlying insurance risks

With ISPVs being able to act de facto as reinsurers without entering into insurance agreements, certain authorities debated whether the nature of the insurance risks that could be transferred to an ISPV should be limited. It would seem that, ultimately, this is not the case and existing ISPVs legal frameworks do not limit the type of insurance risks transferable to an ISPV.

Full funding and subordination

The main legal issue regarding the operation of an ISPV results from the definition of the Directive. Indeed, the Directive requires that an ISPV ‘fully funds’ its insurance risk exposure through the proceeds of financing mechanisms ‘subordinated’ to its reinsurance obligations. These concepts of ‘full funding’ and ‘subordination’ are understandable in the context of the spirit of the Directive. By opting for the establishment of ISPVs, the Directive offers Member States the opportunity to extend on their territory their classical reinsurance capacity.The essence of the ISPVs is to fund their reinsurance liabilities through the issuance of financial instruments such as bonds or other debt instruments issued on the capital markets.

Since ISPVs are not subject to minimum solvency margin or capital requirement (see below), their only source of funds to face their insurance liabilities comes through the capital markets.Therefore, it is important that, once the funds necessary to face the reinsurance liabilities are raised through the capital markets, the corresponding proceeds and other assets remain sufficient throughout the life of the ISPVs to face the reinsurance risks they bear. Furthermore, it is as important that the repayment of the capital investors is subordinated to the payments due by the ISPVs to the ceding company (or other insurer creditors) in case of occurrence of the underlying insured risks.

In practice, these concepts are delicate and may give rise to different interpretations, the details of which can have significant impact, as local rules to be introduced by the relevant Member States may be qualitative and/or quantitative. For example, the FSA took the view that the term ‘fully funded’ simply means that the ISPV’s reinsurance liabilities must be capped at the value of the assets available to fund those liabilities10. Furthermore, the FSA issued guidelines in order to assess the ‘fully funded’ test, including, ultimately, the issue of external opinions to confirm compliance with such guidelines and full subordination of the finance providers to the claims of the ceding insurer or other insurance creditor towards the ISPV.

In Germany, the BaFin has taken the view that the present value of the ISPV’s assets must, at any time, be higher than the maximum potential claims of the ISPV arising under the underlying insurance risks. In order to meet such test, the ISPV may enter into hedging agreements. In France, at the time of writing this article, the situation was less clear-cut. French authorities tended to cumulate quantitative and qualitative tests. French ISPVs must be fully funded, i.e. at any time their maximum liabilities resulting from the underlying insurance risks, net of hedging agreements, shall not exceed their assets. However, the authorised investments in French ISPVs could be significantly restricted by quality tests; thus, increasing security for capital market investors and ceding insurers (or other insurer creditors) but reducing the economic interest of the transactions given the limited remuneration normally associated with very high quality/liquid investments. Finally, to reinforce the fully funded principle, the French law envisages to state that agreements entered into by ISPVs in order to transfer insurance risks cannot impose unlimited commitments to the ISPVs.

Regulatory capital issues and discussions

Absence of solvency margin

It would seem that all Member States have a common approach on ISPV’s solvency margin requirements.The only solvency rule is that the assets of the ISPV must be equal or greater to its liabilities.This rule is the essence of a special purpose vehicle and is therefore not a constraint. Accordingly and with the view to make ISPV attractive, no Member State has fixed a minimum solvency margin requirement.

Credit for the ceding insurer

A ceding insurer (or other insurance creditor) may benefit from a transaction with an ISPV from a balance sheet perspective to the extent that: 

  • amounts recoverable from the ISPV may be considered as reinsurance or retrocession in calculating the ceding insurer’s solvency margin requirement; and
  • amounts outstanding from the ISPV may be treated as reducing, or included as assets covering technical provisions.

In most transactions, these regulatory aspects are of chief importance to insurers and reinsurers11. Therefore, it is as important for the insurance regulators and it would seem that all Member States concerned have opted for a set of strict rules based on simple principles, namely: 

  • in order to obtain a favourable regulatory treatment, the ceding insurer must lodge a request to the competent authority; 
  • such request must be supported by evidence justifying the regulatory treatment; and • the competent authority must be in agreement with the proposed treatment.

In assessing the request, each Member State will have the same concerns, i.e. avoiding or mitigating the potential for the insurance risks transferred to revert to the ceding insurer and they will look at a number of features including the ability of the ISPV to comply with its financial obligations under stress scenarios, taking into account the economic analysis and the legal robustness of the structure. Some Member States may think of adding specific requirements, such as, as in France, the absence of significant correlation risk between the insurance risks transferred to the ISPV and the other insurance risks retained by the ceding insurer in order for the amounts outstanding from the ISPV to be admitted as assets covering technical provisions.12 However, in all cases, the Member States seem to consider that the primary tests for accepting a regulatory relief is the extent of actual insurance risk transfer to the ISPV.

This latter test is apparently objective but it leaves room for interpretation. Some Member States (such as the UK and the FSA) are likely to published appropriate guidelines; others (such as the ACAM) are likely not to do so.This, together with other discretionary areas, show that despite the Directive’s aim to harmonise, in jurisdictions where ISPVs will be incorporated, Member States will still have significant flexibility to encourage or to constrain the location of ISPVs on their own territory. All will depend on their appetite for increasing reinsurance capacity and the development of new tools to provide innovative solutions.