Insurance Guarantee Schemes (IGS) – guide

The European Commission has proposed changes to existing European rules to further improve protection for bank account holders and retail investors. Furthermore, the Commission has launched a public consultation on options to improve protection for insurance policy holders, including the possibility of setting up Insurance Guarantee Schemes in all Member States. Insurance Guarantee Schemes (IGS) provide last-resort protection to consumers when insurers are unable to fulfil their contract commitment.

1) What are Insurance Guarantee Schemes?

Insurance guarantee schemes (IGS) provide last-resort protection to consumers when insurers are unable to fulfil their contract commitment, offering protection against the risk that claims will not be met if an insurance company is closed down.

Insurance is crucial to our economy. If insurance policies are disrupted, for example as a result of the offering insurance company going bankrupt, this can have serious consequences for consumers as well as businesses An example could be when the claim for your burnt-down house cannot be paid out at all. Companies could likewise be forced to suspend or cease activity if the reimbursement from insurance companies is not paid in a timely way.

IGS can offer protection by paying compensation to consumers, or by securing the continuation of their insurance contract through for example facilitating the transfer of policies to a solvent insurer or the guarantee scheme itself.

2) Do all EU Member States have Insurance Guarantee Schemes?

No, of the 30 EU-EEA countries, only 12 operate one or more general insurance guarantee schemes. Countries where IGS are available are: Bulgaria, Denmark, France, Germany, Ireland, Latvia, Malta, Norway, Poland, Romania, Spain and the United Kingdom. This means that, measured in terms of gross written premiums (the revenues/premiums expected to be received by the insurer over the life of a contract), one-third of the entire EU-EEA insurance market lacks any kind of coverage by an IGS in the event an insurance company has to close down. This means that 26% of all life insurance policies and 56% of all non-life insurance policies are unprotected. (See table in the annex)

3) Why has the Commission adopted a White Paper on Insurance Guarantee Schemes?

Guarantee schemes are available in other sectors of the financial services industry. In particular, deposit guarantee and investor compensation arrangements are in place in all EU Member States, and minimum protection standards have been harmonised at EU level with the implementation of the 1994 Deposit Guarantee Scheme (DGS) Directive1 and the 1997 Investor Compensation Scheme (ICS) Directive2. However, there is no such common European framework in the insurance sector.

Where Insurance Guarantee Schemes are in place, they differ frequently in coverage, resulting in different levels of policyholder protection between Member States. There are also significant differences in other aspects of IGS design that affect the scope of the protection provided, and in operational procedures and funding arrangements.

The lack of harmonised IGS arrangements in the EU hinders effective and equal consumer protection. It may also impede the functioning of the internal insurance market by distorting cross-border competition. In light of the lessons drawn from the recent crisis, the development of harmonised insurance guarantee schemes could contribute towards remedying these existing deficiencies. In the White Paper on IGS, the Commission sets out a coherent framework for EU action on IGS protection for policyholders and beneficiaries. In particular, it proposes introducing a directive to ensure that all Member States have an IGS that complies with certain basic criteria (such as insurance policies to be covered, geographical scope, funding etc.).

4) Why does the Commission propose a European solution based on minimum harmonisation and not on maximum harmonisation as compared to the amended draft proposals on the Deposit Guarantees and Insurance Compensation?

Today’s White Paper sets out the Commission’s vision of a coherent and legally binding framework on IGS protection based on minimum harmonisation. This would allow Member States to provide for a higher level of protection if they believe this is necessary and appropriate for their markets.

Compared to the banking and securities sectors, there is no legislation on IGS at EU level. This also means that the current landscape on IGS protection is fragmented in the EU. Twelve countries have one or more schemes in place, sometimes even differing in design in the same country. It is the Commission’s primary objective now to address the most significant problems associated with the current situation. While full harmonisation of IGS protection might be envisaged at a later stage, this is unlikely to be practical or feasible at this stage.

5) When would an IGS be used?

A range of alternative mechanisms exist to reduce the likelihood that insurance companies become insolvent and to limit the impact such an event would have. These include prudential regulation, effective risk management and governance structures, rules on additional information to be given to policyholders, preferential treatment of policyholders in winding-up proceedings as well as public intervention on a case-by-case basis.

However, the collapse of insurance companies cannot be ruled out. In order to avoid taxpayers’ having to pay out in the event of insurance failure, an IGS should be established as a last resort mechanism, which would come into effect when other protection mechanisms had failed. Providing for an IGS as a last resort mechanism may not only contribute to the objective of achieving comprehensive and even levels of policyholder protection but may also enhance confidence in the financial sector and thus have a positive impact on the rest of the economy.

6) How does this relate to the new solvency rules for the insurance sector?

In April 2009, the European Parliament and the Council of the EU agreed on a package of measures that would introduce a modern, economic and risk-based regime for the supervision of the insurance sector in Europe.

Once this package, known as Solvency II, becomes operational (it shall become applicable by 31.12.2012), it is expected to further reduce the incidence of failures. However, neither the current nor a future solvency regime will be able to create a zero-failure environment in the insurance sector. In the event of the insolvency of an insurance company, the lack of appropriate insurance guarantee protection for consumers may trigger a number of harmful effects. These include financial hardship incurred by consumers, an unlevel playing field for industry, and a loss of consumer confidence in the market. This is why the Commission is now coming forward with a White Paper on Insurance Guarantee Schemes.

7) Should an IGS be European or national?

While establishing a single pan-EU guarantee scheme could present a number of advantages, it would seem very difficult at this stage and pose complicated legal issues. At present, the most realistic and useful approach is to establish relevant schemes at national level, which ensure that all Member States are in a position to ensure comprehensive and even levels of protection of policyholders and beneficiaries in the event of an insurer’s insolvency and to require appropriate levels of funding from the insurance sector.

8) Should policyholders and beneficiaries be protected to the same extent regardless of where in the EU they buy an insurance policy?

Yes, the main objective of EU action in the field of IGS protection is to ensure that policyholders and beneficiaries get comprehensive and even levels of protection throughout the EU, regardless of whether they have bought their insurance policy in a domestic or in a cross-border setting: for example when buying insurance for a second home in Italy while living in Belgium, or buying life assurance in Belgium from a local branch of a firm whose headquarters are located in Germany. The Commission has identified in an impact assessment that a considerable proportion of cross-border insurance business lacks any kind of IGS protection. This does not only affect policyholders and beneficiaries in the event of insolvency of an insurer, but also creates an uneven playing field for insurance companies established in the EU.

9) What does the home country principle mean as compared to the host country principle?

Insurance Guarantee Schemes based on the ‘home country principle’ cover not only those policies issued by domestic insurers but also those sold via the free provision of services or by branches of those domestic insurers which are established in other EU Member States. By contrast, Insurance Guarantee Schemes based on the ‘host country principle’ cover policies issued by domestic insurers at national level (but not those sold in a cross-border context) as well as those issued via the free provision of services or by branches of incoming insurers from other Member States. In practice some Member States operate a combination of home and host country arrangements when it comes to cross-border business. This means that those IGS extent coverage to all policies sold by domestic insurers at national level and in their cross-border business, as well to those policies issued by incoming insurers on the domestic market.

10) Who should be covered by an IGS?

The Commission believes that both life and non-life insurance policies, except motor insurance policies which are already sufficiently protected under EU and national legislation, should be covered by a comprehensive framework on IGS protection in the European Union and that this should be for the benefit of all natural persons. In order to strike a balance between the objective of comprehensive consumer protection and cost-effectiveness, coverage of legal persons should be restricted to those legal persons who satisfy certain criteria, e.g. micro and small undertakings.

11) How should an IGS be financed?

At this stage the Commission believes that IGS established at national level should be financed ex-ante by contributions from insurance undertakings. This ensures that the insurer which becomes insolvent will have made prior contributions to the scheme. Moreover, it would be in line with the approach on funding adopted in the banking and securities sectors and has worked well. The determination of how much an individual insurer will pay should take into account the risks each insurer is willing to take. Risk-weighting contributions in this way will shift a larger proportion of the costs associated to the scheme onto riskier insurance undertakings.

12) How big should an IGS be?

The size of funds depends on what IGS are expected to do. Based on preliminary assessments of the Commission, it may be appropriate to set the target level of IGS at 1.2% of gross written premiums per year, taking into account an appropriate transition period. Building up IGS, particularly in those Member States where no IGS have been established so far, will take a number of years and it will be important to balance the overall costs of any new requirements on insurance undertakings against the expected benefits.

13) What will be the follow-up to the consultation on the White Paper?

All interested parties are invited to provide their views and comments on the White Paper by 30 November 2010. The Commission will carefully evaluate the feedback received and take it into account when coming forward with a legislative proposal. It is intended that work on the proposal will start immediately after the end of the consultation period and it is envisaged that a legislative proposal will be tabled in the course of 2011. This proposal will be accompanied by another impact assessment.

Annex

Estimated funds available in existing Insurance Guarantee Schemes (in millions of euros)

* – ex-post funded scheme

Notes

1 : Deposit Guarantee Scheme – further information

2 : Investor Compensation Scheme Directive

Source: European Commission