September 2007

European Commission final report: a stark warning to the insurance industry?

The European Commission (the “Commission”) has now adopted its final report (the “Report”) on the business insurance sector enquiry.   This follows on from the interim report published on 24th January 2007, in which the Commission highlighted a number of concerns on potentially anti-competitive practices within the insurance and reinsurance industry.

Key Findings

The Commission’s key findings are as follows:  

• Certain practices leading to premium adjustments when co-insurance and reinsurance is placed may be anti-competitive;
• There is a potential market failure as regards insurance brokerage;
• Where they are used, long-term contracts may limit competition (Austria is under review); and
• The industry has not provided any compelling justifications for the Block Exemption Regulation No 358/2003 (the “Exemption”) to be extended beyond its expiry date of 31 March 2010. The Exemption, put simply, enables insurers to share information.  

Premium adjustments

In its interim report the Commission expressed concerns that the use of “best terms and conditions” clauses (“BTC” clauses) may be anti-competitive.   The so-called BTC clauses allow a reinsurer to benefit from the best terms made available to other reinsurers sharing the same risk.  

The Commission investigated further and concluded that such practices are widespread, both in coinsurance and reinsurance, with or without an express BTC clause.   There is apparently a de facto alignment of premium and other terms and conditions, most notably in the two-step subscription procedure.   This procedure is seemingly anti-competitive, and the Commission is concerned the resulting “alignment” may lead to terms being agreed which are less favourable to the insured.   Yet the Commission takes the view that such alignment is not intrinsic to the operation of the subscription market, and the industry should therefore review this process.

Insurance brokerage

As in the interim report, the Commission points out that the dual role of brokers, as advisor to the insured and “distribution channel” for insurers, is a potential source of conflict of interest.  

The Report also claims that some market practices prevent insureds from making fully informed choices, and undermine fair competition.   These include the lack of spontaneous disclosure of remuneration received from insurers, incentives used by insurers to lure brokers into placing business with them and, in some markets, the prohibition by insurers of commission rebating. The Commission suspects that SMEs are most affected by these practices, leading to SMEs having to pay higher prices.

The Commission is clearly very concerned about those practices. The Report however acknowledges there are “multiple dimensions” to the issues raised and the Commission has decided to investigate these further in the context of the planned review of the Insurance Mediation Directive.

Next steps

Whilst the Report makes stark reading for insurers, reinsurers and brokers alike, the crucial point is that the Commission is not taking any enforcement action at this stage.  

As regards insurance brokerage the enquiry is, effectively, ongoing.   The same applies for the Exemption, where the Commission has until 31 March 2009 to submit a report on the functioning and the future of the Exemption.

Thus the most pressing issue is that of premium adjustments in the context of reinsurance and coinsurance. . In some markets these practices have been considered normal practice for many years.   The Commission nevertheless urges the industry to take a critical look at those mechanisms and engage in a dialog with the Commission on a case by case basis.   The outcome will either be that the practices will be found to be compliant, or they will have to be reviewed.  

Finally, the Report makes it clear that it deals only with a few selected key issues.   No assumption should be made that practices not earmarked by the Report have the Commission’s seal of approval.   The inevitable conclusion, it seems, is that this is not the last the insurance industry will hear from the Commission .