Legal focus: Insurers drowning in regulation

Legal focus: Insurers drowning in regulation

Uncertainty about the regulations being proposed and adapted by authorities in the European Union and in the US is fixed on the minds of insurers worldwide. Ambiguities in the potential outcomes to these regulatory projects mean that lawyers are predicting that advising clients on compliance questions will be a big growth area for law firms in the year ahead.

“I don’t think there has ever been a period in which so many rules were in flux,” says Bill Marcoux, a partner at DLA Piper. “There is truly an unprecedented amount of regulatory change underway. Moreover it is not only the rules that are changing but also the regulatory architecture.

“The core issue is both the quantity of regulatory developments and changes and the structure changing that makes it a challenging environment for both insurers and reinsurers, particularly those operating in multiple jurisdictions,” he says. “These companies must stay abreast of and anticipate the new rules and establish the right relationships with the new regulatory bodies and the other constituent parties.”

Solvency II

In all likelihood Solvency II is unlikely to be implemented before 2016, despite several years of preparation by the industry and regulators already. The delay and uncertainties caused by it are adding to increasing confusion within the industry.

“Solvency II continues to be delayed,” says Mike Munro, partner at CMS Cameron McKenna. “The UK Prudential Regulatory Authority (the PRA – formerly the FSA) is looking towards an implementation date of 1 January 2016, but there is no certainty around that, and the date may well shift back further. It's not ideal and, in the meantime, the PRA is now consulting with the European Insurance and Occupational Pensions Authority (Eiopa) on interim measures – referred to be some as Solvency 1.5.”

Eiopa’s consultation was heavily criticised by insurers when it was released last month, and the constant delays in the implementation of Solvency II has led to some insurers questioning whether it should happen at all. Munro however points to important reasons underlying the ongoing delays – as correspondence between Eiopa and the European Commission (EC) makes clear.

“In effect, the EC seems to be saying that rebuilding the European economy is a bigger priority,” says Munro. “There is a real need to boost growth across Europe, and one element of that is encouraging increased investment in infrastructure and long term projects. However, with banks deleveraging and government finances challenged, other sources of long-term finance are needed.

European life insurers and pension funds are potentially key to that. Together they hold assets worth over 100% of European GDP and the EC wants to incentivise them to increase their investment in infrastructure and other projects. Unfortunately, the Solvency II rules as currently proposed would act more as a disincentive, so the EC wants the draft rules to help with the wider growth agenda.”

This marks a step in the EC’s attitude towards prudential regulation as a priority, relative to more immediate concerns, such as the eurozone crisis. There is also a political factor to the issue of whether Solvency II has the potential to make insurers more risk averse in certain assets or lines of business in Europe, which could exacerbate other EC political or economic concerns.

“There's clearly a political element to this between the EC and Eiopa,” says Munro. “Eiopa's remit is to ensure that the regime is suitably prudent – and if the rules are to be changed for political or economic reasons, that is probably more of an issue for the EC.” says Munro.

“This situation reflects a growing realisation that there are two conflicting political objectives in operation,” agrees Chris Southorn, partner at CMS Cameron McKenna. “On the one hand, there is the drive to impose tighter regulation on capital management and prudential risk for the financial services sector in general; on the other, there is the need to allow the industry's funds, and particularly those of the life companies, to bolster growth in key areas.”

The need for the EU to encourage and stimulate the fragile European economy is clear. The crisis in Cyprus further demonstrated Europe’s weakness, and the sovereign debt problems faced by several euro zone countries. Such crisis issues have bled over to affect the EC attitude to Solvency II.

“Everyone recognises and I think the European regulators recognise this too, that putting in a whole new regime for regulating capital can have a lot of unintended consequences, given that the European economy is not very healthy right now,” says Geoffrey Etherington, a partner at Edwards Wildman. “It would be risky to change the rules.”

Given these conflicts, it is likely that Solvency II will continue to be delayed until priorities change and a suitable middle ground can be found between risk-based regulation and economic growth. Until uncertainties subside, insurers and reinsurers will have to keep in regular contact with their legal partners to stay abreast of the raft of changes in flux, sliding delays and interim stop-gap measures.

US Regulation

US insurance regulation is still split between federal authorities and state-level insurance commissioners, regulating for each of the 50 states. However, the implementation of the expansive Dodd–Frank Wall Street Reform and Consumer Protection Act, and the establishment of the Federal Insurance Office (FIO) have added new aspects to the regulatory picture.

The FIO was tasked with reviewing the insurance industry and presenting recommendations to Congress. This has been delayed for over a year already and, according to Dan Gerber, partner at Goldberg Segalla, the FIO: “in reality does not have teeth anyway”. Regulatory power remains concentrated at state level, which poses problems of consistency, nationally and internationally for equivalence negotiations with the EU.

“The state regulators meet individually through the National Association of Insurance Commissioners (NAIC), and therefore the issue remains equivalency,” he says, adding that Superstorm Sandy has demonstrated challenges in the consistent running of the US regulatory system.

“The main issue that insurers face over the next year and the next few years is in the northeast as a result of Sandy,” he says. “New York and New Jersey have recently put out regulations requiring the insurance industry to go to mediation in almost all claims on a personal line basis that are denied. There has been very little guidance into what the scope of that mediation will be or what the rights of the parties will be.

“We know that in New York the American Arbitration Association will be running that programme, but even they are struggling to put together how the machinery will run, there is very little guidance on what to do if an insurer rejects a claim because it was the wrong property or it was not covered, the industry was frankly not consulted or worked with on these programmes,” adds Gerber.

The pressure of complying with various state regulations across the Unites States puts significant legal pressure on insurers and the possible federal measures will present more legal challenges to the industry.

“Everyone has been waiting for Dodd Frank and the FIO report on the state of the industry and future regulation,” says Etherington. “That’s now over a year late, they have said that it will be out sometime this summer, however we don’t know whether that will be a non event or not.”

Uncertainty over potential federal regulation will most likely lead to greater demand for legal counsel. However until there is further clarification on Dodd Frank implementation and until the FIO presents its final report to the industry, this is subject to uncertainty. What is clear is that the industry is paying close attention to potential reforms.

“Dodd Frank showed a new level of federal interest and involvement at least in the surplus lines and reinsurance reform” says Robin Willcox, general counsel and corporate secretary at Munich Re America. “The FIO, even though it is not a regulator, is the voice of the federal government in our industry, and clearly the long overdue FIO reports on the modernisation of the state system and on reinsurance are going to be key influences on how the federal government tries to shape the industry going forward.”

The overdue release of the FIO recommendations means that 2013 is likely to be a crucial time for lawyers and general counsels in the insurance and reinsurance industry. Lawyers and their clients await whether or not the recommendations will call for a change in the state regulatory system, and if the New York and New Jersey style of mandatory mediation is adopted by a greater number of states that are affected by natural catastrophes. This would cause an increased demand for legal counsel. It also means that general counsels and their legal partners would spend a far greater proportion of their time dealing with claim disputes.


The litigation footprint of Sandy is yet to be clearly formed, but there is concern within the industry that it could lead to a new series of arbitrations in relation to unpaid claims in the North East.

“Traditionally New York has been a state that the worldwide insurance industry has looked to as one that is favourable to insurers,” says Gerber. “All the law that exists there may not be favourable in every specific case but there has been well developed law. This is why we have seen the Bermuda Form applying New York law even in London arbitrations.”

“You now have a Manhattan based jury pool and group of judges that lived through the storm, much like the jury pool in Hurricane Katrina,” he says. “Law firms are moving in from Texas, Florida and New Orleans setting up shop here and setting up mobile vans to sign up claimants. We are going to see a wave of Sandy litigation and as a result of the jury pool and judges we may see a shift in what was once considered more favourable insurance law to less favourable over the next five years. We may look back at this moment and say it started here,” adds Gerber.

Zurich North America’s general counsel Dennis Kerrigan thinks that although Sandy is likely to cause an increase in litigation, he believes that legislative reform can play a part in easing the burden of litigation on insurers.

“Obviously natural catastrophes do have an impact on litigation environment, although sometimes there is a delay in the actual filing of cases because claims are still being adjusted, insureds may still be rebuilding, and damage estimates may still be in progress,” he says.

“So there is often a lag in the filing of litigation – the cases are not all filed a week after the storm. Nevertheless, most natural catastrophes, whether it is tornado activity in the south eastern part of the US, Sandy in the northeast, or even last year's drought in the Midwest, will have an impact on litigation. On the positive front, however, tort reform continues to be the subject of a great deal of state and federal legislative activity, which is having an effect in certain areas of lowering the overall volume and severity of litigation,” adds Kerrigan.

Litigation challenges are also expected in the European market. “The major challenges are going to come from the bottom end, in the UK at least where the civil justice reforms are starting to take root and they are going to have significant repercussions for underlying liability claims here,” says Clive O’Connell, a partner at Goldberg Segalla, heading up its London office.

He thinks this will change the way in which liability claims are brought, and may make it easier for claimants to bring liability claims to court. This will affect the way claimants’ firms operate, and therefore the way in which the defences to liability claims happen.

“What this ought to do is reduce the legal spend involved in adjusting liability claims it might however make the bringing of liability claims that much more accessible,” says O’Connell. “It will certainly bring a big change to the ownership and management of claimants’ firms now that non legal interests can invest in law firms I think that we are going to see a swathe of purchases of what’s left those firms and a very much more entrepreneurial dynamic thrust behind them working on very low margins but on large turnovers to develop work. That could have implications for us all.”

O’Connell also warns that courts in the UK are beginning to view liability differently. “There has been over the last 20 years a real shift in the way that courts have viewed liability,” he says. “In the past people looked towards the welfare state to protect them but now courts are looking much more at finding liability where they can.”

O’Connell also notes that elsewhere in Europe, state funded solutions are also under pressure. “Asbestos liabilities and other liabilities building up to an extent where state funded solutions are not going to be able to cope anymore,” he says. “There are a lot of countries in Europe where money is not easily found with the Euro Crisis and other things going on and that is going to some extent in the future see those countries looking for other ways to support victims, and that may ultimately come from liability laws and therefore from the insurance industry.”

Life Insurance

Many challenges face the life market in 2013, however according to Gretchen Cepek, general counsel for Allianz Life Insurance Company of North America, perhaps the biggest issue facing the US market is the retirement crisis and the need for lifetime income.

“The statistics are difficult to ignore,” she says, adding that 75m baby boomers in America are starting to retire, with approximately 10,000 retiring every day. Yet, confidence in retirement readiness remains woefully low.

Worryingly, the Employee Benefit Research Institute recently reported that 28% of Americans have “no confidence” they will have enough money to retire comfortably—the highest level that figure has reached in the study’s 23-year history.

Similarly, the Insured Retirement Institute found that the percentage of baby boomers confident in their retirement preparations has declined by 7 percentage points in the past two years, from 44% in 2011 to 37% in 2013.

“Unfortunately, with the uncertain future of Social Security and lack of people with traditional pensions, Americans have more responsibility for their own retirement security than ever before,” says Cepek. “Annuities are important components in helping to address this retirement crisis. One of our most significant challenges as a legal department is to help navigate these products through a very complex regulatory environment. Our success in doing so is important not just for the company, but for the many consumers who can benefit from the products we offer.”

Cyber liability

“The industry may be waiting for its Hurricane Katrina moment with respect to cyber,” says Gerber.

Cyber security is likely to be an important driver in insurer’s plans in 2013 to address the growing risk of cyber attacks and exposure to cyber liabilities. He thinks that underwriting methods to deal with cyber risk can be split into two approaches.

“One is a tick a box approach: how much are your annual revenues; what type of IT security do you have in place; a tick here and a tick there,” says Gerber. “The other is a much more sophisticated approach. You dip your toe in the water and work with the insurer to understand their processes and then underwrite the risk.

“Under that first approach where a lot of cover is just being thrown out there, people are saying we will win on some and lose on others. If there was a large attack then it is likely that the risks may not have been appropriately underwritten,” he says. “We have not had a that significant breach which has caused substantial third party losses, we have had a lot of response costs and a lot of notification costs but no significant third party claims that have rise out of a cyber event. When that happens I believe that it may cause the industry to seriously evaluate this risk.”

Huhnsik Chung, a partner at Edwards Wildman in New York claims that insurance industry must first try harder to understand the risks associated with cyber attacks in order to price them effectively. He thinks that the challenge of cyber risk pricing will take the industry some time to come.

“I think the insurance industry itself has to come to grips with what the exposures depicted by this risk that they’ve signed on to really are,” he says. “It is an exposure that the industry as a whole generally is not familiar with. There are some market leaders that have been writing these types of policies starting seven or eight years ago. Some of those leaders have now pulled out, with others taking a bigger chunk. Every time however that there is a breach, millions to tens of millions of dollars are at risk in responding to a breach, in insuring that there is appropriate monitoring going on, that there is appropriate remediation of the problem that led to the breach, and ultimately liability payments can arise from it.”

“Many insurers are still supplying cover for this type of exposure as an add on policy which has the potential to be disastrous for the insurer “I know that as an add on to a standard policy,” says Chung. “For $50 you can get an endorsement that covers such an exposure and you may have some limits: maybe $1m; perhaps $500,000; maybe even $100,000. Getting $50 for that kind of coverage – when you could have a disgruntled employee that steals all the credit card information and names it – is a frightening prospect.”

Added to that, the rise of cyber attacks as a new method of international conflict will also increase willingness to buy protection against the risk, according to O’Connell.

“We have seen issues like the cyber attacks by North Korea on South Korea,” he says. “This raises in people’s minds the need to buy protection it is whether or not the right protections can be sold at the right price; this is the big question. Businesses out there are more aware, now more than ever, of the need to have protection. What nobody is sure of is what form that protection should take.”

By Sam Kerr –

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October 2018


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