Merger IUA Market Briefing Implications of the EC Commission's Final Report on its Sector Inquiry in

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Merger IUA Market BriefingImplications of the
EC Commission's Final Report on its Sector
Inquiry into Business Insurance
Angela Anthonisz Emailed to Louise Cosgrove
Alexandra Kamerling 08.01.08 _at_ 10.20

• Alexandra Kamerling Charles Gordon
• DLA Piper UK LLP
• 9 January 2008

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Contents

• Overview of the EC Commission's Inquiry
• Summary of key conclusions reached
• Implications for the subscription market
• Other recent developments and reform proposals
• Discussion/QA's

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Background to Business Insurance Inquiry

• Insurance Block Exemption adopted February 2003
• EC investigates aviation insurance post 9/11
  closed March 2005 following certain reforms to
  promote more competition and transparency
• US Spritzer Investigation into brokers 2004
  2005
• EC opens Sector Inquiry 13 June 2005 September
  2007
• Numerous questionnaires to trade associations,
  large and small insurers, re-insurers, and
  brokers
• Public Hearing 9 February 2007

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Scope of the EC Inquiry

• "Business Insurance" not consumer policies
• Jointly set standard policy conditions offering
  only limited possibilities for the demand side to
  negotiate terms of coverage, or otherwise
  restricting competition
• Distortive forms of cooperation may take place
  within framework of insurers' associations and in
  the context of co-insurance
• Certain arrangements for distribution of
  insurance products and services to business may
  give rise to competition concerns

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EC Interim Report 24 January 2007

• Main Findings
• Sustained differences of insurer's underwriting
  profitability
• Long-term insurance contracts and certain
  distribution structures (Austria, Italy, the
  Netherlands and Slovenia) barriers to market
  entry
• "Best terms and conditions" clauses in direct and
  re-insurance contracts leading to harmonisation
  at most favourable level for the re-insurers
• Conflict of interest of the insurance
  intermediaries
• Lack of transparency of intermediaries'
  remuneration
• Notable differences in the degree of cooperation
  among insurers in different Member States raises
  doubts as to the justification of such
  cooperation and scope of the Insurance Regulation

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EC Main Findings Final Report 27 September
2007

• Profitability levels high for some time (although
  with significant variations both in terms of
  business lines Member States SMEs v large
  corporations)
• Underlines market fragmentation and scope for
  savings from further integration
• EC may propose additional EU measures to
  encourage greater market efficiency (DG Financial
  Services)
• Market Definition
• National/multi-domestic
• Little cross border competition constraint
• Entry mostly by acquisition
• Of relevance in merger analysis

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EC Main Findings Final Report 27 September
2007

• Harmonisation of terms conditions for co-ins
  and re-ins
• Recognition of benefits of multiple (re-)insurers
  taking part in a given risk allows for greater
  capacity and risk diversification, and results in
  lower prices and better terms for clients
• BUT some practices "might" fall within Article
  81(1) and "not necessarily" be exemptible under
  Article 81(3)
• Breach of Article 81 means illegal contract and
  risk of fines (and in UK criminal sanctions)
• BTC's used predominantly in re-insurance but also
  co-insurance can result in harmonisation for the
  benefit of re-insurer and detriment of direct
  insurer increase prices increase transparency
  between competitors
• Subscription market - harmonisation of practices
  resulting in de facto alignment of premium and
  conditions of coverage
• "No evidence of actual collusion" but EC
  concerned "may act at least in theory to underpin
  collusion"

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EC Main Findings Final Report 27 September
2007

• Distribution of business insurance
• Dual role of brokers results in potential
  conflict of interest
• Conflict also arising from systems of broker
  remuneration ie contingent commissions
  (provider bias/product bias)
• Lack of transparency regarding broker
  remuneration transparency would not resolve
  conflicts of interest
• Remuneration practices may result in competition
  for brokers not necessarily for conditions of
  cover and service
• Prohibition by insurers of granting commission
  rebates to customers is likely to amount to RPM
  (Italy and Germany)
• Limited competition in relation to price and
  mediation services for SME customers
• Further review in context of the Insurance
  Mediation Directive (2002/92/EC)

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Horizontal cooperation among insurers

• Current Regulation expires 31 March 2010
• Comments submitted as to the benefits of various
  forms of cooperation rather than the need for a
  block exemption
• Cooperation that does not restrict or distort
  competition may not be caught by Article 81(1)
• Cooperation that is caught may benefit from an
  Article 81(3) individual exemption problem is
  self-assessment and legal uncertainly/risk of
  breach

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Summary

• Follow up by EC or national competition
  authorities
• "Certain practices leading to premium alignment
  when co-insurance is purchased through a 2-step
  process involving a lead and following
  (re-)insurers"
• "Instances where a pervasive market practice of
  long term contracts may lead to cumulative
  foreclosure"
• "Indications of potential market failure in
  respect of insurance brokerage"
• Renewal of the Insurance Block Exemption
  Regulation

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Implications of the Report

• The Subscription Market
• What impact could the EU enquiry have?
• What other regulatory legal changes are on the
  horizon?
• The Role of Intermediaries
• Where next for regulatory reform?

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Subscription Market

• What was the EC's main aspiration for future
  change?
• "The Commission invites the customers of
  business insurance and reinsurance which is
  typically awarded on a subscription basis to be
  aware of the possibility of awarding such
  business on terms which do not imply harmonised
  premiums and to ensure that wherever this is
  appropriate, this option is fully explored by
  risk managers and brokers"

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Subscription Market

• EC not so concerned with other aspects of
  subscription market
• "The practices of revealing the price of the lead
  insurer in the subscription phase, guaranteeing
  the lead insurer's share and aligning the terms
  of cover other than the premium are less likely
  to raise concerns from a competition law
  standpoint "

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Subscription Market

• Question for the market
• Can or should more competition as to price be
  brought into the subscription process?
• Response needed "in month not years" EC
  official. But no legacy breaches!
• Each insurer to be seen to independently evaluate
  premium
• Brokers to seek more advantageous terms from
  following market
• More customer involvement
• Impact on contract certainty
• Impact on reinsurance

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Subscription Market

• Other legal/regulatory changes the UK Law
  Commission
• Placing information
• Misrepresentation/non disclosure
• Breach of warranty

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The role of intermediaries

• EC view
• "Brokers act both as an adviser to their clients
  and as a distribution channel for the insurer,
  often with underwriting powers and binding
  authorities. This dual role is a potential
  source of conflict of interest between the
  objectivity of the advice they provide to their
  clients and their own commercial consideration"
• No immediate action but a concern whether
  "disclosure of commission alone is sufficient
  to mitigate conflicts of interest"

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The role of intermediaries

• Where next for regulatory reform?
• The FSA continues to focus on disclosure of
  remuneration
• UK Law Commission
• Whose agent should the broker be? Role in
  communication of pre-contract information

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Merger IUA Market BriefingQ A's
Gillian Askew Emailed to Louise Cosgrove
12/09/2007 at 1214hrs.

• Alexandra Kamerling Charles Gordon
• DLA Piper UK LLP
• 9 January 2008