From mid November 2018 until 28 February 2019, the Swiss Federal Council held consultations on a partial revision of the Insurance Supervision Act (ISA). Subject to completion of the legislative process and the referendum period, the revisions will likely enter into force around 2022.

The proposed bill will update existing provisions in the ISA to bring them in line with international standards and rectify perceived inadequacies in the current regulations. It will also introduce completely new provisions to regulate the restructuring of (re)insurance companies, an explicit statutory basis for the Swiss Solvency Test (SST), product governance and conduct-of-business regulations for specific investment products and, last but not least, a system of differentiated supervisory intensity to better reflect the specificities of the retail/wholesale and professional insurance markets.

By Petra Ginter¹ (Reference: CapLaw-2019-12)

1) Introduction

The Insurance Supervision Act (ISA) has regulated Swiss (re)insurance companies and insurance brokers on a Federal level since 2006. Since then, it has seen only minor amendments. The partial revision that the Swiss Federal Council published for consultation in November 2018 aims to implement regulatory developments in the insurance as well as financial sector of the recent years into the insurance regulations.

Restructuring Framework

Firstly, new provisions on the restructuring of (re)insurance companies shall be introduced. The aim is to be able to restructure (re)insurance companies in the event of financial distress. Under the current law, the Swiss Financial Market Supervisory Authority FINMA (FINMA), as the responsible regulator and authority to initiate insolvency proceedings against Swiss based (re)insurance companies (and certain non-regulated substantial group companies within a FINMA supervised (re)insurance group), only has the option to liquidate such companies directly. The proposed new restructuring regime will close this gap for (re)insurance companies which are currently the only companies under Swiss law for which a restructuring is not available. In addition, by adequately implementing international standards, it aims to improve the protection of the insureds and further supports the reputation of Switzerland as (re)insurance market.

Differentiated Supervisory Intensity

Secondly, a new client categorisation shall be introduced and serve as benchmark for the respective level of prudential supervision. Insurance companies that only deal with professional clients shall benefit from lighter supervisory requirements, such as the release to hold tied assets as coverage for insurance claims. Besides the new client categorisation, the proposed rules include additional elements of deregulation. For example, companies with particularly innovative business models shall be exempted from supervision completely if the rights of the insureds are sufficiently protected. The aim of such deregulation measures is to give (re)insurance companies more flexibility in the use of financial resources and strengthen the Swiss financial centre.

Conduct-of-Business and Product Governance Regulation for
Investment Products 

Thirdly, similar to the conduct rules for financial service providers under the new Financial Services Act (FinSA), which do not directly apply to (re)insurance companies, the draft bill contains specific rules of conduct for specified insurance products.

The following paragraph provides more detailed information on the key aspects of the various proposals. It also indicates where the industry is no amenable to the proposed provisions and has provided counter-proposals during the consultation period. 

2) Key Aspects of the Revision

a) Introduction of a Restructuring Framework (Draft article 52a-article 52m)

The current ISA does not contain provisions on the restructuring of a (re)insurance company. At the same time, ISA explicitly pre-empts operation of the otherwise applicable restructuring provisions in the Debt Collection and Bankruptcy Act. This has resulted in considerable legal uncertainty on how FINMA as the competent authority would be entitled to proceed to protect the interests of the insureds. 

In many hypotheticals, the interests of the insureds are best served by keeping their (re)insurer operating as a going concern rather than by proceeding to a liquidation. Life and health insurance policies are a case in point. Aside from the theoretical and practical difficulties of a close-out valuation of insurance policies, early termination of life and health policies may result in the insureds effectively losing cover altogether. Upon liquidation of the insurer, it may be difficult if not impossible for the insureds or for members of the former collective to obtain replacement cover at reasonable rates: the equivalence principle may lead to substantial increases in premiums, and existing illnesses or age may further result in exclusions/reservations of cover. 

The current regulatory framework is insufficient to account for the interests of the insureds: article 51 conditions FINMA’s authority to issue protective measures on the failure of the (re)insurer to comply with regulatory requirements or a determination that insureds’ interests are compromised. Within the (non-exclusive) list of possible protective measures, article 51 (2) (d) explicitly provides for the possibility to transfer an insurance portfolio to another insurance company. This list does not contain other  important tools that are commonly deployed in a restructuring context, such as capital measures or the possibility to intervene into the rights of third parties. 

Against this background, it is appropriate that sector-specific statutory insurance regulation equips FINMA with a comprehensive toolkit.

The proposed restructuring regime includes procedural as well as substantive provisions. The procedural provisions provide the legal basis for FINMA to order different steps in the restructuring procedures and to issue the associated delegated legislation. The substantive provisions specify various restructuring measures, such as:

– the transfer of a (re)insurance portfolio to another (re)insurer or rescue company (Auffanggesellschaft);

– the continuation of the (re)insurance portfolio within the existing carrier with the right to intervene into the rights of the creditors;

– the reduction and subsequent increase of the share capital; or 

– the conversion of specific debt into equity rights (bail-in). 

When ordering restructuring measures, FINMA must ensure that no creditor will be worse off than he/she would be treated in the bankruptcy (so-called “no creditor worse off than in liquidation” principle). The proposed bill also alters the (re)insurance creditor hierarchy: It introduces a new creditor class to rank between the privileged creditors and the normal third-class creditors for claims of (re)insurance creditors to the extent such claims are not covered by tied assets (such as e.g. reinsurance claims). These (re)insurance claims rank higher than e.g. senior debt creditors.

The goal of a restructuring is to overcome the insolvency threat and to avoid the bankruptcy of the (re)insurance company while keeping the focus on the protection of the insureds. This may, but need not, result in the continuation of the original (re)insurance company. The (re)insurance agreements of the insureds may also be continued by transferring them to another (re)insurance or rescue carrier. Another possibility is the run-off of the original (re)insurance company. In the run-off, no new business is written and the existing (re)insurance contracts will be fulfilled. The (re)insurance company will be released from supervision once all (re)insurance agreement will have been fulfilled.

b) Differentiated Intensity of Supervision (Draft article 30a-article 30d)

The current ISA is based on the principle that all insureds (i.e., irrespective of whether they are private persons, small or mid-size companies, large corporates or direct insurers) require the same level of protection. The law does not tie the supervisory regime to the level of protection of the respective category of insureds. As of today, the only exception to that rule is that for companies that only conduct reinsurance business, a lighter supervisory regime applies (article 35).  

The draft bill changes this approach: insurance companies transacting with professional insureds will benefit from relaxed regulation and reduced supervision. Crucially, primary insurance companies will no longer have to cover their liabilities to professional insureds with tied assets. From an operational point of view, this is a welcomed piece of deregulation. The tied assets rules as currently enforced forbid any manner of comingling with non-tied assets, raising operational costs (separate custody/cash accounts etc). The rationale behind the recalibration of supervisory intensity is that professional insureds should be in a position to fend for themselves, i.e. to apply security measures and be able to assess the financial strength of the counterparties from which they buy insurance as well as the details of the insurance agreements themselves.

The precise delineation of the category professional policyholders is one of the most debated elements in the draft bill. It should operate on clear quantitative criteria and align with article 98a of the Insurance Contracts Act (also currently under revision). 

c) Other Areas of Deregulation

i. InsurTech Solutions (Draft article 2 (3) and article 11)

Under the current regulatory framework, any business a (re)insurance company wishes to undertake and which resides outside and is not ancillary to the business of (re)insurance is subject to prior approval by FINMA. In deciding whether or not to grant approval, article 11 provides FINMA essentially with unlimited supervisory discretion. 

The draft bill establishes a more flexible supervisory regime for innovative insurance solutions. Under the revised article 11, FINMA must grant approval to operate non-insurance related business provided that these activities do not compromise the interests of the insureds. In case FINMA were to dismiss a request by a supervised (re)insurance company, it must provide a reasoned and properly documented decision.

The industry welcomes the proposed liberalisation. However, the Swiss Insurance Association (SIA) voted in its response to the consultation to further relieve innovative (re)insurance solutions from regulatory constraints and thereby strengthen the competitiveness of the Swiss financial market. As a consequence, the SIA suggested to introduce a new supervisory category of “simplified supervision” if certain conditions are fulfilled and to implement a “supervisory free” category for small innovative businesses of up to CHF 1 million business volume which products have limited economic relevance and are offered to a maximum of 1,000 insureds (sandbox model). In addition, the SIA recommended to further relax article 11 and permit (re)insurance companies to offer insurance related as well as insurance supplementary services (to the extent that the risks of the latter do not exceed 10 per cent of the entire target capital of the (re)insurance company).

ii. Tied Assets Rules for Foreign Branches of Swiss Insurers
(Draft article 17 (2))

Article 17 (2) obliges a Swiss-domiciled carrier to hold tied assets as cover for foreign insurance liabilities, unless the foreign jurisdiction concerned mandates equivalent asset coverage. This requirement disadvantages Swiss insurance companies which are active on a cross-border basis vis-à-vis foreign competitors operating under less prescriptive insurance regulation.   

The draft bill abandons the requirement to hold tied assets for the insurance portfolio abroad if the insurance is offered through a local branch.  

iii. Penal Provisions (Draft article 86 and article 87)

The draft bill recalibrates the enforcement model away from penal provisions and the threat of monetary fines to the primacy of supervisory review and enforcement. It retains only those penal provisions that protect crucial elements of the supervisory framework and lowers the maximum level of fines which may be imposed. 

The intention is to align the penal provisions in the ISA with the penal provisions in the recently enacted FinSA (articles 89-92) and implement the principle that lawful behavior shall to the extent possible be ensured through regulatory and supervisory instruments.

d) Additional Clarifications

i. Clarification of the Statutory Basis of the SST (Draft article 9, article 9a and article 9b)

The Swiss Solvency Test (SST) is the risk-based solvency regime for Switzerland. The SST is implicitly already covered in the ISA. With the proposed new rules, the SST shall find an explicit and clear legal basis in the ISA which clarifies the powers of the Swiss Federal Council. At the same time, the revised provisions shall replace terminology in the current law which still relates to the old solvency provisions. The revised rules do not aim to change the calibration of the SST. This will need to be addressed in the implementing Insurance Supervision Ordinance (ISO) and/or the FINMA guidance.

The SIA pointed out in its response to the consultation that it supports the revision of article 9, 9a and 9b. It recommended, however, to broaden the wording in article 9a (1) which determines the valuation methods for the risk-bearing and target capital. According to the recommendation of the SIA, the valuation method for positions in the balance sheet shall be changed from “market values or mark to market values” to “on a market compliant basis”. This is particularly relevant for balance sheet positions without an obvious market value which is e.g. the case for the insurance technical obligations. The broader wording would be in line with international standards (see Standard ICP 14.5.7. of the International Association of Insurance Supervisors (IAIS)).

The proposed adjustment to article 9a (1) shall ensure adequate capital requirements, and consequently safeguard the competitiveness of the Swiss (re)insurance industry as well as the interests of the insureds. In addition, the SIA suggested to explicitly include in article 9b that the Swiss Federal Council should consider the particularities of the specific insurance activity (such as whether the business is of a short-term or long-term nature) when issuing the implementing ISO provisions. 

ii. Supervision of Swiss Branches of Foreign (Re)insurers
(Draft article 2 (1) (a) and (b))

The draft bill updates the supervisory regime applicable to foreign (re)insurers’ Swiss branches exclusively underwriting business outside of Switzerland. 

The proposed article 2 (1) (a) explicitly states that a (re)insurance company with a domicile in Switzerland is in any event subject to FINMA supervision, irrespective of the type of (re)insurance activity it undertakes. With such clarification it becomes obsolete to list the individual primary and reinsurance areas which are subject to supervision on the statutory level. This is in line with current practice.

Foreign insurers which undertake primary insurance activity in or from Switzerland are already today subject to FINMA supervision, unless an international treaty exempts such activity. The key change effected by the draft bill is to also subject reinsurance business underwritten in or from Switzerland to FINMA supervision, to the extent that foreign reinsurers establish a branch office in Switzerland. Recent years have seen an increase in the number of foreign-owned branch offices conducting non-supervised reinsurance business from Switzerland. The draft bill intends to close this gap which has come under increased scrutiny as of late and has given rise to reputational concerns. Existing Swiss branches of foreign reinsurance companies, will benefit from a grace period of six months before the requirement to comply with the supervisory rules becomes effective. 

iii. Internal Audit (Draft article 27 (2))

The current article 27 (2) authorises FINMA in specific circumstances to release (re)insurance carriers from the duty to implement an internal audit function. Such exemption option shall be abandoned given that it is no longer in line with today’s governance requirements for financial institutions and caused an issue under the European Union’s third country equivalence regime.

e) Insurance Broker Regulation (Draft article 42-article 45)

The proposed conduct rules for insurance brokers provide for a level playing field with the conduct rules in the FinSA. The conduct rules should be specifically tailored to the needs of the insureds, i.e. not every insurance advice provided by an insurance broker is subject to the same level of conduct rules (see next paragraph f)). The independent insurance broker has to disclose the compensation he/she is paid by a third party for providing the services. In addition, an insurance broker must not simultaneously act as dependent and independent insurance broker due to the independent insurance broker’s fiduciary duties vis-à-vis the insureds.

The SIA further suggests in its response to the consultation to introduce an education and professional development obligation for insurance brokers as well as a uniform registration duty for all insurance brokers with an independent private registration authority supervised by FINMA. These measures aim to safeguard the quality of the brokerage activities.

f) Specific Life Insurance Regulation (Draft article 37 and
articles 39a et seqq)

Analogously to the FinSA, the proposed ISA rules require from the provider of qualified life insurance products the drafting of a base information document, specific information duties, a suitability assessment as well as proper documentation. According to the proposed article 39a, life insurance products for which the insured bears an investment risk as well as capitalisation and tontine products are covered by the definition of qualified life insurance products. 

The SIA considers such definition, however, as too broad and wants to limit it to unit-linked life insurance and capitalization products without guaranteed performance as well as tontines products in order to align with the scope of the FinSA requirements. 

The SIA criticised in the consultation that the pension conversion guarantee premium (Rentenumwandlungsgarantieprämie) for the pension fund business should be explicitly included in the ISA. Considering the excessive pension fund conversion rate, life insurance companies need to be in a position to obtain adequate premiums in order to appropriately finance the old age allowances. 

3) Implementing Regulation

The revision of the ISA will also need to be further specified in the ISO and potentially other implementing regulations by FINMA. The consultation on the revision of the ISO can only be initiated once the deadline for requesting a referendum on the level of ISA has elapsed without a referendum being requested.

Petra Ginter (petra_ginter@swissre.com)

¹ To the extent the author expresses any view or projection in this article, it is the personal view or projection of the author and does not reflect a policy or position of Swiss Re or the Swiss Insurance Association.