December 14, 2016

Legal systems must respond to unprecedented challenges facing the industry

Brexit, Donald Trump, elections in France and Germany – next year is unlikely to be quiet

Predicting the future is a risky business. It is fair to say few people looking forward at the end of 2015 would have anticipated the bigger stories 2016 has seen, particularly in the UK with Brexit and with the presidential election in the US.

The insurance market is facing its own challenges: a combination of digitalisation, technology, low interest rates, and ongoing legislative and regulatory reform create a uniquely demanding and competitive environment.

Many of the larger insurance markets have plans in place to enact further reforms in the coming year as successive governments recognise enhanced regulation and clearer codification of the legal frameworks are necessary for a successful insurance market.

In the UK 2016 saw the enactment of the Insurance Act; in 2017 the practical impact of this will become clearer as claims start to emerge. While the act to a large extent has codified existing market practice and legal precedent, there are areas ripe for disputes, such as around the meaning of "fair presentation of risk", determining the application of the proportionate remedies and around the precise operation of section 11.

Despite initial fears the Brexit vote would delay the proposed reforms to personal injury claims, the government has continued with its consultation to bring forward a package of measures to drive down minor, exaggerated and fraudulent soft tissue injury (whiplash) claims.

The reform package could save the industry around £1bn ($1.27bn) yearly. However, the proposed increase to insurance premium tax (IPT) announced in the chancellor's Autumn Statement could negate the benefits to consumers. These reforms are proving controversial in some quarters, with the claimant lawyer lobby in particular campaigning against them; however, insurers, constantly looking for ways to battle fraud, broadly welcome the proposals. 

HM Treasury is now consulting on the draft Risk Transformation Regulations, which will provide for the formation and registration of protected cell companies to facilitate the development of multi-arrangement insurance-linked securities (ILS) vehicles in the UK and associated tax regulations.

Both regulators are jointly consulting on the details of their proposed authorisation and supervision framework. Speed to market will undoubtedly be a critical component of London’s ILS proposition and one that must be fulfilled if London is to become an ILS hub. 

The impact of Brexit on UK insurance law is difficult to predict. The exercise of disentangling EU law from UK legislation is expected to be long and arduous. The latest proposal is to enact the Great Repeal Bill, which will retain most of the existing EU legislation until such time as primary legislation can be enacted.

Political uncertainty

Elsewhere in Europe legal changes lie ahead, both in the context of Brexit and with political uncertainty in France and Germany. With both countries facing elections next year, it remains to be seen whether new governments will continue to pursue reforms.

Globalisation is leading to more international claims – in Germany, for example, particularly for directors and officers, increased litigation is expected to continue. Securities class action litigation against entities and their directors and officers is increasingly becoming a global issue.

The influence of third-party litigation funders is changing the global litigation map, with third-party funding being pivotal in the development of collective actions against financial institutions and commercial entities and their directors and officers in the UK. We are increasingly seeing an industry of global shareholders utilising the best of the different procedural laws and opportunities.   

Regulation regularly tops lists of concerns for global corporates and we can expect further regulatory reform in 2017. Solvency II in Europe is being mirrored in some jurisdictions; in South Africa, for example, the Twin Peaks model will see the creation of a prudential regulator, the Prudential Authority, housed in the South African Reserve Bank, with a dedicated market conduct regulator, the Financial Sector Conduct Authority.

In China, the path of regulatory development is two-fold, with a focus both on providing a regulatory framework to facilitate global investment, and domestically on corporate governance. Aside from the C-Ross regime, the regulator is establishing detailed rules for offshore reinsurers to provide collateral guarantees and/or letters of credit in respect of reinsurance transactions with cedants in China.

Regulators in the Middle East continue their moves towards risk-based capital models for insurers and increasing the requirements for intermediaries. This reflects a drive by the United Arab Emirates Insurance Authority and the Saudi Arabian Monetary Agency to encourage consolidation in the insurance sector. There will continue to be a focus on corporate governance and compliance requirements as regulators seek to comply with international standards.

Despite this fast-moving regulatory change, the relative non-accessibility of regulatory materials in certain jurisdictions, sporadic implementation and supervision standards, will continue to confound regional insurance markets.

Cyber risks also remain high in the list of priorities, particularly with the introduction of mandatory breach legislation in a number of jurisdictions, and with the General Data Protection Regulation in Europe coming into force in 2018.

With the expected introduction of mandatory breach legislation in Australia in 2017 and the resulting potential for financial exposure and reputational damage to the company and directors, who may incur personal liability as a result of a data breach, directors' and officers' insurance is expected to be particularly affected, both in Australia and elsewhere. Directors will need to ensure that robust cyber resilience frameworks are embedded in their companies, consistent with the expectations of Australia's corporate regulator. 

Data breaches are occurring daily, globally, and both legislation and insurance penetration have yet to keep pace. The recent data breach impacting a number of major Indian banks, thought to have been caused by malware on an ATM network, compromised the security of an estimated 3.2 million customers in one of the country's largest-ever cyber incidents. Cyber security continues to be an after-thought in every sector of the Indian economy. 

Wake-up call

Incidents such as this may serve as a wake-up call and help to precipitate a reversal of the low growth trend in the cyber insurance market. More Indian insurers are now including cyber as part of their treaty arrangements and are recognising the scale of the opportunity and looking to launch new cyber insurance products. Many of them will seek collaboration with foreign insurers that have greater experience and capacity in writing cyber insurance business for reinsurance and underwriting support.

The need for the insurance industry to focus resources on innovation, with technology presenting both an opportunity and a potential for disruption cannot be overlooked. It is notable that the most significant legal changes which are anticipated globally are backward looking; as legislation and regulation seek to catch up with the post-2008 landscape. Looking further forward, are the existing legal systems equipped to address the unique challenges that the fast-paced technology revolution may bring. 

For most of 2016, investment in insurtech has outpaced investment in other areas of fintech. In 2017, entrepreneurs, investors, existing insurers and other players in the insurance industry in the US will intensify their efforts to bring innovation and modernisation to the sector. These developments will affect every part of the insurance industry – but especially in personal lines – from sales and marketing through underwriting to administration of claims.

However, existing state laws and regulations will require a rethink to avoid stifling such innovation as many were formulated to address the sale and administration of insurance in ways that will cease to be relevant. In the longer run, insurtech developments might even put pressure for more federalsation of insurance regulation as new technologies will have a greater nationwide reach, such that state-level regulation of insurance may become increasingly difficult to administer.

With the insurance market facing unprecedented challenges, it will likely look very different in five to ten years' time; the legal systems that underpin the market will similarly have to adapt to meet this change.