At the onset of the 1980s, the insurance sector of the European economy was rather comfortable and quiet. Competition has been described as being quite gentlemanly. Insurance, under the umbrella of regulation, had long avoided rapid change. The domestic insurance markets were essentially of two types. The first, the continental model, involved an insurance business subject to a high degree of regulation, which discouraged product innovation. The primary mode of distribution consisted of agents tied to their companies. The second type, the Anglo-Saxon model found in the United Kingdom, Ireland, and the Netherlands, involved less prescriptive regulation, a wider range of consumer choice, and a distribution system dominated by independent brokers. With respect to individual business, minimization of risk rather than the client constituted the primary focus of management. The improved information technology available was regarded as a cost rather than an opportunity to improve marketing, productivity, and service. Other than the Swiss insurers, even those companies having foreign subsidiaries or branches had established only a marginal presence elsewhere throughout Europe. Furthermore, there was a sharp demarcation between the roles of the various providers of financial services, with only the United Kingdom having banks which ventured into the competition for insurance business.

By 1990, Europe substantially changed. Most European nations have moved toward greater deregulation. Consumers have become more sophisticated in seeking attractive products whether sold by local insurers or not. Barriers between insurance and other financial services have been eroded. Competition between insurers for size and market share has increased dramatically in both individual state domestic markets and Europe as a whole, leading to mergers, acquisitions, and alliances. Insurers have had to adapt to a rapidly changing environment in order to survive the trend toward market domination by a smaller number of insurers in each national market. At the same time, insurers, large and small, are threatened by competition from other financial institutions lured by the rapid growth in the insurance industry.

This emerging, fluid, and dynamic activity in the markets of Europe is rooted in the founding and growth of the European Common Market. In 1957, six Western European nations (Belgium, Italy, Luxembourg, France, Germany and the Netherlands) signed the Treaty of Rome and created the Common Market, more recently referred to as the European Community (EC), to foster the free movement of capital goods, services, and people across EC member borders. Under the treaty, insurers could provide cross border services, establish subsidiaries and branches in member states, repatriate dividends, and appoint management within the limits imposed by local law. Since the original founding, nine additional nations have joined the EC (Denmark, Greece, Ireland, Portugal, Spain and the United Kingdom, followed by Austria, Finland, and Sweden as of January 1, 1995).

Efforts to establish a true common or single economic market within the EC have been ongoing. In 1967, the EC established two governing bodies to initiate policies and legislation. The first is the European Commission (the primary executive body), which initiates policies and proposes legislation. The second is the European Council (consisting of representatives of the member state governments, normally at the ministerial level), which approves policies and adopts legislation. In 1985, the Commission launched a single-market program by publishing approximately 285 directives aimed at dismantling the remaining barriers to competition and free trade, with the view that this would be completed by the end of 1992. These directives were endorsed by the Council. In 1986, the EC member states ratified the Single European Act (SEA), which reaffirmed the objective of a single market and the 1992 timetable. The SEA removed the power of a unilateral veto and required that all decisions, other than those affecting human rights, defense, and some fiscal matters, be simply made by a majority of the member governments. The SEA also established the principle of mutual recognition, which means that EC members agree that the law and rules enforced in one country are recognized and acceptable to all others. Under the timetable, by December 31, 1992, all obstacles to a genuine single market within the EC were to be removed. There were to be no national regulatory barriers preventing free trade in services across EC member country borders nor were there to be barriers to free establishment of subsidiaries or branch operations by EC companies.

As planned, the EC largely completed its legislative framework by the end of 1992. Although incomplete in some areas, the framework already allows freer movement of people, capital goods, and services throughout the EC. In addition, the EC has made considerable progress toward the creation of a single market in insurance. Large parts of the framework are in place. When completely operational, the single market for insurance is anticipated to grant insurers complete market access throughout the EC as well as affording consumers a wider selection of insurance products at more competitive prices.

Underlying the efforts to establish the structure for free trade for financial services was agreement to two basic principles: (1) Members agreed to the need for harmonized standards among EC member countries for the regulation of financial institutions and consumer protection. Pursuant to the principle of harmonization, the EC reduces regulatory disparities among member states by establishing common minimum regulatory standards. The harmonization of standards permits member states to recognize the adequacy of each other’s regulatory and supervisory systems. Although each member state must adopt these standards, each state retains responsibility for supervising their national markets and generally retain some discretion as to how the standards are implemented. The EC harmonizes standards only in those areas deemed essential for the creation of a single market. (2) In areas where the standards are not harmonized, EC members grant mutual recognition to each member state’s regulatory bodies and supervisory standards. Underlying this principle is the assumption that each member country either has or will implement an effective system of insurance regulation upon which the other members can depend.

The EC insurance directives constitute the body of EC insurance legislation which provide the framework for the common insurance market. Since 1964, the EC has adopted 21 legislative directives on insurance. These directives harmonize key areas of insurance regulation by mandating certain minimum regulatory standards to be incorporated into the national regulatory systems of each member country. Thus, while insurers must conform to the law of each nation in which it does business, the law of each nation must conform to the common set of principles set forth in the EC directives.

Under EC insurance directives, no member country can restrict, on the basis of nationality, an EC-based company from establishing a subsidiary or a branch. The establishment directives introduced a common authorization procedure. If an EC insurer meets the requirements set forth in the directives, it must be granted permission to establish a branch or subsidiary. However, such establishment is subject to local rules, which do vary by country. The right of EC-based insurers to conduct business in another country by subsidiary or branch is termed trading by establishment. Formal authorization by the host country is required and the establishment must behave as part of that national market, including compliance with the host country’s regulatory and supervisory provisions. In essence, if an insurer is authorized in its home country (which is a member of the EC), the insurer is in effect licensed throughout the EC. The insurer possesses freedom to set rates, reserves, and underwriting criteria as long as it follows the local laws on marketing and distribution.

To ensure adequate supervision of the entire insurance company, the home state possesses sole responsibility for the financial supervision of the insurer’s operations throughout the EC. The home state must monitor the insurer’s compliance with the "minimum prudential standards" of financial soundness aimed at the maintenance of a sufficient level and mix of assets to ensure payment of policyholder claims and avoidance of insolvency.

The Director General of Financial Institutions of Company Law notes that the original approach of detailed harmonization was changed to a system of mutual recognition of member states’ legislation enabled by a minimum level of harmonization. However, this minimum level is not a minimal level. The prudential standards of regulation are very high in the EC, as attested by the limited number of failures in the past. Furthermore, mechanisms have been established to ensure cooperation among member states, and these are sufficient to deal with regulatory uncertainties. The EC has succeeded, according to the Director General, in bringing about important liberalization of its insurance markets.

Although the EC has adopted the key elements of its framework for insurance regulation and has issued directives pursuant thereto, according to the U.S. General Accounting Office (GAO), there remain three major sets of issues which may require further attention as the single insurance market becomes fully implemented. The first set of issues includes equal treatment of creditors and policyholders of all member states in liquidation proceedings, minimum qualifications for agents and brokers, the adequacy of the current minimum prudential standards, and problems associated with the regulation of standards of supervision of financial conglomerates.

The second set of issues requiring further attention relates to the continuing regulatory differences between the member states. The EC has no plans to attempt to harmonize these differences, which include taxation, contract law, valuation methods for assets and liabilities, supervisory reporting information, and anti-fraud measures. EC officials maintain that these areas do not require harmonization. They are sufficiently addressed by existing EC or member state mechanisms. However, the GAO notes that efforts were made to harmonize these differences, but such efforts failed because the differences were either too complex or too difficult to negotiate. Some observers believe that the absence of harmonization in these areas could undermine some of the objectives of a single insurance market.

The third set of issues noted by the GAO reflects uncertainties as to how some elements of the regulatory system will function when fully implemented. These issues include EC-wide financial supervision of insurance companies by home states based upon minimum prudential standards, the amount of cooperation required by the regulatory authorities of the various member countries, the resources and expertise available to each nation’s regulatory body, the criteria for one member country to take action against an insurer based in another member country, the definition of insolvency, and the financial effects of competition on insurers in the single market. To address this third set of issues, the EC and member countries have developed and are considering various regulatory mechanisms, such as an early warning system to enhance the home country’s financial supervision of life insurance companies.

The EC directives on life insurance include the concept of reciprocity under which a non-EC insurer may be refused access to the EC market if that insurer’s home country denies an equivalent right of access to EC insurers. That is, access to the EC depends upon the treatment of EC insurance companies in the foreign markets considered. The proposed rules for reciprocity posed two tests. The first, the "national treatment test," provides that if a non-EC country discriminates against EC insurers (that is, it does not treat EC insurers in the same manner as it treats its own domestic insurers), the Commission can mandate member countries to limit or suspend applications for authorization or acquisition by insurers from such non-EC country. The second, the "mirror image test," provides that if a non-EC country does not grant EC insurers "effective market access comparable to that granted by the Community to insurance undertakings from that third country," the Commission may propose to the Council that negotiations be conducted to obtain comparable competitive treatment for EC insurers.

Under these rules, if applied to the United States, for example, the Commission would first determine whether EC insurers in the United State are granted the same treatment as local companies or whether they are discriminated against (the national treatment test). This would not appear to be a significant problem since state regulation, as a general proposition, treats foreign insurers in a manner comparable to that of out-of-state and domestic insurers. The state insurance regulatory system does not discriminate against alien companies. Second, under the mirror image test, the Commission would ascertain whether EC insurer access to U.S. markets is comparable with that granted by the EC to U.S. insurers. If this test were applied, substantial problems could arise. For example, an insurer doing business in the United States must obtain a license in each state in which it does business, whereas a single-license approach is used in the EC. Also, under U.S. federal law, restrictions have been imposed on combining insurance and banking activities, unlike the current situation in Europe. Thus, strict application of the mirror test could result in U.S. insurers being denied entry into Europe.

There have been suggestions by some EC officials that the EC wants regulatory treatment and powers in the United States equivalent to those the EC grants its own and foreign institutions in Europe. Since this is unlikely to happen, at least in the immediate future, there have been concerns that the EC will establish barriers against non-EC companies, thereby creating a "Fortress Europe." However, it appears that the EC has backed away from such a stringent "Fortress Europe" approach. Indications are that the EC will not insist on the United States creating an internal market which is an exact mirror image of the EC market. But presumably the Commission will attempt to bring some pressure to bear on the basis of its reciprocity rules for liberalizations in the American regulatory scheme. Such pressure promises to contribute to the continued evolvement of insurance regulation in the United States.

With the implementation of the various Commission directives and the establishment of a single-license integrated insurance market throughout the nations making up the EC, the EC promises to create the world’s largest single market for insurance products. Some 4,000 insurers generating a premium volume approaching $500 billion will have direct access to a market containing approximately 380 million consumers. However, not all is likely to go smoothly. Some of the unresolved issues noted by the GAO illustrate potential problem areas. The Commission’s directives are issued within a loose-knit structure. Success depends upon the cooperation of national governments and regulators. It still remains to be seen whether divergent influences will allow the opening of national insurance sectors within the time frames envisioned. Not only do different philosophies on regulation have to be reconciled in practice, there still remain the cultural problems of doing business on someone else’s turf. European insurance buyers have the tendency to buy national, if not local. Directives notwithstanding, a truly single integrated insurance market may take longer to accomplish than some might hope. Nevertheless, monumental progress has been made and a strong trend towards a viable single market is moving forward, thereby increasing the internationalization of the insurance business.