With more than 93% of premiums collected outside the Grand Duchy,(1) Luxembourg life insurance has undeniably contributed to the dynamism of the European passport with regard to both freedom of services and freedom of establishment.(2)
Luxembourg life insurance is mainly a passported activity and is thus marked by cross-border issues shaped by local developments that require constant monitoring by practitioners, particularly when it comes to one of the sector's leading products: life insurance linked to investment funds.
Life insurance linked to investment funds, more commonly referred to as 'unit-linked life insurance', gives rise to a number of questions when used in the international context due to its composite nature. One such question is the division of powers between the various legal orders that make up the sphere of pan-European life insurance.
The difficult but nonetheless appropriate distinction between prudential and contractual matters can provide clarification in this regard.
Prudential matters governed by insurer's home member state
'Prudential' refers to foreseeing and identifying the consequences of a particular situation or action which could be morally or materially dangerous and adapting conduct in order to avoid these consequences.(3) Thus, an insurer's organisation and governance, as well as its finances and ability to accomplish its corporate purpose, fall within the prudential field.
The prudential framework governing the activity of insurers essentially aims to safeguard:
- the economic stability of the sector;
- insurers' solvency; and
- the optimal functioning of the insurance market.
Ultimately, while they also serve to reinforce the protection afforded to policyholders, insureds or the beneficiaries of insurance contracts, the various prudential constraints imposed on insurers – particularly in terms of the solvency ratio, governance and even substance – are first and foremost intended to limit the risk of bankruptcy and ensure a climate of confidence in the insurance market.
The EU Solvency II Directive (2009/138/EC) entrusts the prudential control or supervision of an insurer with its home member state. Specifically, pursuant to Article 30 of the directive, the financial supervision of insurers, including the oversight of activities performed by branches or pursuant to the principle of freedom of services, is an exclusive power of the insurer's home member state. This means that verification of the solvency, technical provisions and eligible assets and funds of an insurer distributing its products in another member state are governed exclusively by the law of the latter.
In Luxembourg, the Commissariat aux Assurances (CAA) is responsible for the prudential supervision of insurers, pursuant to the Insurance Act,(4) which transposes the EU Solvency II Directive. Luxembourg insurers therefore must have technical provisions with a value equal to their total obligations to insurance creditors. The investment of these provisions is governed by the prudent person principle. With respect to an insurer's obligations relating to unit-linked life insurance contracts, the investment must be made in qualifying (ie, eligible) assets, within the meaning of CAA Circular 15/3.(5) These assets – said to be "representative of technical provisions" – must be deposited in accordance with the conditions defined in CAA Circular 16/9(6) and are subject to quarterly reporting to the Luxembourg regulator.
The purpose of this strict framework is not only to ensure prudential oversight, but also to protect creditors in the event of the bankruptcy of a Luxembourg insurer.
Law of contract closely connected to policyholders
An insurance contract is a standard form contract which is governed by specific legislation in most EU member states. Among other things, this legislation aims to re-establish the balance of power by providing protection to policyholders and their beneficiaries and right holders against potential abuse by insurers. It is therefore logical for this contractual relationship to be governed by provisions closely connected to policyholders.
The EU Solvency II Directive refers to Article 7 of the Rome I Regulation (593/2008) on the law applicable to contractual obligations, which limits the choice of law for insurance contracts. Apart from contracts covering large risks, the parties may choose as the governing law of an insurance contract only:
- the law of the policyholder's country of habitual residence;
- the law of the member state of which the policyholder is a national; or
- any other law permitted by the law of the policyholder's country of habitual residence.
If the parties do not select one of these options, the contract will be governed by the law of the member state where the policyholder's habitual residence is located at the time of the contract's conclusion.
This means that Luxembourg life insurers operating within the European passport framework must, in the vast majority of cases, be able to offer contracts that comply with the law governing the insurance contract in the host member state. In other words, products thus issued must meet the prudential requirements of the home member state as well as the contractual requirements of the host member state. Insurance contracts issued in this context by Luxembourg insurance undertakings are thus Luxembourg-Italian, Luxembourg-French, Luxembourg-Belgian, Luxembourg-English(7) or similar, as the case may be.(8)
The specificities of the law governing insurance contracts in each member state make it virtually impossible to offer a product that complies, on the one hand, with Luxembourg prudential requirements and, on the other hand, with the rules governing insurance contracts in more than one host member state.
It is not always easy to determine whether a particular matter is prudential or contractual in nature. With respect to unit-linked life insurance contracts, the friction between the various applicable rules and regulations is particularly apparent when assets representative of technical provisions are held in investment funds backed by contracts taken out by policyholders. In other words, such assets are prudential in nature but have contractual implications.
For example, the law applicable to an insurance contract in a host member state could regulate the qualifying assets not as assets representative of the insurer's technical provisions, but rather as underlying assets of the life insurance contract. Such regulation of qualifying assets could result from the pursuit of a tax-related objective or the protection of policyholders.
What happens if assets qualifying for the representation of technical provisions do not correspond to qualifying assets under the contract in the host member state? Would strict compliance with the asset qualification (or eligibility) rules applicable to the contract in the host member state allow the Luxembourg insurer to limit its – perfectly legal – investment possibilities? Although less likely, having regard to the extensive choice of qualifying assets pursuant to CAA Circular 15/3, the Luxembourg insurer could risk violating its own prudential obligations if a qualifying asset in the host member state was not a qualifying asset in its home member state?
Due to the absence of harmonisation of insurance contract law at the international or European level, insurers operating within the European passport framework must engage in arbitrage in each host member state.
As mentioned above, the main objective of the regulation of insurance contracts is to protect policyholders. While the member states remain free to regulate insurance contracts for objectives in the general interest, including the protection of policyholders, they should bear in mind that the objective pursued could already be safeguarded by the rules of the home member state.(9)
With regard to Luxembourg life insurance contracts linked to investment funds, while the regulation of assets which qualify for the representation of technical provisions has a prudential objective, the fact remains that such regulation also ensures the protection of policyholders.
Above all, assets representative of technical provisions are encumbered, for the benefit of the insurance creditor, with a double lien(10) in the event of the Luxembourg insurer's bankruptcy. The system thus put in place is reputed to be one of the most protective in Europe.
Further, with regard to the structure of Luxembourg life insurance contracts backed by investment funds, it should be noted that protective measures are in place to protect policyholders' interests.
First, such contracts are linked to 'investment funds' (ie, collective instruments in which selected assets are held in accordance with a predetermined investment policy and among the permitted classes). Unlike a conventional unit-linked life insurance contract which allows direct investment in shares or bonds, for example, Luxembourg life insurance authorises investments only in units of internal funds or external funds backed by the contract. The collective nature of the instrument helps to spread the investment risk.
Second, Luxembourg life insurance contracts involve professionals for the purpose of reinforcing consumer protection, so that the latter benefits from support in the context of switching among underlying assets. Regardless of whether a fund is internal or collective or dedicated, the management of an investment fund backed by an insurance contract is performed either by the insurer itself or by a professional manager to which the insurer entrusts the management of its assets. For their part, external funds are managed by their own managers. The policyholder's leeway is thus limited to selecting from among the investment funds proposed by the insurer those whose investment policy best corresponds to the policyholder's risk profile and needs.
A special feature of specialised insurance funds is worth mentioning. The assets of this type of internal fund can be directly chosen by the policyholder. This is similar to a conventional unit-linked contract which allows the policyholder to directly choose the underlying assets, including non-collective assets. However, in Luxembourg, a practice has developed which applies to specialised insurance funds and brings such funds closer to other contract-backed investment funds. The use of a specialised insurance fund is, in most cases, subject to a contractual obligation imposed by the insurer on the policyholder to be assisted by a financial adviser before making any choice of assets.
Due to both its structure and the prudential supervision of insurers, the Luxembourg life insurance contract backed by investment funds contributes to the protection of policyholders which should not be overlooked in the host member state's assessment of the general interest of protection.
Although cross-border insurance is being challenged by the heterogeneous implementations of the EU Insurance Distribution Directive (2016/97/EU), the Luxembourg insurance industry can, once again, demonstrate its characteristic adaptability and cross-border expertise.
Endnotes
(1) CAA Annual Report 2017-2018.
(2) EU Directive 92/96/EEC of 10 November 1992 introduced the single authorisation per home member state, the mutual recognition of authorisations and prudential control by home member states.
(3) As defined in the Larousse dictionary.
(4) Act of 7 December 2015 on the insurance sector, as amended.
(5) CAA Circular 15/3 on the investment rules for unit-linked life insurance products.
(6) CAA Circular 16/9 on the deposit of securities and cash used as assets representative of the technical provisions of direct insurers.
(7) One consequence of Brexit will be that, as is the case with other non-EU countries, risks situated inside the United Kingdom (ie, policyholders with their habitual residence in the United Kingdom) will no longer be subject to the obligatory choice of law in accordance with the Rome I Regulation. Article 7 of the regulation concerns only insurance contracts for which the risks are situated in a member state. The parties may thus choose the applicable law in accordance with Article 3 of the Rome I regulation, taking into account the reservations set out in this article.
(8) For the most part, Luxembourg life insurers consult specialists in insurance contract law in the various member states in which they distribute their products, either internally within their legal departments or via outside counsel.
(9) EU Life Assurance Directive (2002/83/EC).
(10) Namely, a first-ranking lien on assets representative of technical provisions coupled with a right to preferential payment in the event of deficient assets, which is ranked only by a restricted category of creditors (eg, the Treasury, municipalities and social security organisations).
This article was first published by the International Law Office, a premium online legal update service for major companies and law firms worldwide. Register for a free subscription.
