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European insurance law; exhaustive summary KU Leuven
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Exhaustive summary for the course on "European Insurance Law" of KU Leuven!
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Welcome to this summary! This is an EXHAUSTIVE summary of everything that you neededto know in the academic year 2023-2024 for the course European Insurance Law at KU
Leuven. I’m sorry in advance for any possible spelling mistakes. This however does not
change the accuracy of the content of this document. Best of luck!
A brief introduction
Insurance is a way to manage risks either as a company or individually. It can be defined as “a
financial arrangement or contract between an individual or entity (the insured) and an insurance
company (the insurer)”. In this agreement, the insured pays a premium (a regular payment) to the
insurer in exchange for protection or coverage against potential risks, losses, or damages. The
insurer, in turn, agrees to provide financial compensation or benefits to the insured in case the
specified events or perils outlined in the insurance policy occur. The purpose of insurance is to
mitigate or manage potential financial losses or liabilities that may arise from unforeseen
circumstances, offering peace of mind and financial security to the insured party. The basic idea is to
group those risks and mutualization’s, which is an economic activity based on calculation of
probability.
“Insurance” is considered to be a financial service (See the FSAP of European Financial
Regulation). It does, however, differ notably from other financial services such as banking and
investment services. It does so on the following four elements:
1. The role and business model of an insurance company is different to the one of banks.
Insurance is made up of risk pooling, and its role is to protect people against potential
unknown negative events. The core business of a bank is to collect savings from depositors
and to grant these savings as loans to borrowers.
2. The balance sheet of an insurance company is different to the one of banks. In the insurance
company there is an asset and liability match. Banks tend to have a longer liability side than
asset side.
3. The risks of an insurance company are different than those of a bank. An insurance company
faces the phenomenon of the inverted production cycle (the risk that the losses will be
higher than the losses that the insurance company will have calculated) and an investment
risk (as the premiums are invested). The main risks that a bank is facing is credit/liquidity
risk.
4. The systemic risk of an insurance company differs from that of a bank. The systemic risk of
an insurance company is less in comparison to banks because banks have
interconnectedness. An insurance company does not have this interconnectedness, or at
least less severe.
Who are the parties to the insurance scheme?
PARTY TO INSURANCE SCHEME DEFINITION
INSURER / INSURANCE COMPANY The entity that provides the insurance coverage for a
specific insured risk.
INSURED / POLICY HOLDER The individual or entity that purchases the insurance policy
and pays a premium to receive coverage against a specific
risk.
BENEFICIARY The person or entity entitled to receive the coverage in
case of the occurrence of the specific insured risk.
THIRD PARTY / VICTIM The person who is not a party to the insurance contract but
is involved in a claim.
REINSURER The entity that shares the risk and the profit with the
insurer.
INTERMEDIARIES A person who has ties with specific insurance companies
(agent) or is under the legal obligation to look at the market
(broker) in order to connect policyholders with insurers.
SUPERVISOR / REGULATOR EIOPA and national regulators.
,A lot can be insured. There are however borders, illustrated by this quadrangle:
Insurable v. Uninsurability: Insurance has technical limits like natural disasters, terrorism
and pandemics for which the damage cannot be insured. This is because the damage will
either be ginormous or is unpredictable. Insurance also has legal limits. Uninsurability is
however losing ground to private insurance.
Private insurance v. Alternative Transfer Techniques: This is what separates insurance
from risk management, auto-insurance, captives, use of capital market and other techniques
of alternative risk transfer. These methods offer different ways to handle risks, complementing
or sometimes substituting traditional insurance.
Private insurance v. Social security: The International Labor Organization lists nine social
risks. Social security contribution is based on solidarity, the idea of the company’s that mange
this is to not have a profit.
Private insurance v. Banking and investment: Traditional insurance activity is more about
long term securities for example life insurance. Specifically in life insurance banks are stealing
from insurance companies. Banks are attracted to short term ones.
The quadrangle helps to visualize the dynamic nature of the insurance industry, where private
insurance is increasingly playing a significant role: private insurance is interesting in a capitalist
system because it allows people to reverse decisions, similar to the stock market. If something goes
wrong, insurance can help fix it without losing all the initial investment. As people own more things,
they need more insurance to protect them, following the idea that 'safety breeds unsafety'.
Governments are now asking for more types of private insurance, like for social needs, environmental
damage, natural disasters, climate change, and terrorism. Our economy is shifting towards services
rather than just selling products, making private insurance more crucial, especially in financial
services. This change emphasizes access to services over ownership of things, further increasing the
role of private insurance. As businesses and economies become more global, the need for private
insurance grows. The role of insurance in managing risks and safety is constantly evolving.
There are four main trends in insurance:
covering more things that used to be uninsurable,
, people and companies managing their own risks instead of using traditional insurance,
the lines between private insurance and banking blurring, and
the distinction between social security and private insurance becoming less clear.
There's a growing need for cooperation among the government, banks, and insurance companies,
especially evident in areas like old age pensions. Traditional government pensions are being
supported by extra plans from insurance companies and banks because of the increasing number of
older people. Technology and big data are greatly influencing insurance, and society is also asking
insurance companies to help with big goals like caring for the environment, looking after people, and
being well-managed. In summary, private insurance is becoming more central in today's advanced
society, adapting to new economic and technological changes.
Part I: The bare essentials of the insurance business
Let’s start off with the definition of “insurance”. According to Chaufton, insurance is “the
compensation of the detrimental effects of fate upon man’s patrimony by mutualization organized
according to the rules of statistics.”
The key issue with this is that the insurer must be able to predict losses (accurately) because of the
peculiar phenomenon of the “inverted production cycle”: The insurer will have to set the premium
before the service is rendered, before they know the cost of the service, which means that, in order to
calculate this accurately, the insurer has to look into the future. In the earlier days they did not
know how to do this. It was only at the beginning of the 17th century (Lloyd’s coffee house) that
mathematicians and scientists figured out how to provide statistics to accurately do so.
The mutualization (sharing of financial loss) in the insurance business is organized along two major
models: (I) “mutual insurance” (e.g. health insurance), in which the members insure each other’s
losses by variable premiums and (II) “fixed premium insurance” (e.g. life insurance), in which
the amount of premium you pay stays the same. Lloyd’s of London is sometimes considered as a third
way of organizing insurance, because it is a specialized insurance market that operates through a
network of syndicates, offering a platform for insuring a wide range of risks, including those that are
too complex or unusual for standard insurance providers (e.g. marine insurance). Other business
models may include (a) a direct writing company (e.g. car insurance), (b) captives (e.g. large
cooperation insuring itself), (c) pools (e.g. reinsurance), (d) bancassurance (e.g. property
insurance) or (e) assurfinance.
How do you create sufficient mutualization? (“the insurance technique”):
- Disperse the risk: don’t take up an entire block of houses on the same river. In case of flood
the premiums won’t be sufficient.
- Correct prediction of the frequency of the risk: you can only build up reliable statistics
when it is based on a large number of impacts.
- Create homogeneous groups: create groups based on the nature, the financial value or
duration of the risk.
- Utilize risk selection; differentiate in premium: insurer needs to obtain information.
- Law of large numbers – law of averages: the larger the number of people in the pool, the
higher the probability that an actual loss will equal the expected loss.
- Prevention: insurance needs to make an effort to avoid the occurrence of a loss.
Why are predictions of loss important?
1. Adverse selection: Adverse selection refers to a situation where individuals or entities with a
higher risk of suffering a loss are more likely to seek insurance coverage than those with
lower risks. If insurers do not accurately predict and account for the potential losses, they may
attract a disproportionate number of high-risk policyholders, which can lead to financial losses
for the insurance company. Accurate predictions of loss help insurers set appropriate
premiums for different risk profiles, ensuring that premiums are fair and sustainable. Insurers
combat adverse selection by underwriting, risk classification, risk pooling and by
continuous monitoring.
2. Moral Hazard: Moral hazard occurs when insured individuals or entities alter their behavior
because they know they are protected by insurance. This change in behavior can lead to an
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