The Future Regulation of Insurance – Progress Report 3

United Kingdom

Last week the FSA published a report by John Tiner, the Managing Director of FSA’s Consumer, Investment and Insurance Directorate, dealing with the progress FSA has made on the programme of work (the ‘Tiner Project’) it has undertaken to strengthen insurance regulation in the UK.


The Tiner Project commenced in September 2001. It quickly led to a report being submitted to the Treasury in November 2001 outlining the FSA’s agenda (the ‘Strategic Plan’) for strengthening insurance regulation. This progress report sets out the steps that FSA has taken to fulfil the Strategic Plan and those it intends to take in order to complete the programme.

Content of the Report

The report comprises five chapters. Whilst the first is a general overview, the next three chapters deal with the three key objectives highlighted in the November 2001 Report, which were: (i) securing a ‘fair deal’ for consumers; (ii) sound management and adequate financial resources; and (iii) smarter regulation of insurance. The final chapter deals with future developments. There is also an appendix summarising how FSA is addressing the recommendations set out in Chapter 7 of the Baird Report.

Chapter 1 (Overview)

FSA believes that it is important that firms recognise that current legal and regulatory developments in the UK, EU and wider international arena will require them to modernise their governance and risk management frameworks and their internal systems and controls. Moreover, FSA points out that significant challenges may well flow from the ‘Sandler’ and ‘Pickering’ Reviews as regards industry structures, distribution channels, product types and regulatory requirements.

FSA believes that it is important that the UK has a strong and competitive insurance market in which all participants can operate with confidence. The Report sets out the characteristics that FSA feels will best contribute to the achievement of this goal. These include granting retail consumers access to competitively priced and well-designed products and the provision of sound advice based on the consumer’s needs. FSA also notes that its proposals for the reform of polarisation (as set out in CP 121) have the potential to bring about substantial changes in the distribution of retail financial products. The introduction of an additional suite of stakeholder products (as proposed by Sandler) would also provide an opportunity to develop a differentiated regulatory regime for such products.

In response to current concerns about the solvency of life firms, FSA confirms that it is satisfied that the industry has been meeting its minimum solvency requirements to date in spite of stock market volatility and that it has the capacity to continue absorbing further large falls in stock prices. However, in the longer term, FSA intends to reform the calculation and reporting of the solvency margin requirements to make the amount of these margins more transparent.

The chapter also deals briefly with future developments as regards the regulation of Lloyd’s and general insurance intermediaries. In the light of its review of insurance regulation and the Lloyd’s Chairman’s Strategy Group’s proposals for change to Lloyd’s governance structure, FSA has decided to take steps to exercise more directly some of its responsibility for the regulation of the Lloyd’s markets and to move in the short-term to apply full ‘risk-based’ regulation to Lloyd’s (thus covering not just the Society of Lloyd’s itself but also managing agents and other authorised market participants). A fuller treatment of FSA’s proposed changes to the regulation of Lloyd’s can be found in Chapter 4 of the Report (see below).

On general insurance, FSA has now started work on developing a regulatory regime to cover insurance intermediaries and insurance firms’ sales functions, with implementation expected in the second half of 2004.

Chapter 2 (A fair deal for consumers)

In this chapter, FSA describes the progress that it has made in helping to secure a fair deal for consumers. Since the November 2001 Report, FSA has published various papers and launched several initiatives in respect of marketing, the sales and the advice regime, with-profits funds, unfair contract terms and consumer education.

FSA believes that its proposed reforms in respect of the way retail products are sold, chiefly through the liberalisation of the ‘polarisation’ regime, should lead to improved choice and greater access to financial advice for consumers. Although the Treasury will take the lead in setting the standards for new stakeholder products, FSA will work closely with the Treasury and consult with consumer bodies and the industry on the establishment of an appropriate and proportionate risk-based regulatory regime for such products. FSA aims to issue a discussion paper in December, which will set out its thinking on a differentiated sales regime for stakeholder products, with a view to consulting on detailed rules during 2003.

On consumer education, FSA are taking a leading role in a range of consumer education initiatives and they intend to put forward some proposals later this year for augmenting this work in the 2003/2004 financial year. FSA intends to establish a long-term plan for delivering clearly specified consumer education objectives and will issue a consultation paper about its strategy in 2003.

FSA has now been granted powers under the Unfair Terms in Consumer Contracts Regulations 1999. As well as considering complaints about clauses in particular contracts, FSA will use its new powers to carry out thematic reviews of contracts to identify terms causing significant consumer detriment.

On the disclosure and explanation of risks, FSA are examining ways of ensuring that firms have a better understanding of their obligations to analyse, disclose and explain risks to consumers. In seeking to get firms to provide better, clearer and fairer information to consumers, FSA aims to move the financial industry away from reliance in advertising on small print towards a more fair and balanced style of marketing products. FSA are also looking at ways to improve the Consumer Information Document (presently known as the ‘Key Features Document’). FSA intends to make this document the most read and understood document in the whole sales process. It is aiming to publish a consultation paper on this topic at the turn of the year. FSA are also undertaking a wide-ranging review of information given after the point of sale by firms selling products with a long-term investment risk element.

As regards with-profits funds, FSA issued a paper on the governance of such funds in spring of this year setting out various models for improving governance arrangements to protect policyholders in relation to the exercise of discretion. FSA expects to consult on firm proposals by the turn of the year. FSA state, however, that firms will need to be much more open and clear about the risks run by such funds and more transparent about the calculation of annual and terminal bonuses and the financial strength of the funds. FSA also intends to integrate into its ‘With-Profits Review’ a consideration of the issues raised by the Sandler Review as regards with-profits products. Insurance firms will be expected to be much more open in future about the composition of their with-profits funds and the investment strategy they pursue.

Chapter 3 (Soundly managed insurance firms with adequate financial resources)

This chapter describes the progress FSA has made in strengthening the requirements for insurance firms to be soundly managed and to have in place adequate financial resources.

The FSA has published during the course of the year various papers dealing with topics such as financial engineering, the role of actuaries, with-profit funds, systems and controls, the Integrated Prudential Sourcebook, regulatory reporting and financial penalties.

In its November 2001 Report, FSA expressed the view that the insurance regime it had inherited had failed to take account of the nature, diversity and scale of the risks in insurance firms. FSA’s remedy was to:

· improve the basis upon which solvency requirements are determined;

· place more responsibility on insurance companies’ management to maintain proper systems and controls; and

· improve public and regulatory reporting.

Chapter 3 contains comments on FSA’s development of its prudential regime for insurers, which is taking place against the backdrop of changes to European insurance and accounting directives. FSA plans to publish a consultation paper (with draft rules) later this year dealing with the implementation of Solvency I and will also be consulting next year on the implementation of the Financial Group’s Directive in 2005, which will affect both financial conglomerates and pure insurance groups. FSA is also pressing ahead with developing the insurance-related elements of its Integrated Prudential Sourcebook (PSB). FSA intends to bring the PSB into effect for insurance firms in 2004. It also intends to consult the industry on some important new proposals, including:

· a higher minimum capital test (in excess of the EU minima);

· individual capital adequacy standards;

· the alignment of the valuation rules to accounting standards; and

· the reform of the ‘permitted links’ regime (as regards unit-linked business).

A cornerstone for achieving sound management will be the increased responsibility and accountability placed on senior management of insurance firms and the development of robust systems and controls. FSA expects to have additional guidance on systems and controls in place by early 2003, although this will eventually be superseded by the guidance section in the PSB. However, FSA are now proposing that some of its guidance on operational risk will be incorporated in SYSC instead of the PSB.

Chapter 3 also deals with FSA’s proposed changes to the future role of actuaries in life insurance companies and its plans and proposals for the governance of with-profits funds. FSA intends issuing consultation papers on these subjects by the end of this year. The Report also covers insurers’ use of ‘financial engineering’ techniques, where FSA is currently consulting on new guidance, and the improvements FSA wishes to make to insurers’ regulatory returns and other reporting. FSA’s aim is to produce reporting that is more focused on the key aspects of firms’ businesses, more forward-looking and less voluminous than at present. FSA are planning to issue a detailed consultation paper in mid-2003 on the reform of insurance reporting, which will take account of the responses received to its discussion paper issued in May 2002 (which had put forward various options for constructing a new reporting environment).

Chapter 4 (Smarter regulation of insurance)

The November 2001 Report had identified four key areas of change to deliver smarter regulation, which were:

· implementing a proactive, risk-based regulatory approach:

· building a more effective working relationship with high risk firms;

· delivering an integrated approach to regulation; and

· equipping insurance supervisors to operate effectively in the new environment.

This chapter describes the progress FSA has made in delivering these objectives. It mainly discusses the changes FSA has made to its internal organisation and procedures.

The final section of this chapter provides details of FSA’s future regulatory approach to Lloyd’s. FSA is committed to maintaining a regime for Lloyd’s equivalent to that for insurance companies. In response to developments within the industry and the Lloyd’s market itself (particularly Lloyd’s decision to adopt a new approach in managing and supervising the market), FSA has decided to exercise more directly some of its responsibility for the prudential regulation of insurance business conducted at Lloyd’s. However, FSA intends to liaise closely with Lloyd’s to avoid undue duplication of effort and to determine the appropriate division of responsibility between the two organisations. FSA envisages that it and Lloyd’s will, in due course, need to consider the extent to which Lloyd’s will continue their present functions for their own risk management and compliance purposes. FSA also anticipates having to adapt its regulatory approach to take account of significant changes to Lloyd’s management and structure, as the latter embarks upon the programme of change implementing the recommendations of the Chairman’s Strategy Group.

FSA is now applying its risk assessment framework to Lloyd’s and it will, going forward, develop more effective working relationships with managing agents, with a view to commencing risk assessments for managing agents from 2003. FSA also intends that changes arising from its general review of regulatory reporting will apply to Lloyd’s as well, but will carefully consider the timetable for implementation in Lloyd’s case, given that the Society introduced fundamental changes to its regulatory reporting regime as recently as December 2001. With the introduction of the Integrated Prudential Sourcebook (PSB) being scheduled for 2004, FSA plans to review and update the Lloyd’s rules to ensure that their requirements are equivalent with those for other insurers as far as is practicable. FSA will consult on detailed changes in the first half of next year. Finally, FSA is also proposing to review the consumer protection arrangements that are available to Lloyd’s policyholders, which may eventually lead to them being brought within the ambit of the Financial Services Compensation Scheme.

Chapter 5 (Future Developments)

In the medium term, progress on strengthening insurance regulation will continue to be monitored by the Tiner Project Board. A timetable for future work is set out within this chapter. Over the course of the next year, FSA will be consulting the industry on several key issues and is looking to the industry to engage actively in this process. FSA’s risk-based supervisory approach will continue to be rolled out to firms over coming months. An analysis of the key risks (environmental and sectoral) facing the life and general insurance industries will be set out in FSA’s ‘Financial Risk Outlook’ in January 2003.

Reaction to the Report

The insurance industry has broadly welcomed the Report, although there is concern in some quarters at the increased cost of compliance. Lloyd’s has also welcomed FSA’s proposals for changes to the regulatory regime governing the Society and the Lloyd’s markets. Somewhat unsurprisingly, the Association of British Insurers are also pleased that FSA has confirmed its confidence in the financial strength of life offices. However, there has been some questioning of how much real progress has been made on securing a fairer deal for consumers.

We still await, however, crucial proposals on securing a fairer deal for consumers (through depolarisation and Sandler) and details of how FSA proposes to regulate the general insurance industry.

To access the Report please click on the link below.

For further information, please contact Nick Paul at [email protected] on +44 (0)20 7367 2806 or Paul Edmondson at [email protected] on +44 (0)20 7367 2877.

5 October 2002