Insurers face rough road as BoE begins supervisory role

Unitary regulation and supervision under the Financial Services Authority (FSA) will be abandoned in favour of a twin peaks structure. Some financial institutions will be supervised by two separate regulators – a Prudential Regulatory Authority (PRA) and a Consumer Protection and Markets Authority (CPMA). The new system will be radically different to what has gone before.

Insurers are concerned reform is being driven by lessons learnt from the banking crisis and insufficient attention has been paid to the insurance market in the design of the new regime.

Traditionally, the insurance market has been regarded as independent of banking.

But under the new system, insurance firms will be prudentially regulated by the PRA, a subsidiary of the Bank of England (BoE). Insurance brokers will have their prudential rules set by the CPMA. Both insurers and brokers will be regulated by CPMA for conduct of business and market regulation.

Insurance, it seems, is being “fitted into” a system driven by the priority being given to reform in the banking sector. The current consultation says little about how the Lloyd’s insurance market will be regulated and the domestic regulator for insurance brokers – the CPMA – will not be a member of the new European Insurance and Occupational Pensions Authority (EIOPA), which will be responsible for broker regulation and supervision in the EU.

FSA regulation and supervision worked effectively in the insurance market. The new design for regulation looks to be less efficient and less convenient for insurance firms. Whereas under the existing system, a complex Memorandum of Understanding between the Treasury, BoE and FSA streamlines regulation at firm level, under the new system regulated firms will be directly responsible to a number of different bodies.

This includes the PRA and CPMA. The BoE’s new Financial Policy Committee (FPC) might take an interest in specific firms. In addition, the new European authorities are set to have greater powers – in both their rule-making and supervisory capacities.

Both insurers and brokers are likely to feel the effects of the BoE’s new dominant role in regulation. The BoE is deliberately being made a potent regulatory force – with macro-prudential tools and micro-prudential insight. The FPC will sit at the centre of the regulatory framework; its responsibility for protecting macro-prudential stability will trump all other regulatory concerns.

Planning for and managing the failure of financial institutions will be a priority of the new regime. The primary objective of the PRA will be to “promote the stable and prudent operation of the financial system through the effective regulation of firms, in a way which minimises the disruption caused by any firms that do fail”.

Recovery and resolution plans – or so-called living wills – were the previous government’s tool of choice for resolving the dilemma of systemically important financial institutions (SIFIs) which are too big, too complex or too interconnected to fail.

A reawakening of the living wills agenda will be met with dismay in the industry. Insurers believe living wills represent yet another inappropriate read across from the banking sector and have urged policymakers to consider important differences between banking and insurance business models.

Accountability within this new fragmented system is a major concern. Twin peaks regulated insurers will want to know precisely where decisions are to be taken.

Who will make which rules, who can authorise what, who should firms contact regarding particular queries, which supervisors will come to visit and what will they be checking for? And who will take enforcement action if breaches are discovered?

Meanwhile, Beachcroft partner, Dan Preddy, added: “The jury is still out on whether the end result of the proposed overhaul will be any less ‘confused and fragmented’ than the existing regime.

“The new regime is designed to address a perceived ‘underlap’ but brings with it the very clear risk of overlap and duplication, particularly between the PRA and CPMA.

“The overlap and duplication will inevitably mean increased costs for both the regulatory bodies (paid for, in the case of the PRA and CPMA, by way of levies from regulated firms) and, more significantly, the regulated firms.

“The transitional costs of the former are estimated at £50m [$79.7m] over three years. The Treasury has not been able to measure the transitional or ongoing cost impact of the latter but 1,500 to 2,000 firms, including many small insurers, credit unions and building societies, will have to raise the additional costs of dealing with two regulators.