Select Committee on Treasury Minutes of Evidence

Memorandum submitted by the Financial Services Authority

  1.  In preparation for the oral evidence session on 10 July, the sub-committee has asked for a note from the FSA by way of update on issues raised in its March 2001 report on the Government Actuary's Department (GAD). This Memorandum covers:

    —  the way in which the FSA uses actuarial expertise in its regulation of life insurance companies, and the FSA's relationship with the Government Actuary's Department (paragraphs 2-4);

    —  the FSA's plans to publish sectoral analysis of the life insurance industry (paragraphs 5-6); and

    —  the FSA's evolving thinking on the future role of the Appointed Actuary in life insurance companies (paragraphs 7-14).

Using actuarial expertise in insurance regulation

  2.  In regulating individual life insurance companies and overseeing developments in the life insurance sector as a whole, the FSA continues to benefit from substantial actuarial expertise. This is required principally for the following purposes: detailed scrutiny of the financial returns submitted by each company; advice on company-driven events (eg new authorisations, transfers of business, requests for concessions); and technical advice and assistance with regulatory programmes generally, including work on FSA Themes (eg the implications for firms, consumers and the FSA of an ageing population).

  3.  As foreshadowed in our Memorandum to the sub-committee in January 2001, in April 2001 a team of actuaries transferred from GAD to FSA employment, in order to provide the necessary expertise in-house and to integrate the work of actuaries more closely with that of our insurance regulators. We have recently further strengthened this integration by restructuring our Insurance Firms Division so that the actuarial teams report to the Heads of the relevant regulatory departments. The Senior Actuarial Adviser reports direct to the Director of the Insurance Firms Division. The Senior Adviser remains responsible for the continuing professional development of the FSA's actuaries.

  4.  Although GAD no longer has responsibility for providing actuarial advice to insurance regulators in the UK, the FSA maintains contact as appropriate with GAD. We take the opportunity to discuss our evolving thinking on particular issues with GAD colleagues (for example, our review of with-profits business), as a way of taking soundings with informed professional opinion.

Sectoral analysis of the life insurance industry

  5.  In the FSA's Report to the Economic Secretary (`The Future Regulation of Insurance'), published last December, we said that we had been considering the need for improved insurance-specific sectoral analysis and the identification of external business risks. We undertook to consider whether to publish this analysis for the benefit of consumers and the market.

  6.  In January 2002 we published the first edition of the "Financial Risk Outlook" (FRO). This considered significant developments in the broader environment within which the FSA operates, the key themes arising from those developments and their implications for the FSA, markets and consumers. We have decided that future editions, starting in January 2003, will include more detailed information on individual sectors, including the insurance sector. This will be aimed at a reasonably informed audience and will cover a wide range of environmental risks, including macroeconomic, social and demographic, political, legal and regulatory risks. We will provide a copy of future FROs to the sub-committee. We will also publish a series of articles and press releases addressing the implications of the issues discussed in the FRO from a consumer perspective. The FRO and other material will be published on our website.

The future role of actuaries in the governance of life insurers

  7.  The current regulatory regime requires life insurers to appoint an actuary (the "appointed actuary"). The role of the appointed actuary has developed in the UK over the last 30 years, encompassing a wide range of duties. These include carrying out an annual valuation of the firm's policyholder liabilities and reporting on them, and certifying the results, to the FSA. The appointed actuary also determines the amount of surplus in the fund and makes recommendations to the firm's board on the distribution of the surplus to policyholders and/or to shareholders. The appointed actuary is also required to identify and monitor the risks a firm is running, advise the firm on the adequacy of financial resources to meet policyholder liabilities and certify the adequacy of premium rates to the FSA. As a result, while the board of a life insurer has overall responsibility for its business, many important responsibilities currently rest with the appointed actuary.

  8.  A cornerstone of the FSA's new regulatory regime is that directors and senior management are responsible for securing a firm's compliance with regulatory requirements. This is consistent with the FSA's duty under the Financial Services and Markets Act 2000 to have regard to the responsibilities of senior management of regulated firms.

  9.  The responsibilities which the FSA's Handbook currently places on the appointed actuary may lead directors and senior managers to rely on the views of the appointed actuary too much rather than reaching their own views. For example, in the regulatory returns, the policyholder liabilities and the methods and bases of the calculations are currently signed off by the appointed actuary. The directors do not sign off on these liabilities, nor are they audited. These aspects are of fundamental importance to the financial condition of long-term insurance firms.

  10.  In line with their responsibilities under our rules, it is essential that directors reach their own decisions, while of course seeking actuarial advice where appropriate. Directors will require sound information on which to base such decisions and will need to give careful and thorough consideration to the issues before reaching a decision. In the light of this, the FSA considers that a new framework is required. This needs to reflect the responsibilities of boards and senior management for decision-making, including for decisions taken on actuarial advice.

  11.  Consistent with this overall approach, and following feedback from the market and from consumer representatives, the FSA recently proposed that:

    —  the appointed actuary system should be removed for non-profit business;

    —  for with-profits business, the scope of the appointed actuary's advice should be limited to the firm's exercise of discretion;

    —  all firms should be required to have a controlled function (the "actuarial function") to provide them with actuarial advice, in particular on the calculation of policy liabilities; and

    —  additional rules and guidance should be introduced to limit the potential for conflicts of interest in respect of appointed actuaries and the actuarial function, to the extent that the individuals concerned hold a senior management position in the firm, and to require an independent review of certain aspects of the actuarial work.

  The changes to the role of the Appointed Actuary form part of a wider programme of work which we are carrying out to reform the regulation of insurance companies.

  12.  FSA has also recently made proposals on the governance of with-profits funds through the feedback statement on the With-Profits Review. These would require firms to:

    —  define and publish the Principles and Practices of Financial Management that are applied in managing with-profits business; and

    —  report annually to policyholders on their compliance with these practices.

  13.  Firms would also be required to establish governance structures that:

    —  give assurance that due regard has been paid to the interests of policyholders in the exercise of discretion;

    —  bring transparency to the way directors ensure that competing interests of different groups of policyholders are managed fairly; and

    —  provide independent assessment of a firm's compliance with the Principles and Practices of Financial Management.

  These proposals, together with our proposals on the future role of the appointed actuary, are designed to strengthen governance arrangements in life insurers and provide new safeguards for consumers.

  14.  Later this year the FSA will issue formal consultation papers on the role of actuaries in the governance of life insurers and on the proposals for changes to the governance of with-profits funds. In October we will also publish a further report summarising the changes to insurance regulation which have already been made or which are planned. We will provide copies of all these documents to the sub-committee.

The Financial Services Authority

5 July 2002

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Prepared 25 November 2002