Select Committee on Treasury Minutes of Evidence

Memorandum submitted by the Financial Services Authority


  1.  This memorandum is submitted in advance of the FSA's appearance before the Committee on 30 October.


  2.  The FSA recognises that the Baird Report makes pertinent criticisms of various aspects of its management of both prudential and conduct of business regulation of Equitable Life from the beginning of 1999 until December 2000. With the benefit of hindsight it is clear that a number of issues could have been better handled and the FSA will take those lessons to heart. The Report did, nevertheless, conclude that by 1 January 1999 the "die was cast" and ". . . nothing which the FSA could have done thereafter . . . would have mitigated, in any material way" either the outcome of the Court case or the final outcome as far as Equitable Life is concerned.

  3.  The Report also makes some important recommendations about the regulation of the insurance sector. The Schedule to this memorandum summarises these and indicates what changes the FSA has already made, or is consulting on, in each area and what further improvements are already under consideration. The FSA will take these forward as a matter of urgency. Overall, the Authority accepts that a more proactive approach to insurance regulation will be needed in the future.

  4.  Some of the issues to which the Report draws attention have been addressed in developing the new regulatory regime that will come fully into effect when the FSA obtains its full powers under the Financial Services and Markets Act 2000 on 1 December. The wider powers given to the FSA in this Act—in particular relating to information gathering, investigations, intervention and enforcement—will also strengthen our ability to respond appropriately when risks increase in specific firms or market sectors.

  5.  Howard Davies has already announced, in speeches in March and April this year, the FSA's commitment to implementing an integrated approach to prudential standards for insurance companies, based on the "three pillar" conceptual framework which has been used by the Basel Committee in its review of the Capital Accord for banks. The three pillars are minimum capital adequacy standards, review by the supervisor of firms' systems and controls, and use of public disclosure to harness market discipline.

  6.  There is much further work to do, both in taking forward the initiatives already in progress and in considering what other improvements to the regulation of insurance need to be made. The FSA Board has therefore asked John Tiner—Managing Director, Consumer, Investment and Insurance Directorate, who joined the Authority in June this year—to lead a project to take this work forward.


  7.  In April 2001 the FSA made several organisational changes designed to improve regulatory co-ordination and internal communication:

    —  prudential regulation and conduct of business regulation of life insurance companies were brought together;

    —  responsibility for the largest financial groups was moved into the Major Financial Groups Division to achieve better co-ordination of the supervision of firms with the greatest potential impact on the FSA's statutory objectives. These included the nine largest insurance companies (representing over 50 per cent of the life insurance market). Responsibility for supervising the rest of the insurance market, including friendly societies and the Society of Lloyd's, remains with the Insurance Firms Division;

    —  the provision of actuarial work (formerly in the Government Actuary's Department) was integrated into the Insurance Firms Division; and

    —  responsibility for policy on prudential issues for all sectors (including insurance) was moved into a new Prudential Standards Division; (responsibility for conduct of business policy was already assigned to a single area).

  8.  Other significant changes relating to insurance regulation that the FSA has already initiated include:

    —  a more consistent risk-based approach which is being progressively applied to the insurance sector;

    —  an enhanced regulatory toolkit which facilitates more focused and flexible forms of investigation, monitoring and intervention;

    —  requiring insurance companies to submit their regulatory returns more quickly;

    —  launching in February a wide-ranging review of with-profits business, covering among other issues enhanced disclosure, governance and discretion; and

    —  a new regulatory regime for Lloyd's.

  9.  Consultation has also begun on fundamental changes to the prudential requirements for insurance companies and friendly societies. These proposals (which were set out in June this year in Consultation Paper 97) include moving towards a more realistic solvency measurement for life companies (including provisions for terminal bonuses and market testing of the valuation of guarantees and options within policies); requiring all insurance companies to undertake stress and scenario testing in assessing their capital adequacy; and strengthening systems and controls requirements. This will require much tighter identification, control and monitoring of market risk, credit risk, operational risk and liquidity risk as well as the normal insurance technical risks. The six-month consultation period on CP97 is still in progress.


  10.  The project that John Tiner is leading includes both life and general insurance, and both prudential and conduct of business regulation. To ensure a coherent approach, it will cover both the new issues arising from the Baird Report and a number of related issues on which work was already under way. It will therefore include:

    —  any lessons to be learnt from other recent insurance cases (including Independent Insurance);

    —  proposed changes to European insurance-related requirements, in particular the current review of solvency requirements;

    —  the implications for insurance regulation of the Basel Committee's "three pillar" approach;

    —  international best practice;

    —  the views of consumer groups, the insurance industry and relevant professional bodies;

    —  the recent report of the Corley Committee (set up by the actuarial profession to inquire into the Equitable case); and

    —  other relevant current initiatives, both internal and external (for example the FSA's with-profits review; and the Sandler review of medium and long-term retail savings).

  11.  The FSA intends the resulting changes in insurance regulation to be a coherent response not just to the Equitable case, but to the wider challenges facing the insurance industry. These challenges include the changing economic environment including lower inflation and lower margins; the increased emphasis on consumers' personal responsibility for longer-term financial wellbeing; new products; and restructuring within the insurance industry.

  12.  At the end of the project the FSA will be better equipped to identify, analyse and assess the risks in insurance firms and to implement procedures to mitigate such risks in a timely, proportionate and effective way. This may include a redefinition of the responsibilities of senior management in insurance companies and of their professional advisers, addressing as necessary FSA's rules and guidance and developing the FSA's human resources and IT capacity.

  13.  The project is due to be completed within a year. There will be consultation with stakeholders and we will undertake cost-benefit analyses of any proposed changes to our rules. While some changes may take longer than a year to implement (because of the need to consult fully and, in certain cases, to allow the industry time to implement changes), other changes—for example in the FSA's internal operating procedures—can be implemented over the coming months.

  14.  Because of its very wide scope, this project will be taken forward through a number of discrete, but co-ordinated, workstreams covering all aspects of insurance regulation. They will include:

    —  a re-examination of all relevant aspects of the FSA's regulatory processes, with particular emphasis on proactive risk identification and mitigation, and improving management co-ordination and communication, in particular when matters of potential significance start to emerge;

    —  pressing ahead with the practical development of the proposed new prudential standards for life and general business announced in June (in CP97);

    —  a wide-ranging review of regulatory reporting (both on the public record and to the FSA) and the disclosure of other information to the FSA, in the context of the proposed new regulatory standards and supervisory approach;

    —  an examination of the role in insurance regulation of professional advisers and skilled persons, including auditors, the Appointed Actuary and actuarial Quality Assurance; and

    —  a review of conduct of business and other requirements designed to ensure the fair treatment of customers.

  15.  As requested by the Economic Secretary in her letter of 17 October, the FSA will make a more detailed report to HMT by 20 November on the action it will take in response to the Baird Report.

October 2001

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Prepared 17 December 2001