Financial Services


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Mr. Hands: I am slightly surprised there has not been a numeric value put on that because I thought doing so was standard for any of these sorts of cost benefit analysis. Moving on, I think she mentioned something about the one in 200 calculation being standard or regular in the UK insurance industry. Will she confirm that that is the FSA regulation at the moment?
Kitty Ussher: Yes, it is.
Mr. Hands: Okay, it is exactly one in 200. Will the Minister also tell us how she would characterise the regime, because is not dissimilar to how the Bank for International Settlements regulates capital adequacy ratios for the banking industry? Will she outline how the regime is different from the BIS regime for banks?
Kitty Ussher: It is the same in that it operates on a risk-based principle. That is why there was an incentive to bring forward the “Solvency II” framework to update the “Solvency I” framework, which consists of a number of different bits of legislation introduced during the past few decades. The regime is similar in that it regulates through prudential and capital adequacy requirements on the basis of risk, which we feel is the most appropriate way. That is the same system as currently exists for the banks.
Mr. Hoban: May I just take the Minister back to her previous answer? She said that the one in 200 regime was the same under “Solvency II” as under the FSA’s rules. Yet, I believe that in looking at equities, the FSA considers a 40 per cent. reduction in the value of equities, whereas “Solvency II” only takes into account a 32 per cent. fall in equity values. Will the Minister explain how those two statements are consistent, given the reduction in the impact of equities?
Kitty Ussher: In order to have a one in 200 risk of a problem, we believe that the equity ratio to which the hon. Gentleman refers should be in the range of 38 to 40 per cent. That is being debated across the EU, and has not yet been set. “Solvency II” has not yet set a value on equity, and that issue will be resolved at the level two arrangements that are made once the overall outline of the directive has been reached. The overall principle has been set and the FSA think that a figure in the range of 38 to 40 per cent. is required, but the matter is still being debated, as the hon. Gentleman knows.
Mr. Hands: Returning to the Basle and BIS capital adequacy ratios, the Minister sounds familiar with their introduction to the banking industry, but what lessons have been learned from their introduction in the 1990s? What problems are being ironed out, and what impact that has that had on this set of proposals?
Mr. Hands: Will the Minister briefly outline how the one in 200 probability is calculated and provide the rough methodology of how it is arrived at? Is the calculation based on historic data—in other words, is it made by looking back over a number of years to see the biggest possible move in equity prices and saying it should not be in the worst half a per cent.—or is it based on current volatility levels? Will the Minister give us some more detail on that?
Kitty Ussher: The hon. Gentleman has asked an extremely good question. My advice is that it is a normal calibration standard. However, on the specifics, perhaps he would permit me to respond later.
Mr. Hands: Finally, the European Scrutiny Committee looked at the issue, and in our paper, on page 370 of the pack, the fifth and final bullet point in the equity risk section states that
“agreement has not yet been reached on this issue and further alternatives are being considered”.
I cannot remember when we wrote the paper, but will the Minister update us on what has happened between the date that she wrote her letter, 23 May, and today?
Kitty Ussher: Not a huge amount, in that the issue remains unresolved but there are intense ongoing negotiations at a European level to try to reach a resolution. It is worth continuing to push for the figure of 38 to 40 per cent. It would be fair to say that other member states’ views are evolving, and I shall be happy to update the Committee on that point perhaps later in the year.
Mr. Hands: Will the Minister outline which issues are still not yet resolved? Will she list them? I was not entirely clear.
Kitty Ussher: As I said in response to the Opposition Front-Bench spokesperson, the hon. Member for Fareham, there is not yet any agreement about the level of the capital charge in the standard formula for the solvency capital requirement. However, it is being tested through various quantitative studies that the Commission has organised. Discussions are ongoing between industry and Governments throughout the EU, but that is the main area of disagreement and it is as yet unresolved.
Mr. Breed: I want to explore some of the potential practical difficulties with cross-border supervision. Will the Minister confirm that information will be shared between all the supervisors—between those who supervise subsidiaries and those who supervise the group?
Kitty Ussher: Yes, and various committees have been set up at a European level to deal precisely with those issues. It is extremely important that supervisors share information as much as possible. In fact, on a separate and broader point, the hon. Gentleman will be aware that my boss, the Chancellor, recently proposed to his European counterparts a system of supervisory colleges for some firms. That is separate from the hon. Gentleman’s point, but the consensus—the prevailing mood—throughout Europe is that that is precisely the area in which greater informal but effective co-ordination is required.
Mr. Breed: Given that insurance companies often fall foul of the same large disaster, and that the risk of something very large, such as the New Orleans tornado, is spread among the different insurance operations, is it not possible that two subsidiaries in two different countries might have difficulties and rely on the same group’s capital adequacy? Who would be the arbiter of which subsidiary had a better claim on the group reserves to get out of trouble if two or three subsidiaries had the same difficulty because of a major world risk?
Kitty Ussher: Legally, the situation would be the same. The important point to realise is that protection for each policy holder would be the same whether the situation involved just one company operating in one country or a group office that the company was legally required to support. In extreme circumstances when a firm is unable to meet its liabilities, there are separate insurance, reinsurance and compensation arrangements, but an individual policy holder would be no different from an individual group; it would come down to law in the end.
Mr. Hoban: May I ask the Minister about article 131, which relates to the restriction of assets permitted within an insurance unit-linked contract? Currently, the FSA has rules that restrict the use of assets. Article 131 sweeps away that restriction, yet the FSA has tabled an amendment to reinstate it. I believe that the FSA has not discussed that with the industry or consulted on it. Could the Minister explain why it has taken that approach?
Kitty Ussher: That is probably a matter for the FSA, as it tabled the amendment. The Government are aware of the industry’s concerns about the issue, but we are also aware that the FSA is concerned that it might not be able to protect retail policyholders if “Solvency II” were to prevent any limitation of the kind of assets to which a unit-linked policy can be linked.
The modification of the directive text that we are seeking would allow supervisory authorities to impose rules on the assets to which unit-linked policies can be linked, but only for retail policyholders. There would be no possibility of such rules for products sold to institutional policyholders. In addition, we are seeking to limit the scope of any rules that are imposed in respect of products sold to retail policyholders so that they are not more restrictive than those for comparable investment products.
Mr. Hoban: Is not there a risk that insurers will end up having to create two classes of fund—one for institutional investors and one for retail investors—and are there not better ways of protecting retail investors through, perhaps, the rules around the sale of products?
Kitty Ussher: There could well be, which is why the FSA would consult before actually using the powers that it is seeking in this regard, if it is successful in seeking them. This is at a very early stage, and perhaps the industry should speak to the FSA about the details.
Mr. Hoban: I want to move on to the separate area of annuities. Clearly, many insurance companies write annuities—it is an important area of business for them and for consumers. What thought has the Treasury given to the impact that “Solvency II” might have on annuities?
Kitty Ussher: As I said in response to a point that was raised earlier, we published a partial impact assessment because we believe that it is best to start as early as possible to attempt to quantify the costs and benefits. The evidence on the cost of writing annuities under “Solvency II” is only beginning to emerge. We want to work with the industry to ensure that we have a shared understanding of how the directive will work.
Mr. Hoban: At what point will the Government finally sign up to “Solvency II”? The Minister identified an important area about which there is still some uncertainty. We would not want the process to go so far that we cannot stop it and then find that the cost-benefit analysis does not support the introduction of “Solvency II”. Where will the Minister draw the line?
Kitty Ussher: The hon. Gentleman has put his finger on a crucial point. That is why we have been clear from the start that we want to work with the industry to identify, as a general point of principle, whether the directive offers a good opportunity for UK companies. The answer that we are getting back clearly is yes, which is why we are proceeding.
Everybody knows that part of the implementation will not be done at the high level that is currently being discussed but through the level 2 Lamfalussy-type committees, at which point we will go into battle again with our arguments through the agreed mechanisms. We would not be following that route if we did not think that we had a good chance to get an overall outcome that would work to the UK’s advantage. We believe that we are bringing the industry with us in doing this in the way that we propose, which is the normal way to implement EU directives in the financial services sector.
Mr. Hoban: So am I right therefore in saying that we could get to a position where the Government have signed up to “Solvency II” but would still be working out the details through a Lamfalussy process at the second level? We could end up at level 2 with the run of the debate against us and a cost-benefit analysis that does not quite work.
Kitty Ussher: That is theoretically possible, but I would be surprised if we did not end up in a situation that was not to the net benefit of UK industry. However, the industry will know—as the hon. Gentleman knows and as we know—that these things are done in two stages, because that is seen as the best way to make decisions in a complicated, technical area.
The hon. Gentleman is right, theoretically, in terms of the sequence, in that we are hoping to get substantial agreement in the second half of this year—it could be the first half of next year, under the Czech presidency—and the level 2 discussions will probably only be starting just as the substantial agreement has finished. He is right theoretically; however, I come back to my earlier point, which is that we are confident that the balance of argument lies with us and that British companies will end up having more opportunities, not less, as a result of this.
Mr. Hoban: Can I just check the sequencing of this? Clearly, one of the best ways in which the Government can secure benefits from “Solvency II” is to get the right group supervision arrangements in place. Will those be properly signed off, in terms of ensuring that the balance is right between the lead and local regulators, prior to signing off solvency II as a directive?
Kitty Ussher: The general principle of group supervision is in the higher level directive agreement, so as far as I am aware the answer to that question is yes, although the detail must be worked through under the liability process.
Mr. Hoban: That is where my concern rests, because the way to maximise a value for “Solvency II” is in how the group supervision will work. The weaker the position of the group supervisor, the less benefit there will be for UK insurance companies. I want to make sure that the Minister knows how important it is to get those arrangements set out in as much detail as possible at the directive level, so that there can be no doubting the relative strengths of the lead supervisor and the local supervisors.
Kitty Ussher: Yes, we are fully aware of that and are doing precisely that.
 
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