Memorandum from Association of British Insurers

 

Response to Regulatory Reform Committee Inquiry: Themes and Trends in Regulatory Reform

 

 

The Association of British Insurers (ABI) is the voice of the insurance and investment industry. Its members constitute over 90 per cent of the insurance market in the UK and 20 per cent across the EU. They control assets equivalent to a quarter of the UK's capital. Through the ABI their voice is heard in Government and in public debate on insurance, savings and investment matters.

 

General comments

 

The ABI welcomes the opportunity to respond to the Committee's inquiry.

 

Key points outlined in this submission include:

 

· The importance of preserving the ability to accept and manage risk, and in some cases better risk-sharing with the state

 

· More consistent international prudential regulation and a new balance between the different types of regulation to reduce costs for consumers

 

· Open reporting to investors to enhance governance, combined with a clear separation of roles between accounting and prudential supervision.

 

Insurance companies in the UK and Europe have not been in the front line of the crisis. Generally, they entered it well capitalised and well placed to weather the storm and remain so. In the UK, radical FSA reform of prudential standards in insurance after 2001 have improved the position of firms and moved the industry closer to a "market consistent" framework for managing capital, for example, in the introduction of "realistic reporting" for with profits funds. That said, insurers are profoundly affected by the crisis. The profitability of some products has reduced and they could be affected by regulatory reform - there is a paradox that robust regulation may increase the cost of, or reduce the availability of some products.

 

The crisis affecting the banking sector has uncovered serious weaknesses in some banks and in regulation. Failures have occurred in risk management, Board oversight, regulation reporting and the market's response. Insurance has not suffered from the same problems and the same substantive changes to its regulatory system are not required. Liabilities are more intensively backed by capital and many liabilities are far more long term. However, in an integrated financial system, changes in the banking sector will affect insurance and it is right that the lessons learned should be applied across the system where that is appropriate.

 

Risk-based regulation

 

1. A failure of risk in banking should not lead regulators to eliminate risk at all costs from the institutions they supervise. Insurance offers a means of managing long term risks effectively, backed by strong capital requirements, supervision of risk management, controls within the firm, and robust disclosure. Risk is inescapable and risk-taking is inherent to all life and economic activity. We must ensure that the financial system in general and insurers in particular are able to absorb and manage risk on behalf of society at large. If they cannot, consumers will suffer, with fewer opportunities to manage their risks and higher prices for risk management products. The alternatives to insurance-based risk management are also not attractive. Either the state must assume, on a permanent basis, a much more substantial set of risks and liabilities; or individuals must shoulder a greater proportion and scale of risk alone.

 

2. Going forward, we need to consider whether there are new relationships with government that could enable more risk to be covered. For example, the industry could offer long term care products more easily if government could give assurances about a positive and sustained tax treatment; long term annuity and protection products could work better if presently unforeseen changes on longevity were carried by government.

 

Innovation and Competition

 

3. The commitment to competition has been undermined by the crisis. A closed market with very basic products that does not respond to customer needs, in which there is little differentiation, is a recipe for stagnation. There must be a capacity to innovate and flexibility to fulfil the wide range of customers' needs. Only through this process of innovation will the industry deliver choice 'value-added' products to underpin future growth of markets and profitability. Innovation should not mean just re-badging of products. Nor should it mean over-complication of products and consumer confusion. Innovation should allow new products in savings and protection, to address changing longevity and the near for care late in life; it should allow more flexibility in savings; and it should ensure that traditional products such as motor insurance evolve as the structure of demand and technology changes.

 

4. An innovative and competitive industry does more for consumers than regulation ever can. Regulation always has a key role to play - from protecting consumers all the way to protecting financial systems, but it needs to work symbiotically with the market.

 

The UK Tripartite Framework

 

5. The ABI continues to support the UK regulatory arrangements (the Tripartite Authorities) but believes that improvements need to be made to ensure better co-ordination between the FSA, the Bank of England and HM Treasury.

 

6. There have clearly been failures in the supervision of individual banks and the FSA needs to rectify these - in particular there is a need for improvement in the regulation of liquidity requirements and a need to ensure better risk management. Recent events have made a strong case to rethink reserving policy and the proposal for an "economic cycle reserve" has already gained currency in the Financial Stability Forum. In general, the authorities should be wary about a "read across" to insurance.

 

7. The FSA should remain responsible for the supervision of individual firms (including banks) and the Bank of England should have a statutory remit to achieve financial stability. Only if these arrangements do not work is there a case to consider more radical alternatives. Wherever the line is drawn between the two there will be a need for HM Treasury's capabilities to be expanded in this area. It needs more close and continued involvement with its counterparties on all aspects of financial services, financial regulation and financial stability.

 

8. Proposals for a twin-peaks approach to regulation need careful thought. Prudential and business conduct regulation cannot be entirely separated. Some conduct decisions have large prudential effects. And there is a risk of costs being driven up by competition between regulators.

 

Industry Initiative

 

9. Much regulation designed to help and protect consumers has made it difficult, if not impossible for them to purchase the financial services they need on a reasonable and cost effective basis, as flagged by the above remarks on conduct of business rules. Regulation has narrowed markets and led to damaging practices. That said, there have been occasions, from pensions and endowments to the treatment of claims in critical illness, where the insurance industry has fallen short in its treatment of customers.

 

10. Going forward the ABI is committed to a variety of initiatives - some, such as customer impact are industry led - others led by the regulator. Making sure that the mixture of principles and rules, backed by sanction delivers high quality customer outcomes remains the role of the regulator. Doing this in a way that minimises uncertainty about what the minimum standards are in respect of consumers is also the role of the regulator. Beyond this, however, industry initiatives have potential to deliver better outcomes for consumers. Beyond these, a properly functioning market can do so much more as firms compete on brand, service, and price.

 

Ombudsman Requirements

 

11. All consumer initiatives, industry or regulator led, are affected by the requirements by the Financial Ombudsman Service (FOS). It can cause providers to withdraw from the market - particularly for those customers with more modest incomes. This leaves those consumers with a restricted choice of very basic products or without any product at all. In consequence, markets are being stifled and consumer needs are not met because of the actual or perceived regulatory risk that exists in the UK regime around the role of the FOS. To help address some of these concerns the FSA has introduced the idea of 'principles-based' regulation. It is potentially very helpful, but in execution this has resulted in considerable uncertainty when taken together with FOS requirements. It is time to build a new 'regulatory settlement' based on greater certainty in the regulatory framework. This requires that the FOS retreats from a broader and often retrospective policy role and focuses more on arbitration in specific cases, so as to deliver quicker and cheaper dispute resolution.

 

Wholesale Markets and Governance

 

12. A great deal has been said defensively by various groups - senior management, hedge funds, traditional investors, regulators and now Government, as to why they are not to blame for the recent crisis. This debate will continue but there is already much talk of a move towards more restrictions on markets and firms e.g.- narrowing the role of commercial banks, returning to functional regulation between types of institution, geographical regulation to restrict cross border activities; and product controls, for example to prevent insurance companies operating financial product divisions.

 

13. All this is understandable but wrong. There can be no return to a financial services sector of 20 years ago. That would simply create instability and a mass of new opportunities for regulatory arbitrage. New regulation should be carefully focused to address specific issues. In general the best solutions lie in improving transparency (as opposed to having reams more disclosure). This would include products such as CFDs and short selling. In both cases it is possible to take significant positions on firms without others in the market knowing. If off exchange trading is to remain valid for risk transfer and as a means to force efficiency on exchange, then it needs to be monitored to make sure it does not distort on exchange prices.

 

14. A number of major institutional actors - such as pension fund trustees and sovereign wealth funds need to be embedded into the corporate governance framework better, and in some cases need to show willingness to become involved in dialogue with the boards of companies in which they invest about risk management and long term plans for the business. Insurance companies have a stronger record than other groups in corporate governance, though recent events will clearly give rise to a review of what needs to be improved. There is much to be said for finding ways in which the owners of businesses can get better sight of, and better control over, the executives running those businesses. The reason why the effort needs to go into improving and enhancing governance is that because in a market economy it is the owners of firms who in the end need to provide governance, not government or regulators.

 

 

February 2009