Written evidence submitted by Lloyd's
of London
1. Lloyd's welcomes the opportunity to respond
to the Select Committee's Inquiry into the Government's proposed
changes to the system of financial regulation in the UK.
2. Lloyd's is the world's leading specialist
insurance market and wrote more than £22 billion of premium
income in 2009. It is the fifth largest reinsurer in the world
and the second largest surplus lines insurer in the US. In 2010,
78 syndicates underwrite insurance at Lloyd's, covering all classes
of non-life business from more than 200 countries and territories
worldwide. Its headquarters are located in the City of London
and it is regulated by the Financial Services Authority.
3. The Committee's website identifies a
number of questions which the Committee may look at. We do not
propose to address the questions individually but to provide both
general and specific comments on some of the main issues which
the proposed changes raise for the insurance sector and the Lloyd's
market in particular.
GENERAL COMMENTS
(a) The current UK regulatory system
4. The Government's motive for wishing to
propose changes to the current UK regulatory system is explained
in its consultation paper "A new approach to financial regulation:
judgment, focus and stability". The paper states that "there
were real and significant failings in the UK regulatory framework"
and that the most obvious failing was "that no single institution
has the responsibility, authority or powers to monitor the system
as a whole, identify potentially destabilising trends and respond
to them with concerted action".
5. In light of this finding, we agree it
makes sense that a Financial Policy Committee (FPC) be established
to monitor the UK financial system's stability and to take action
in response to rules and vulnerabilities in the system although
we believe that the FPC should have at least one member with background
and experience in the general insurance sector (please see specific
comments below).
6. The Government's consultation paper explains
that the financial turbulence of the last few years has exposed
serious weaknesses in conventional micro-prudential supervision
and regulation of the financial sector although it also notes
that the FSA has taken "significant steps to improve its
performance in this area" recently by implementing a more
intrusive and proactive approach to the regulation of firms.
7. We would note that our experience of
being regulated by the FSA has been a positive one. The FSA has
been a leading insurance regulator with a strong reputation for
the quality of its supervision of general insurance. We do however
recognise that, due to the banking crisis, the Government has
determined that fundamental change is required to the system of
regulation in the UK. We do not seek to oppose this but are concerned
to ensure that the system of insurance regulation that has served
the UK industry well over the last nine years is not damaged as
the Government seeks to address perceived inadequacies in the
management of systemic risk within the banking sector.
8. Since the FSA assumed its supervisory
responsibilities, it has established itself as a leading player
on the global stage. Its influence can be seen in the EU's development
of Solvency II, which is informed by the FSA's experience of its
Insurance Capital Assessment System (ICAS) and in the Insurance
Core Principles of the International Association of Insurance
Supervisors (IAIS), international compliance with which is strongly
encouraged by the Financial Stability Board's Framework for Strengthening
Adherence to International Standards. FSA staff have thus made
significant contributions to a more harmonised global insurance
supervisory environment, which has benefited UK insurers which,
like Lloyd's, have an international focus.
(b) The differences between the insurance
and banking sectors
9. The Government's consultation paper proposals
focus on lessons to be learnt from the banking crisis and on banking
supervision. This is understandable given that the previous Government
felt obliged to part-nationalise two of the largest banks in the
world at a cost to the tax payer of hundreds of millions of pounds.
10. However, any consideration of reforms
to the structure and substance of financial services supervision
as a whole must take account of the fact that the financial services
sector has different constituent parts. Although the insurance
and banking industries form part of the broader financial services
sector, there are very significant differences between them in
terms of their business models, key activities and risk profiles.
11. It is also the case that the two industries
performed very differently during the financial crisis.
12. The insurance sector, certainly on the
non-life side, has navigated the global financial crisis fairly
well to date. Indeed the Lloyd's market has traded very profitably
during recent years and, notwithstanding the banking crisis, its
financial strength has continued to grow.
13. Research has also demonstrated that
there are differences in the extent to which the activities of
the two industries present potential risk to the global financial
system. A recent report by the Geneva Association on "Systemic
Risk and Insurance"[18]
found that the core activities of insurers and reinsurers are
not a cause of systemic risk and do not represent a threat to
the global financial system. This view has been broadly endorsed
by the International Association of Insurance Supervisors (IAIS).
In a June 2010 Position Paper on "Key Financial Stability
Issues",[19]
the IAIS commented that:
"The insurance sector is susceptible
to systemic risks generated in other parts of the financial sector.
For most classes of insurance, however, there is little evidence
of insurance either generating or amplifying systemic risk within
the financial system itself or in the real economy."
14. It is therefore vital that the specificities
of the insurance sector are taken into proper account in the design
of the new regulatory architecture. The consultation paper focuses
almost entirely on the supervision and regulation of banks. The
result is that it lacks detail as to how exactly supervision of
the insurance sector is to be undertaken by the authorities and
how an appropriate separation of banking, insurance and other
financial services oversight responsibilities will be achieved.
15. We believe that ensuring the right level
of separation between insurance and banking supervision will require
the Prudential Regulatory Authority's (PRA) internal structure
to include a separate insurance division, headed by a senior and
respected individual at the same level of seniority as the head
of banking supervision.
16. We also submit that it is vital that
the PRA includes a sufficient number of qualified staff with experience
of insurance risk. Implementation of the EU's Solvency II regime,
due to enter into force in late 2012, is the most fundamental
reform of prudential insurance supervision undertaken by the EU
in the last 30 years. It represents a formidable challenge for
UK regulators and the industry to meet its demands. It is important
that the PRA has the resources and appropriate skills and expertise
for these challenges and that it is able to discharge its new
duties in an efficient and effective manner.
(c) Proper co-ordination between the
separate regulatory authorities
17. The new regime will involve separation
of regulatory responsibilities across several regulatory authorities,
including the PRA, the Consumer Protection and Markets Authority
(CPMA) and the Economic Crime Agency. This separation carries
an obvious but serious risk that there may be either duplication
of regulatory oversight or possible failure of the authorities
to co-ordinate their activities in an appropriate and effective
fashion. It is therefore pleasing that the consultation paper
acknowledges the importance of effective co-ordination between
the authorities and makes various proposals for achieving this,
including suggesting that the authorities should have regard to
the objectives of the other authorities in their work which should
"be supplemented with mechanisms for operational co-ordination
and, where appropriate, formal consultation". It is very
important that measures and protocols are put in place to ensure
such proper co-ordination is achieved between the authorities.
The Government should explain in more detail how it will achieve
such co-ordination learning the lessons from the perceived failure
of coordination within the tri-partite arrangement.
18. We would make one practical suggestion
in this regard. It is highly undesirable that an authorised firm
or individual should be required to seek approval from two different
supervisory organisations. This will mean an increased administrative
burden, with the potential for delay, duplicated work and an absence
of coordination that could even see a person or firm approved
by one body and rejected by the other. We suggest that the PRA
and the CPMA take full responsibility for all the authorisations
that the firms they regulate require, as well as the authorisations
of the firm's staff. This is just one example of the ways that
the proposed structure will give rise to additional administration,
unless careful thought is given to supervisory coordination and
cooperation.
(d) Observance of better regulatory
principles
19. One of the strengths of the existing
UK regulatory system has been its attention to principles of good
regulation. The overhaul of a regulatory system provides an opportunity
to further embed and improve this strength,
20. It is pleasing that the paper suggests
that the regulatory authorities should have regard to principles
of good regulation and to act proportionately. More assurance
is, however, necessary. The Government should affirm that the
PRA will retain the full range of statutory safeguards under FSMA
(eg proper consultation on rule-making, a complaints process,
rights of appeal).
21. Indeed, we would go further and urge
the Government to legislate that all the new authorities will
be guided in their actions and behaviour by core principles of
regulatory best practice, such as these under consideration by
TheCityUK[20]
covering the following areas:
— Transparency: regulation should be transparent
and accessible, delivering consistent outcomes;
— Proportionality: regulation should balance
necessary controls with scope for innovation. It should be proportionate,
both as to regulatory solutions and as to the varying scales and
types of business, as well as targeted and technologically neutral;
— Accountability: responsibility should
be clearly defined, including to whom and for what;
— Facilitation: regulation should facilitate
and reinforce the role of financial services as a key enabler
of social and economic development, both domestically and internationally;
— Impact Assessment: robust regulatory
impact assessments should become standard and should include assessments
of the cumulative impact of regulatory requirements;
— Scope and compliance: before introducing
new regulation, authorities should ensure existing regulation
is being used to its fullest extent;
— Convergence: regulation at regional and
national levels should reinforce global convergence, not impede
it and should provide a firm base for businesses from any jurisdiction
to operate globally; and
— Competition: market structures should
promote competition and openness to international participants.
Regulation should facilitate progress towards easier market access
and growth in international trade.
(e) Efficient use of resources by the
authorities
22. The new authorities should have regard
to the need to use their resources in the most efficient and economic
way and should not seek to impose disproportionate and inappropriate
levels of regulation on the industry. The insurance industry has
been subject to very significant increases in recent years in
financing the costs of regulation imposed by the FSA (the costs
for the Society of Lloyd's have risen from £1.3 million in
2008-09 to £2.2 million in 2010-11). We would hope that the
new architecture would not lead to yet further significant increases
in fees payable by the insurance sector.
(f) Interaction with the European authorities
23. The vast bulk of insurance regulatory
rules applicable in the UK derive from EU legislation. It is vital
that the UK is effectively represented in the various deliberative
and decision making bodies in the EU which determine the detail
of legally binding financial services regulation. Much greater
consideration must be given to how the proposed new structure
and multiple agencies will interact with the EU to ensure that
the UK has a strong and effective voice in the development of
financial services regulation within the new European Supervisory
Authorities, supervisory colleges and the other European initiatives.
24. The new EU financial supervisory structure,
to be introduced in January 2011, makes it even more important
that UK supervisory bodies engage constructively with their EU
counterparts. The EU's supervisory authorities, including the
European Insurance and Occupational Pensions Authority (EIOPA)
will have enhanced rule-making and intervention powers, but will
continue to rely on the contributions of national supervisors
for the informed development of regulatory initiatives. EIOPA's
remit will cover both prudential and business conduct issues.
The UK authorities will need to decide between themselves which
would be the appropriate body to represent UK interests at EIOPA
meetings most effectively. We would also expect the importance
of prudential regulation to be recognised through the PRA's participation
on EIOPA's Board of Supervisors.
(g) Competitiveness of the UK insurance
industry
25. Last but certainly not least, we would
stress that the UK insurance industry is a very significant source
of income, tax and employment for the UK Economy. The proposed
changes in financial supervision in the UK should have regard
to the desirability of maintaining the competitive position of
the UK. This is not a plea for light touch regulation: the two
new supervisory bodies will have their primary objectives and
maintaining the UK's competitive position need not deflect them
from achieving those objectives. The consultation paper states:
"there is a strong argument that one
of the reasons for regulatory failure leading up to the crisis
was excessive concern for competitiveness leading to a generalised
acceptance of a light touch orthodoxy".
26. We believe that this "argument"
is itself open to challenge. The Turner Review, in its detailed
assessment of regulatory developments preceding the financial
crisis, makes no reference to this. Certainly it has no validity
in relation to the supervision of non-life insurance, which has
been subject to an increasingly intrusive supervisory approach,
both on the solvency side, through the introduction of ICAS, and
on conduct of business, through the "Treating Customers Fairly"
initiative. We stress that we believe that the industry gains
significant benefit on the international stage from being subject
to high quality supervision.
27. The UK is the world's third largest
insurance market, receiving total premiums of $309 billion in
2009.[21]
Although it is smaller than the insurance markets of the US and
Japan, a much greater proportion is made up of international business,
dependent on the industry's global competitiveness. The London
market remains the world's leading wholesale insurance centre
and the only place where, in addition to the Lloyd's market, the
world's 20 largest international insurance and reinsurance companies
are active. Its premium income in 2008 was conservatively estimated
as £24.7 billion.[22]
The London insurance market is also a major employer. Insurers
and pension funds employed 325,000 people in June 2009, including
50,000 in the London Market. Insurers' activities also give rise
to significant employment in supporting services.
28. There is nothing inevitable about London's
current financial success. London market insurers such as Lloyd's,
operate in global markets and compete with firms from other jurisdictions
that benefit from more benign tax regimes. It faces significant
competitive challenge from international markets in jurisdictions
such as Bermuda and Switzerland. Solvency II's implementation
is costing insurers significant amounts. It is important that
the proposals for UK financial supervisory restructuring do not
impose a further heavy burden of cost and administration.
29. The Government should therefore recognise
the particular position of the London insurance market and ensure
that any moves it makes on financial supervision strengthen rather
than undermine its competitive position.
SPECIFIC COMMENTS
(a) Financial Policy Committee
30. The FPC has a broad remit which includes
powers to give directions to the individual regulatory authorities,
such as the PRA and the CPMA. That being the case, it is vital,
that the FPC's expertise is broad, comprising not just persons
knowledgeable about banking issues but about insurance and reinsurance
also.
(b) Supervision of the Lloyd's Market
31. The consultation document contains very
little information about the proposed approach to regulation of
the Lloyd's market and its constituent parts. Indeed only one
paragraph addresses this subject.
32. The paper seems to suggest that prudential
supervision of the Lloyd's market would be undertaken by the PRA
and supervision of the market's conduct of business activities
undertaken by the CPMA.
33. It seems clear that the Government is
resolved to introduce this proposed separation of responsibilities
but we believe that responsibility and expertise for prudential
supervision of different entities engaged in the Lloyd's market
should be focused in one team in the PRA rather than dispersed
across different agencies. We would therefore anticipate that
the PRA will take over regulation of the Society of Lloyd's (otherwise
known as the Corporation of Lloyd's) and relevant subsidiaries
as well as the Lloyd's managing agents currently authorised by
the FSA.
EXECUTIVE SUMMARY
34. In summary, Lloyd's:
— supports the establishment of the FPC
but believes it must include persons knowledgeable about insurance
issues;
— stresses the significant differences
between the banking and insurance sectors, and proposes that the
PRA's internal structure should include a separate insurance division,
headed by a senior and respected individual at the same level
as the head of the banking division;
— requests that measures and a protocol
be put in place to require proper and effective co-operation between
the authorities so as to avoid risks of duplication of oversight
or inadequate interaction;
— underlines the importance of the authorities
observing principles of good regulation;
— seeks assurance that the regulatory authorities,
and in particular the PRA, will be subject to the full range of
statutory safeguards that exist under FSMA to ensure that they
are properly accountable including in areas such as consultation,
a complaints process, and rights of appeal;
— asks that due regard continues to be
paid to the competitiveness of the UK industry in the further
design of the new regulatory system; and
— proposes that responsibility and expertise
for prudential supervision of the Society of Lloyd's, relevant
subsidiaries and managing agents, lie with a dedicated insurance
team within the PRA.
22 September 2010
18 Geneva Association: "Systemic Risk in Insurance-an
analysis of insurance and financial stability" March
2010. The Geneva Association is a leading international insurance
"think tank". Back
19
IAIS Position paper on key financial stability issues 4 June 2010. Back
20
A body for the promotion of the UK-based financial and professional
services industry. Back
21
Swiss Re Sigma World Insurance in 2009 February 2010. Back
22
IFSL Research International Financial Markets in the UK May
2010. Back
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