26.The Chancellor issued remit letters to various bodies, including the Prudential Regulation Committee of the Bank of England, at the March Budget 2017. In them he asked the organisations, where relevant and practical, to:
“take the following considerations into account in their assessment of the costs, burdens and benefits of potential rules or policies:
i. Competition—The government is keen to see more competition in all sectors of the industry, particularly retail banking. This includes minimising barriers to entry and ensuring a diversity of business models within the industry.
iii. Competitiveness—The government wishes to ensure that the UK remains an attractive domicile for internationally active financial institutions, and that London retains its position as the leading international financial centre. The government considers that achieving this aim in a manner that is consistent with robust institutions and a resilient system will support its aims for sustainable economic growth.”
27.This theme was anticipated by many of those who gave evidence to the previous Treasury Committee in its inquiry. They considered that it would be beneficial to reconsider the PRA’s remit, and specifically how it carries out its prudential oversight responsibilities in the light of the Government’s wishes for an internationally competitive insurance sector that offers good value for money to its customers. There was widespread concern that the PRA’s focus was weighted too heavily towards prudential matters, and that this was inhibiting competition.
28.While previous regulators had to learn important lessons from Equitable Life and Independent Insurance, history indicates that prudential oversight of the UK insurance industry has generally been effective. The industry’s responses to the inquiry recognised the importance of maintaining a robust approach to prudential supervision, in order to protect the industry’s customers and its worldwide reputation. Alongside their various concerns, witnesses were not short of praise for the regulator, both in oral and written evidence to the previous Committee. For example, Jane Portas stated:
“The PRA, as I have said previously, is one of the most—if not the most—highly regarded regulators in the world. It is highly respected by other regulators.”
These sentiments were supported by Lloyd’s of London who noted that the PRA was “respected internationally”, and the ABI stated:
“the PRA are, as I think we would all agree, hardworking public servants who introduced Solvency II in an ordered and measured way into the UK environment, and work phenomenally hard to clear a lot of Internal Models”
30.Finally, the ABI noted that there are a range of factors contributing to the standing of the UK Insurance industry, and as such Solvency II should not be considered in isolation:
“level of trust in the UK legal system, tax regime, time zone, talent and skills base are also significant factors that contribute to the UK’s leading global standing in the insurance market”.
31.The predecessor regulatory body to the PRA, the Financial Services Authority (FSA), was required to have regard to both competition and competitiveness when advancing its objectives. Specifically, the FSA were required under section 2 (3) of the Financial Service and Markets Act 2000, to “have regard to …(e) the international character of financial services and markets and the desirability of maintaining the competitive position of the United Kingdom; (f) the need to minimise the adverse effects on competition that may arise from anything done in the discharge of those functions; (g) the desirability of facilitating competition between those who are subject to any form of regulation by the Authority.”
32.When the FSA was abolished, the FCA was given an objective to promote “effective competition in the interests of consumers”. But the requirement to have regard to competitiveness when discharging its general functions fell away.
33.In a similar development, the Bank of England lost its third core purpose—to seek to ensure the effectiveness of the UK’s financial system—in 2004, following its fundamental review of its Strategy and Objectives, which had concluded that “the third core purpose is essentially a part of the first two; and while the Bank may from time to time wish to support particular initiatives in the financial sector, we have concluded that the possibility of doing so should not in itself be a core purpose”.
34.The Prudential Regulation Authority’s objectives are set out in the Financial Services and Markets Act (2000). These are:
i)a general objective to promote the safety and soundness of the firms it regulates;
ii)an objective specific to insurance firms, to contribute to the securing of an appropriate degree of protection for those who are or may become insurance policyholders; and
iii)a secondary objective to facilitate effective competition.
35.Evidence provided to the previous Committee gave strong support for the PRA’s secondary objective to be promoted to a primary objective, and for it to reflect competitiveness as well as effective competition. This would bring it closer to the objectives of its predecessor organisations. The ABI believe that the PRA’s objectives “should be about maintaining a safe, vibrant market that firms are interested in entering, in addition to recovery and safe resolution”. For these reasons they argue that the PRA should have a responsibility to “consider the implications for UK competitiveness when developing and supervising the UK prudential regime for insurers, to ensure that the regulatory framework and its implementation is supportive of a strong, dynamic and growing UK economy”. In oral evidence, Huw Evans asserted that the ABI’s members are “overwhelmingly in favour of it being an equal objective”. Agreeing with the former Committee Chairman’s comments at an earlier session that secondary objectives never really get taken into account at all, he said that competition should be a primary objective:
“That would be good for the market. This is a market, not least because of the wider public policy landscape, freedom of choice in the life side, the challenges of meeting new risks in the GI side, such as cyber and different types of flood risk, that needs innovation in the market to thrive and to continue to make sure it is a market that works for consumers, and internationally that it continues to be one of the leading markets in the world, as it always has been.
“That cannot just happen by accident in a more challenging environment. We think that having a regulator that was attuned to that, and one full of highly intelligent people who are perfectly capable of striking a decent balance in operational, daytoday practicalities, is not just doable but desirable.”
36.Prudential were also in support of turning the secondary competition objective into a primary objective, with Julian Adams referring to the issue of conflicts of interest:
“We feel very strongly it should because if you do not, the incentive structure of regulators is always to encourage greater and greater caution. I understand that you asked the same question of the first session, and one of the objections was, “Does that not introduce a conflict of interest?” I would argue that conflict of interest exists at present. There is always a tension between microprudential regulation and its impact on competitiveness. At the moment, that conflict is neither recognised nor managed.
“I would encourage competition from two perspectives. I would encourage competition in the sense of low barriers to entry, to encourage domestic competition, with the socalled challenger bank issue, but, in particular postBrexit, we would encourage them to have regard for the international competitiveness of the UK relative to other financial centres. It is a difficult balance, but there are regulators around the world who in my view recognise and manage that more effectively than in the UK.”
37.Finally, both KPMG and the IFoA expressed support for the elevation of the secondary objective. Phil Smart commented:
“I think there is a danger that, if you don’t hold them to account—not doing it as a primary objective may not achieve that—the regulator is just encouraged to layer further prudence on top of the capital requirements. To a certain extent, that is what we have seen in Solvency II, and that has a detrimental impact on competition.”
38.This can have the effect of the consumer paying more than he or she needs to in premiums. Andrew Chamberlain added that:
“I think the fact that it is a secondary objective has led to its being left behind. I don’t think it is seen as important in the PRA.
“We have to remember what this is primarily about: in the case of insurance, it is much more about the protection of the consumer than it is about the stability of the system, which is more applicable in banking. The price that the consumer is paying now for the level of protection of Solvency II, together with PRA’s interpretations on top, is very high, particularly in some business lines such as annuities. It makes the product so expensive. The balance between security and value for money has got out of kilter.”
39.However, not all witnesses and submissions advocated a primary competition objective. Jane Portas of PwC stated that:
“[I]t is really important that the PRA is held to account for competition, but actually that the primary objective should be policy-holder protection and financial stability. I say that because it can create conflicts of interest if you have it as a primary objective. It is really important that the two—policy-holder protection and financial stability—come first.”
40.John Parry of Lloyd’s of London was of a similar view, stating:
“We would say that the primary focus of a prudential regulatory authority should be prudence. It should be on the prudential side. There is no doubt that competitiveness is a mixture. Both capital efficiency and capital sufficiency are necessary for us to be competitive. We have seen other regulators being able to embrace that dual focus, so having a secondary objective, or having mind to competitiveness of the UK when we are competing on a global scale for capital and talent, yes. However, we would say that their primary focus should be prudential.”
41.The regulator was against the idea of elevating its secondary objective on the ground of financial stability, and also detailed its efforts at promoting competition. On the subject of financial stability, Sam Woods explained that, as insurers do not present as much stability risk as banks it would be “thoroughly confusing” to elevate the competition objective for insurers only.
42.The PRA’s first Annual Competition Report 2016 outlines its efforts at embedding the secondary competition objective. These include “applying the principle of proportionality to domestic regulations”; undertaking research work that assisted the Competition and Markets Authority regarding retail banking; appointing a senior advisor on competition; updating internal guidance to ensure competition issues are identified at the earliest opportunity during policy making; and undertaking research projects on the relationship between prudential regulation, financial stability and effective competition. The PRA also authorised 17 new insurers during the first three years of the PRA’s existence.
43.This evidence led Sam Woods to conclude that the secondary status of the competition objective is “correct and adequate”, but in evidence to the previous Committee, he added that “if people think we are not taking that competition objective seriously because of its secondary nature, then that would be a source of great concern”.
44.The Committee notes the views of many of those who gave evidence to the previous Committee that the PRA’s approach is overly focused on solvency, to the detriment of competition and the ability of the industry to meet the savings and protection needs of consumers.
45.While the PRA and a minority of industry voices argued in favour of the status quo, many respondents advocated a primary competition objective for the PRA to carry as much weight as its solvency objective. The Committee agrees.
46.The insurance function has implications for solvency in a number of areas, notably market, credit and operational risk, for which they are required to hold capital against under Solvency II. Even taken together, these risks are lower than in the banking sector. For example, AIG was brought down by risks on its balance sheet that were of a banking nature. If so, then insurance solvency issues are less disruptive. Competition was rightly subordinated to systemic risk in banking, but these circumstances do not apply in insurance.
47.The Treasury should immediately review the PRA’s approach to its competition objective, at least for insurers, and consider giving the secondary competition objective equal primacy with the PRA’s other statutory objectives, introducing primary legislation if necessary.
48.In his evidence, Sam Woods said that it would be a concern if the industry felt the PRA was not taking the competition objective seriously. But that is exactly what industry is saying. Regulation in the USA involves a legalistic stand-off approach, whereas in the UK the PRA’s approach to insurance supervision “relies significantly on the judgment of the supervisors” to determine whether a firm will continue to meet its Threshold Conditions. As such, the PRA needs a high level of organic engagement with the industry that it regulates.
49.The industry and the PRA should review their approach to working together (including the conduct of consultations) in order that there can in future be a better and more productive dialogue on issues like Solvency II. Each side may have a different perspective, but there should be more common ground, and greater confidence in each other than the Committee detected during this inquiry. The PRA should set out how it intends to achieve this, as part of the work described in paragraph 88.
50.Insurance regulation was transferred to the Bank of England in 2013. Prior to that, the Bank had little to do with insurance and when it was bolted on, the regulation of the insurance industry appeared to be a relatively poor fit with the rest of the Bank’s activities.
51.The Bank of England can rely on an immense depth of experience in banking regulation. The PRA needs to assess whether it has the skills necessary for effective insurance regulation, particularly at the most senior supervisory and policy levels. The Committee encourages the PRA, in carrying out this review, to consider the skills and experience of its Insurance Directorate to ensure there is a genuine ‘feel’ for the insurance industry. The Committee also suggests that the PRA and industry develop a higher level of staff exchanges so that each can appreciate the objectives of the other.
52.While this could give rise to potential conflicts, the potential benefits are greater than the risks—provided any conflicts are managed correctly.
41 Section 1E of the Financial Services and Markets Act 2000 (as amended)
42 In its description of the third core purpose, the Bank’s 2003 Annual Report said that “the Bank wants a financial system that offers opportunities for firms of all sizes to have access to capital on terms that give adequate protection to investors, and which enhances the international competitive position of the City of London and other UK financial centres.”
60 For definition of Threshold Conditions please see p.14 & 15
25 October 2017