Examination of Witnesses (Questions 20
- 37)
TUESDAY 23 OCTOBER 2007
Professor Gerry Dickinson
Q20 Lord Steinberg:
Obviously you are not as turned on by it as I am.
Professor Dickinson: He is a very brave and
good investor with an insurance company.
Q21 Chairman:
It is an interesting idea because what does regulation do with
that kind of fund. I am not sure that Lord Jordan quite got an
answer about how you feel about the Lamfalussy directive procedure.
Do you think it will work?
Professor Dickinson: The actual process from
now on?
Q22 Chairman:
Yes, the process; how will that fit in?
Professor Dickinson: I think it is working quite
well. I think that the European insurance industry and the regulators,
with the support of the European Commission, are working well.
This whole process is working well; it is a success story of cooperation.
There are a few issues about the mutuals, the smaller companies,
which is the main problem, but the process going forward is that
we have the framework and the framework is very sound; it not
only looks at regulation it looks at market development, and this
is important. It is integrating the European market a bit more,
which has lessons for globalisation. We want to have markets that
are global and regional. So I think the framework is good. Going
forward there are what is called QIS, the different testing of
the model, but they keep changing their mind on this. There is
QIS3 at the moment and there will be QIS4. QIS4 will be the final
test of the model—they are more or less getting there—and
this will come next year. I think in 2009 we will have the final
model in place. I am hopeful that that model will have the ability
to be reduced—it can be sufficiently complex if it wants
to be, but not too complex that it will penalise the small companies.
We do not want too much complexity because on the other side the
regulators cannot regulate it; it is just too complex to be implemented.
So it has we have a little more care about the complexity. But
the final model will be agreed in 2009. Then there is the process
of approval, so it is planned to come into force in 2012, which
gives plenty of time to get through the parliaments and revisions,
etcetera. In 2010 there will be a lot of effort on to how the
regulators will need to work together to implement it. There is
too much focus so far on the technical detail of the model but
not so much on how it will be implemented. I think more effort
needs to be put in on how are the regulations will work, are regulators
competent enough to handle it, do they need to be trained and
who is going to train them so?
Q23 Lord Cobbold:
Is this what the Committee of European Insurance and Occupational
Pensions Supervisors will be doing? It sounds horrendously bureaucratic.
Professor Dickinson: It is the Committee itself,
the CEIOPS. This is a group of insurance regulators, the FSA are
members, chaired by Thomas Steffen, a German regulator. So this
is a technical committee and they will have to look at setting
the standard, how do they work with each other and help each other
to implement it. So CEIOPS will work together to help each other.
The challenge will be emerging markets in Eastern Europe, Southern
Europe—will they need even more training?
Q24 Chairman:
I want to probe a little about training but what I have not quite
understood is where we are in the so-called Lamfalussy proceedings.
Have we got below the general agreement—and I am picking
away at the detail—to the stage to whatever we are at, one,
two, three?
Professor Dickinson: We are at stage one. We
have agreed the general shape of it and the regulators have agreed
the shape of it and the insurance industry is happy with that
shape.
Q25 Chairman:
And it has been handed out fundamentally to people to pick away
at?
Professor Dickinson: Yes, the principles have
been set and the framework is also set. There will be a market
consistent balance sheet which will mean capital will be measured
accurately. Hybrid capital will be allowed, and other forms of
capital will be allowed—all agreed in the framework. The
next stage is what is the risk-based system, how do you calculate
the risk factors and how do you allow for risk diversification
effects? This is in fact being worked through by the CEIOPS committee
under the QIS process. CEIOPS has put forward ideas, asked the
companies to test it out to see whether it makes sense and then
they come back. Then there will be a further iteration. We are
working on the detail of the model now and that detail will be
more or less clear next year, and finalised in 2009.
Q26 Chairman:
I think I am clear where we are. Can I ask a bit about risk because
I have been here with banking, I have seen them all come and I
have watched it all fail at intervals. Do you feel that the directive
takes into account enough the quality of the risk mitigation and
decision making qualities of the managers within the insurance
companies? And measuring risk management often requires a qualitative
decision by the supervisors. Are the regulators sophisticated
enough or are we in danger of devising a system about which nobody
quite knows enough to run or to regulate?
Professor Dickinson: Yes, absolutely; these
are important questions. I think that the large companies clearly
can implement this; there is no problem, that they have the resources.
Because of Solvency II they have been improving their internal
processes. In the past there was less incentive. The boards will
say, "Improve our risk management systems" but only
when you get the threat of regulation that do they say that it
is a must-do. They have invested a lot of money in this; they
have hired chief risk officers and they have invested in IT systems.
They have been building up their internal asset-liability models
and capabilities and their enterprise risk systems. I think that
the larger companies are well positioned. The smaller ones still
need to catch up. There is always a problem with the smaller ones—are
they really aware of how it is going to affect them? But they
do have time before 2012 so there is still some time to catch
up. Probably what will happen is that the consultants will make
a lot of money out of this, as usual. I have always argued that
some of the complexity is caused by consultants. You basically
have the regulators who want a solution—so you tend to have
over- complexity because there are vested interests in the system.
I think that the smaller companies will have to hire consultants
to help them to do this. It will cost them, but they can do it.
My main concern is with the regulatory authorities. The FSA clearly
is competent to handle this but some of the regulatory regimes
in East and Central Europe, in Southern Europe. I do not think
are really sufficiently equipped to handle this yet. And the danger
with the complexity is not so much how the companies deal with
it—they can always bring in consultants. But the responsibility
on the regulators to implement the complex system, especially
with internal models because they not only have to make sure that
they test these regulatory requirements and that they are consistent
with the formula in standard capital requirement. But the bigger
challenge will be to assess the internal models? Can they go into
the company with sophisticated financial models and say, "This
model is okay"? So there is a lot of work that needs to be
done to make sure that the regulators are up to the muster to
be able to implement this process. Not enough work has been done
on this. The FSA is ahead of the game on this and the German and
French are, but some other countries are not up to it.
Chairman: That clearly is a worry. Lord Trimble.
Q27 Lord Trimble:
Following on from that, it is clear that the modelling is going
to be completed by 2009 and then around about 2010 and 2011 people
will know the level of the cost but they will also know how much
has to be done in terms of it and you have expressed concern that
some countries will not have the capability in terms of regulating.
When we come to this crunch both in terms of the skill of the
regulator and the cost, will there then be a political will on
the part of the Member countries to actually put this through
or will the wheels start to come off?
Professor Dickinson: A good question. There
is a peer group pressure. One of things one should see this as
is not so much the developed countries are pushing this because
it suits them—because it does suit the UK, to be honest
with you, because we have a very, very good system here which
means that the foreign firms will locate here, a place where you
can put their holding companies. So we are equipped for this.
The problem is that the smaller countries have to catch up. But
they are not dragging their feet, because they know that their
current systems are not appropriate. But more than this, because
under the IAIS with its 140 countries, they know that it is going
to happen. The IAIS has been working on their model, their blueprint
for the global solvency, and it is very similar to what Solvency
II is—it is almost an extension of it. So if I am in Hungary
or Poland or Slovakia, or whatever, I know that it is going to
happen globally. Eventually, in 2020 say, it will happen to us
through the Basle route and so we may as well start now. There
is a peer group pressure within the IAIS because they sit in on
the IAIS meetings, and they are also in CEIOPS. So it has to happen.
They are quite happy; they think the concept will work. Do not
forget that people in Central European countries are pretty smart—very
good at mathematics, better than we are in sciences, so they can
pick these things out quicker, so we do not underestimate them
on the technical side. But their political processes and the transparency,
are not as good as we have here. There is no one dragging their
feet, I think everyone is on board with this one, not least because
it is going to happen through the IAIS.
Q28 Lord Trimble:
So in effect it is going to be a global market.
Professor Dickinson: Global, yes.
Q29 Chairman:
Not the EU at all.
Professor Dickinson: This is the big thing;
this is the excitement. If you talk to regulators in Poland or
and other countries—they know it is going to happen. I was
in China recently and in Korea, talking specifically about this,
and they said, "We want to do this," because in principle
it looks good, but what they have not really thought about is
the detail, the complexity, and the cost.
Chairman: Lord Jordan.
Q30 Lord Jordan:
You have already praised the FSA. Is the draft directive a victory
for the UK and the FSA system of prudential supervision?
Professor Dickinson: First of all I would say
that it has been a team effort. If you look at the regulators,
the CEIOPS, it has worked very, very well and it has been a team
effort, but I do think that the FSA has been a key player in this.
It spotted all the trends, all the things that are in Solvency
II—they were picked up by the FSA earlier on when risk-based
capital came in. I would like to say that without the FSA being
so actively involved, and John Tiner in particular, just retired,
was tireless in his efforts to make sure that this went through.
He got Paul Sharma to be head of the technical committee of CEIOPS,
who works very hard on this. Even the IAIS has got Rob Curtis,
who chairs its technical solvency committee. A lot of the thinking
has come from the FSA so I think the FSA has done a great job
on this. They always look to the FSA for technical expertise.
It is not just because we are good technically here but also because
the thinking is global—we think globally. So although we
are thinking about the European market the model naturally extends
globally.
Q31 Chairman:
When we were brooding about this before our session with you one
always likes to test a proposed system against a particular case.
I know Equitable Life was life and that is therefore slightly
different, but could it have happened under Solvency II?
Professor Dickinson: I think it is much less
likely. The problem with Equitable Life was it came, as you know,
from the pension mis-selling—the mistakes were make in pushing
personal pensions too fast. The industry did not realise that
the interest rate would fall so they were guaranteeing interest
on pensions later, on annuities, and no one knew—everyone
was caught out. No one realised the important rise of China; which
is why we have low inflation and therefore low interest rates?
It is the rise of globalisation, particularly the growth of China
with its low labour costs. This was a surprise, everybody was
surprised. Under Solvency II the embedded options, those guarantees
will be costed properly when before they were not. Companies were
giving away these guarantees and they were not fully costed. Liabilities
will be much higher now. Now if you are giving guarantees, you
will have to have more liabilities and hence more capital. I think
it is much less likely now because those guarantees, which were
mis-priced, will now be priced more accurately.
Q32 Lord Steinberg:
It is like a Northern Rock situation a bit, is it not?
Professor Dickinson: Yes.
Q33 Chairman:
It is the classic uncosted risk.
Professor Dickinson: Yes. Who would have forecast
the rise of China? Who could have forecast that China would grow
so quickly and flood the market with cheap goods and therefore
inflation has been so low? No one predicted that degree of impact.
Q34 Lord Jordan:
But the customer is going to pay for the protection.
Professor Dickinson: Exactly.
Chairman: At least the customer is going
to be able to buy it.
Q35 Lord Steinberg:
And pay pretty heavily as well.
Professor Dickinson: I think one of the problems
with this, if the insurance company does not give those guarantees
then products will change and the company will push the risk back
to the customer, so there will be less guarantees—they will
be too expensive to suppliers.
Q36 Lord Steinberg:
I think Lord Jordan is right, that the customer is going to pay
quite heavily. The small insurance companies will probably go
out of business or sell to the large ones, which will exacerbate
the increase in premium costs.
Professor Dickinson: It would tend to. Maybe
the small ones would have gone in the long-term anyhow, but we
do not want to prejudge that. We should let the market decide.
Q37 Chairman:
We are nearly at an end, certainly at the end of our time. Does
any other Member of the Committee want to ask a question I have
left out? No. Then it remains for me to thank you very much for
coming Professor Dickinson. I am afraid that you have caught us
at various stages of our knowledge but we feel that we have been
moved on to a more unified state of knowledge and we are very
grateful to you for coming.
Professor Dickinson: Thank you very much
for your questions; I have enjoyed them.
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