Regulatory reform – gauging the

impact on the insurance sector

Maxine Cupitt, Ash Saluja and Paul Edmondson Lloyd’s library – 20th October

Mitre House – 4th November

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Outline

Insurance and the new regulatory order – the new authorities and roles, broader regulation and the insurance and consumer agendas

Prudential regulation - Solvency II update (not relevant to brokers) – risk management and governance, the Walker review and systemically significant firms

Tougher supervision and enforcement in insurance

Keeping up to speed and assessing the impact on your firm

– using the RegZone

Insurance and the new regulatory

order

Ash Saluja

Partner, CMS Cameron McKenna LLP

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The big issue

A decade of tougher regulation

– Not an insurance sector specific crisis but unavoidable change in regulation across financial institutions of all kinds

How far will banking sector reforms read across into insurance regulation?

FSA coy so far on defining read-across in each area

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The new complex process for policy and

rule making

International

European

National

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Regulation at the international level

International - G20 lead

(High level) policy driven

New/beefed-up institutions

– Bank of International Settlements (BIS) hosted

– Financial Stability Board (FSB) – beefed up/expanded

– Basel Accords/Committee on Bank Supervision (BCBS) – thinking again about its Basel II regime

– International Association of Insurance Supervisors – a less powerful force

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Regulation at the EU level (1) – the

policy agenda

EU policy agenda

– Good - implementing Basel changes, remuneration, credit rating agencies, policyholder protection

– Bad - the infamous proposed Alternative Investment Fund Managers Directive

– Ugly – some current issues on Solvency II

EU regulatory regime needs to be –

– More joined up (groups and home/host)

– More systemic,

– More consistent

– technical standards and

– supervision

– Enforced (getting tough with the supervisors)

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Regulation at the EU level (2) – the

proposed new institutionsEuropean Systemic Risk Board (ESRB) – a talking shop for

central bankers?

European System of Financial Supervision (ESFS) –

– Supervision to remain with domestic authorities

– European Insurance and Occupational Pension

Authority replaces CEIOPS but is still a forum of

regulators (acting by qualified/simple majority)

– More powerful authority to

– Set detailed technical standards ( e.g. technical

provisions under Solvency II)

– Ensure common supervisory standards

– Promote colleges and resolve disputes between

home/host/group supervisors

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Domestic reform

Financial Services and Business Bill – a rag bag following HMT white paper and BIS/BERR consumer consultations

– Keep FSA as combined financial and CoB regulator for all sectors

– Keep existing tripartite

– Macro-prudential role including –

– New FSA objectives and powers (systemic role)

– Living wills

FSA

– Lobbying internationally

– Moving ahead in some areas (bank liquidity and remuneration)

– Big issues debated in FS 09/3 and DP 09/4

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Regulation under a Conservative

government

Scrap FSA, the single regulator model and the tripartite

system

– within 12 months of winning election

Bank of England –

– Gets the entire macro-prudential role

– And main role in financial regulation of firms

New Consumer Protection Agency (CPA) – takes on

Conduct of Business/consumer protection

They are thinking about a third continental style ‘Markets ’

authority (UKLA, market abuse plus takeover panel and

Financial Reporting Council)

Little consideration given to insurance regulation

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Regulating the insurance market – the

Conservatives’ policy muddle

(All or large only?) Life offices, general insurers,

reinsurers and Lloyd’s to be dual regulated –BoE (financial) and CPA (CoB)

Brokers and intermediaries to be regulated only by CPA (including commercial business under ICOBS)

But very unclear about many other areas of insurance regulation – individual regulation, systems and controls, conflicts, governance,

wholesale markets etc

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Current FSA agenda – macro-prudential

regulation

In support of financial stability objective –

– Looking at the financial system/markets as a whole

(rather than ‘micro-prudential’ regulation of

individual firms)

– systemic risk across markets

– systemic consequences of firm failure

– The missing bit of the old order

– Insurance markets are part of the system and FSA

says they may involve macro-prudential risks

Current policy debate focusing on how to regulate

systemically important firms

New focus/division at FSA

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Current FSA agenda - remuneration –

insurance market impact (1)

Even FSA admit remuneration is not the cause or cure but huge political focus

Scope

– new international/EU principles apply to insurers and brokers

– But FSA’s new Remuneration rule and code currently only applies to 26 banks/broker dealers

– FSA to announce decision on application to insurance market

It is all about risk mitigation in remuneration and HR policies

– Main focus on bonus schemes – to be based on risk adjusted criteria,deferred and subject to claw-back

– Various other HR aspects

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Current FSA agenda - remuneration –

insurance market impact (2)Impact has been

– Changes to bonus schemes

– Huge exercise for the banks to show relevant bonus schemes are risk adjusted/appropriate

– Bigger role for REMCOs covering employees below board level (and bringing HR, compliance and risk together)

– More internal/external transparency - Walker recommends public disclosure of high end non-board remuneration (above board median)

Insurance

– Some insurers long term/deferred bonus structures held up as model for the banks

– Capital penalties for risky remuneration structures (applicable to banks) – will be included in Solvency II

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Current FSA agenda - extending the

regulation of insurance marketsRegulating more individuals

– Some SIFs at holding companies to be regulated

Holding companies – FSA wants to regulate directly (rather than indirectly) as US also proposes

Regulating groups and cross border businesses

– FSA review of intra-group relationships – complex structures

– Better cross-border supervision - colleges of supervisors and the ESFS

– Groups level regulation versus local survivability

– Industry keen to keep the EU passport regime (under threat after the Icelandic banks trauma)

– Solvency II and ESFS measures could achieve this?

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More read-across and general reform…FSCS

– EU proposals on new harmonisation of policyholder protection

– revised EU deposit guarantee legislation - should there be one EU wide scheme? BoE wants pre-funded DG with risk based premium

– Insurance sector faces potential FSCS levy for capital cost of B&B etc (but not interest costs)

More power to consumers –

– FOS/FSA industry wide intervention under ‘wider implications process’ to kick in much earlier

– Class actions as another route to redress

Financial crime

– Anti-bribery – New bill and FSA interim findings on commercial insurance brokers and enforcement

– Sanctions

Reforming prudential regulation in

insurance markets

Paul Edmondson

Partner CMS Cameron McKenna LLP

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Solvency II update

Framework finally adopted

– 31/10/12 implementation date remains – timetable compressed

– Lessons to be learnt (from banking crisis)

– Detailed rules being negotiated and calibrated

– vast consultation process underway

– and some big issues for UK market (despite the switch in 2004 to risk based and individual capital assessment under Tiner)

Likely to be implemented

– by BoE – not FSA

– Under new ESFS system with EIOPA

– More consistent supervision and technical standards, closer co-operation on groups and home/host

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Regulatory capital under solvency IISolvency Capital Requirement (SCR)

– The £50 billion bombshell – no illiquidity premium

– CEIOPS response delayed for ‘further work’

Internal models – huge exercise to develop and obtain FSA approval under new Euro rules

– Use of models by large banks to achieve lower capital (than standard formula) now questioned?

The form of regulatory capital

– Changes in tiers, components and ratios

– Extent of read-across from banking and the new emphasis on common equity (FS 09/1)

Bank capital

– Reducing non-common equity – insurers as investors

– Opportunities for insurers – contingent bank capital based on ART/catastrophe bond principles?

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Solvency II - cross border regulation and

international

Group support abandoned

– but bigger role for group supervisor

Equivalence regime –

– Does the financial regulation of insurers/reinsurers in non-EU country meet Solvency II standards?

– If so – EU regulators can rely on

– Group/subsidiary supervision

– Strength of inward reinsurance (with non-EEA reinsurers) held by EU insurers

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Risk management and governance

Lots of new rules from different perspectives

Starting with Solvency II –

– Enterprise Risk Management embedded to board level

– Own Risk and Solvency Assessment (ORSA)

– Internal model

– Plus other controls/requirements……

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Board/ Senior Management Responsibility/ Business Decisions

Risk Management System

ORSA(Own Risk and

Solvency Assessment)

Internal Model for SCR

Internal Control

Internal Audit

Actuarial

Function

Outsourcing

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Other risk management and governance

developments

Stress testing for insurers –

– FSA 2008 update for insurers

– Reverse stress testing (as for banks)

– Causes of failure – mitigation

– EU wide insurance sector stress test – 30

firms (CEIOPS - Dec09 – credit and market risk focus)

Risk in remuneration policies

The Walker Review of corporate governance…

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Walker– the insurance market impact

Big bank focus but extended to BAOFI including insurance – but muddled on read-across

Draft proposals focus on developing the Combined Code for listed companies

– ‘Comply or explain’ may not be enough for HMG/FSA

– Non-listed groups outside scope?

– FSA to respond/consult on its rules

Remuneration and shareholder engagement debate (insurers as investors)

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Walker on risk– the insurance market

impact

Separate board risk committee

– NED chair

– NED majority

– More insurers already have these than banks (but only 13% in FTSE 250)

– (same % on governance, compliance/disclosure committees)

Independent enterprise risk management function

– independent Chief Risk Officer

– risk report

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Non-executives in the insurance market

FSA –

– New APER guidance on NED role

– Original ideas more radical than Walker?

– Beware internal group appointments

Walker proposes…….

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Non-executives in the insurance market

– the Walker consultation

More time

– but not full time (non-exec chairman at least 2/3rds

of his time)

Better understanding of business model, risks and legal

structure

More challenge of executives and more independent

– but not dual level boards

More training and expertise/qualifications

More support/resources for independent role

Greater overall responsibility for risk management and

remuneration

No liability cap

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Regulating systemically significant firms

Policy debate on too big/inter-connected/complex to fail

– Must be capable of supervision, recovery and resolution (without taxpayer support).

– But how to achieve this?

Options –

– Tougher regulation (additional capital/liquidity)

– living wills

– Structural restrictions – narrow banking (a bit like insurers!) – or equivalent via capital penalties

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Living wills – FSA’s requirements for

recovery and resolution plans2 plans –

– Recovery as a going concern

– Eg contingent capital/liquidity

– De-risk and contagion control plan

– Resolution/wind down

– Eg Transfers of business

– Demonstrate ability to unplug from the system and no systemic impact requiring taxpayer support

– Data capabilities eg for fast transfer

International dimension – group and local perspective

Negotiated with regulator – reverse engineering –changes to group structure etc

All UK banks and building societies

– Some large banks to start immediately

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Regulating systemically significant firms

– the insurance market impact

Potential for insurance firms to have systemic impact

(although FSA accepts that less systemically significant

than banking)

– impact due to inter-linkage between sectors (insurers

as counterparties) and insurers’ funding role (FS

09/3)

Early days in assessing regime for insurers and

reinsurers –

– But FSA intends to apply living wills to systemically

important insurers/life offices

– But how will SI be defined in insurance?

Expect questions on reverse stress testing –

– what would cause your firm to fail?

Intrusive supervision and tough

enforcement – in insurance

Maxine Cupitt

Partner CMS Cameron McKenna LLP

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The new supervisory regime – the

impact on the insurance market

Intensive supervision/regulation –

– More intrusive, challenging and ‘systemic’

– Increase in front line supervision

– Increase in specialist resources

– Shift in style and focus – ‘proactive rather reactive’

Expect challenge in new areas, previously out of FSA

scope

– Competence of senior management and NEDs

– Accounting decisions

– Business model sustainability and strategy

– Products

– Firm failure and systemic/FSCS impacts

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And also

More frequent meetings

More frequent MI

Closer engagement on projects

Pushing the high-impact/non-relationship managed perimeter

More interviews - when

– Approval (‘Dear CEO’ on SIF approval process –172 interviews so far)

– ARROW

– All the time

Probing

– Your competence, understanding and judgements

– Grasp of lessons from reverse stress tests

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Five key messages to convey

1. I know my role

2. I know the strategy

3. I know the risks

4. I understand our governance

5. I understand the new order

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The new enforcement regime – the

impact on the insurance market

“Credible deterrence”

More high profile criminal action

Fines (recent FSA consultation) –

– More intelligent approach

– Higher (by a factor of 300% or more) –

£50/100 million possible

Conservatives say FSA enforcement has been very weak - ? new prosecutor to replace SFO

BUT THE KEY POINT IS……..

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New emphasis on enforcement and fines

against individuals personally

An investigation will now normally include relevant individuals

– Chairman

– Chief executive

More investigation and enforcement against

– senior management and NEDs personally

– even where not involved in front line breach and acted honestly

– FSA now ‘making judgements on managements’ judgements’

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Regulatory change - keeping track

of……

What is proposed by international forum, EU, labour government, the Conservatives, FSA, BoE etc etc

Stream of publications – 100s of pages a day, mostly with heavy political spin/twist

Difficult to gauge what the read-across/impact/timing will be for the insurance market

Only bite sized chunks today but all the detail is

in the RegZone…..

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RegZone and the roadmap

On-line – free to view without passwords!

Up to date

Roadmap report – 40 areas of regulatory change –

– Overview, status/timing and impact

– More detailed chronology with hyperlinks

Charts and visuals

Other tools – by topic (‘Handling a regulatory crisis’ tool), by type of publication (Articles and press quotes), by sector (insurance specific section ‘coming soon’)

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