RESPONSE TO FINANCIAL SERVICES AUTHORITY€¦ · Web view3.1 ABI considers that Annex B does not accurately estimate the potential cost to the industry which will be incurred to

RESPONSE TO FINANCIAL SERVICES AUTHORITY

CONSULTATION PAPER 97

THE INTEGRATED PRUDENTIAL SOURCEBOOK

CONTENTS

OVERVIEW

Executive Summary

General Comments

DETAILED COMMENTS AND RESPONSES TO QUESTIONS:

1 Introduction Questions and Responses

2 OverviewQuestions and Responses

3 CompatibilityQuestions and Responses

4 Application and General Requirements (PRAG)Detailed Comments including:

Application, purpose and contents (PRAG1) Adequacy of Financial Resources (PRAG4) Valuation (PRAG 5) Prudential Systems and Controls (PRAG 6)

Questions and Responses

5 Capital (PRCA)Detailed Comments:

Calculation of Capital Resources Requirements (PRCA 1) Capital Resources (PRCA 2)


6 Credit Risk (PRCR) -Detailed Comments:

Credit Risk Systems and Controls (PRCR 1) Credit Risk in Insurance Funds (PRCR 10)


7 Market Risk (PRMR)Detailed Comments:

Market Risk in Insurance Funds (PRMR 11) Derivatives in Insurance Funds (PRMR 12)


8 Operational Risk (PROR)Detailed Comments:

Operational Risk systems and Controls (PROR 1) Outsourcing (PROR 2)


9 Insurance Risk (PRIR)Detailed Comments:

Insurance Risk Systems and Controls (PRIR 1) Financial Resources for Insurance Business (PRIR 2) Mathematical Reserves (PRIR 3) Equalisation Provisions (PRIR 4) Internal Contagion Risk (PRIR 5)


10 Group Risk (PRGR) –Detailed Comments:

Introduction (PRGR 1) Systems and Controls (PRGR 2) Capital Requirements: Insurance and Reinsurance

Groups (PRGR 4) Capital Requirements: Cross – sector Groups (PRGR 5)


11 APPENDIX 1 – DRAFTING COMMENTS

12 APPENDIX 2 - DEFINITIONS

EXECUTIVE SUMMARY

INTRODUCTION

This response sets out the comments of the Association of British Insurers on CP97 – The Integrated Prudential Sourcebook. The Association represents over 400 insurance companies and accounts for 96% of the worldwide business of UK insurance companies.

The Integrated Prudential Sourcebook (the “PSB”) covers requirements for firms to have adequate financial resources and appropriate systems and controls. In contrast to previous practice it sets requirements by reference to risk categories, eg market, operational or insurance risks, rather than to sectors eg insurance or investment activities, to produce a single set of rules and guidance applicable to all sectors.

The PSB is based on an underlying requirement for firms in all sectors to take their own view of their financial resource requirements. For insurance companies this means an increased emphasis on risk identification and management. This response seeks to concentrate on the aspects applicable to insurance companies.

This consultation is part of a wider series of consultations including both the ‘Tiner Project’ and the Penrose Enquiry. In addition, the content of the PSB will be determined in part by a series of important international developments including the EU Solvency II Review, the draft EU Directive on the Supervision of Financial Conglomerates, the introduction of new International Accounting Standards and the revised Basel Accord.

There is to be extensive consultation by the FSA which will cover aspects such as specific capital requirements of firms and the revision of financial reporting requirements. The ABI is keen to continue to have a full involvement in these discussions to represent the interests of the insurance industry and to develop an interactive debate with the FSA on these issues.

APPROACH TO CONSULTATION ISSUES

The PSB is intended to promote the FSA’s statutory objectives of consumer protection and market confidence and also their statutory obligation to have regard to the international competitiveness of the UK. The ABI regards these as complementary. International competitiveness is crucial for the UK economy. In an era of increasingly international capital markets facilitating mobility of capital, it is also essential if the UK is to attract and, more importantly, retain adequate capital resources to enable the domestic insurance industry to supply the levels of protection and savings products required in the UK.

A system based upon identification and management of risks offers the potential to focus on achieving these objectives. Nevertheless this approach needs to be complemented by:

Measures being proportionate;

Consistency in the application of rules between sectors and individual companies within a sector having due regard both to the cost which results from a measure and also the practicality in the timing of its introduction, and

Flexibility to respond to developments, and indeed to encourage innovation, and particularly to adapt to changing EU requirements and other wider international developments.

KEY ABI RESPONSES TO CONSULTATION ISSUES

Set out below are the key points in the ABI response to CP97. These are cross-referenced to the main text and have been grouped under headings.

Paragraph Reference

Competitiveness

Separate consultation is under way on with profits business and the relevant regulatory reporting implications. The comments in this response are on a preliminary basis ahead of the ABI response to this other consultation and the discussion which the ABI will be seeking with the FSA. The key issue at this stage is that the reserving rules should not be so onerous as unnecessarily to restrict investment freedom lowering returns to policyholders.

9.14 to 9.20 and Response to Q.62, paras. 9.38 to 9.40

Super-equivalence, ie the imposition of higher standards than those required by relevant European Directives, should not be allowed to reduce the international competitiveness of the UK insurance industry.

General CommentsParas. 3.2 & 3.3and Response to Q.5

The rules for the use of derivatives by insurance companies should be applied as flexibly as possible within the constraints of the Directives to level the playing field with other financial institutions as well as assisting insurers in the

7.8 to 7.11

management of financial risk faced by their businesses.

Proportionality and Consistency

We welcome the PSB’s approach to rules for the valuation of assets whereby the basis for regulatory reporting and accounting purposes will be the same. However, it is essential that any changes to financial reporting requirements are fully coordinated with the changes which will flow from the international developments referred to in the Introduction. In particular successive systems changes should be avoided.

General CommentsPara. 5.7 and paras. 4.8 to 4.13

The FSA should provide guidance on resilience testing issues and this should not be left to the ABI or professional bodies. We propose a joint working group of the FSA and the actuarial professional bodies as the best way of producing such guidance.

General Comments para. 2.2 and Response to Q.48 paras. 7.35 to 7.38

Provision should be made for different permissible structures for the risk assessment function in firms to reflect their differing management and operational structures.

4.16 to 4.18

The requirements for measurement of exposure to third parties on a daily basis should not usually apply to insurers. It is primarily a matter of control in the banking industry.

6.3

Are changes to the rules relating to the implementation of the Insurance Groups Directive intentional?

10.3 to 10.6and Response to Q.5, Para 2.3

Principal Issues for Clarification or Further Consultation

Further guidance/consultation is required on the requirements for self-assessment of capital needs of insurance companies.

4.5

Further consultation is required to achieve a satisfactory level of specific guidance on the stress

4.4 to 4.6

and scenario testing requirements for both life and general insurers. Clarification is also required on the FSA’s proposals to monitor compliance and on whether there will be an audit requirement. Please refer to our proposal under proportionality and consistency above.

Clarification is required on the operation of the prohibition of insurance firms from entering into new contracts of general insurance on inadequate terms.

9.5

Consultation is required to achieve simplification of the practical difficulties in applying the proposals on margins for adverse deviation.

9.7 and 9.25

Consultation is required to simplify the difficulties which result from the change in the rules to be applied in the calculation of equity yields.

7.6

Clarification is required on the application of the rules regarding material outsourcing by insurance companies.

8.1 to 8.4

Clarification is required concerning the interaction between the requirements for capital adequacy at regulated firm level and those at group level.

4.6

Clarification is needed of the position when assets exceed the counterparty limits.

6.5 and Response to Q.41, para 6.7

Consultation is required to develop workable rules and guidance on the introduction of a requirement to include a provision for the anticipated cost of terminal (final) bonuses.

9.11 and Response to Q.59

Clarification and consultation is needed on various aspects of the rules and guidance on internal contagion risk.

9.14 to 9.20

Guidance is required on the undertaking of non-insurance activities by insurance companies.

9.21

Presentational, Timing and Cost Issues

Implementation must be no earlier than 1 January 2004, with the full text agreed 12 months before, to allow the necessary time for systems changes.

General Comments paras. 5.1 and 5.2 and Response to Q1. paras. 1.1 and 1.2

We consider that the cost benefit analysis considerably understates the cost to the insurance industry.

Response to Q.9Paras. 3.1 to 3.4

The introduction of increased solvency requirements to comply with the EU Solvency Directives must be accompanied by the transitional provisions permitted by the Directives. FSA should not anticipate the outcome of Solvency II by introducing further requirements until there is a definitive conclusion to that Review which has been adopted by the EU.

General CommentsPara. 5.5

The structure of the draft PSB is hard to navigate. It should be simplified by bringing together all the systems and controls requirements and introducing links so that users can readily find definitions, cross references etc. There should be more provision of tables to gather together obligations for each category of firm in a single place.

General CommentsPara.4Response to Q.3 Paras 1.3 to 1.5and Response to Q.20, Para 4.28

Appendix 1 sets out comments on drafting points including incorrect cross references and typographical errors.

Appendix 1

Appendix 2 identifies definitions which are incorrect or where additional wording is required to give a clearer meaning. It also identifies areas in the text which would benefit from additional definitions.

Appendix 2

Next Steps

ABI wishes to be involved with FSA in the development of the next version of the draft PSB, and looks forward to participating in an interactive dialogue with FSA.

GENERAL COMMENTS

1 BACKGROUND AND CONTEXT

1.1 The PSB was first published for consultation in the summer of 2001, since when, the insurance industry has come under an increasing amount of scrutiny by Government and others. It must therefore be viewed in the context of:

the Baird Report on the FSA’s supervision of Equitable Life;

the FSA’s response to the Baird Report, published in November 2001 (The Future Regulation of Insurance) ;

the Penrose enquiry into the Equitable Life affair;

the FSA’s review of With – Profits Business and in particular Issues Paper 2; and

the implications of the collapse of Independent Insurance.

All of these enquiries, which are being coordinated under the aegis of ‘The Tiner Project ‘ will, doubtless, have an impact on the form and content of the PSB as well as other parts of the FSA Handbook of Rules and Guidance, when it is finally adopted by the Board of the FSA. To that extent, the draft Rules as set out in CP97 may be regarded as something of a moving target.

1.2 In addition to the foregoing events which will change the basis upon which the insurance industry is regulated, ABI wishes to point out that, after a considerable gestation period, the FSA Handbook of Rules and Guidance has finally come into force on 1 December 2001. This has brought with it a number of immediate changes in the supervisory requirements affecting the insurance industry. It is worth pointing out that, even under the Interim Prudential Supervision regime insurers are required to submit annual returns at a much earlier date than under the previous regulations, which requires additional work on the part of finance and other areas within companies as well as additional audit time. There may well be systems issues which have to be addressed in order to comply. In addition, the Interim Prudential Sourcebook for Insurers implements the EU Insurance Groups Directive, and the PSB builds on this implementation and additional systems changes will be necessary in that context.

1.3 Since N2 has only recently been reached, it must be said that ABI and its member companies would have preferred a longer period for response. This is partly because many of the key people in the industry who are deeply concerned with the review of CP97 have also been heavily involved in the work needed in their companies to ensure a smooth transition to the post N2 regime

but also, and more importantly, because it would been helpful to have experienced a few months of FSA supervision under the 2000 Act. That way, a more fully informed and considered response would have been produced; something which would have been of benefit to the FSA as well as ABI member companies.

1.4 ABI suggests that it would be desirable to let the new regulatory regime bed down and see whether any major problems arise in practice, before making root and branch changes to the regulatory system. To that end, ABI agrees with the proposal in CP97 that the implementation date for the PSB should be no earlier 1 January 2004; however, even though that is two years away, it will require a major effort both by the FSA and by ABI member companies to achieve all the changes which will be necessary to ensure a smooth implementation.

2 RISK-BASED APPROACH TO SUPERVISION

2.1ABI notes that the rationale for the introduction of the PSB is the FSA’s intention to move to a system of risk based regulation, as stated originally in the document “A New Regulator for the New Millennium” and as amplified in subsequent FSA publications. The ABI supports this approach to supervision; we welcome the statement in paragraph 1.4.5 of The Future Regulation of Insurance that the Tiner Project will lead to a regulatory regime which will, for those regulated firms which are fully compliant with the relevant rules and obligations, ultimately involve less intensive supervision by the FSA relative to less well managed firms. ABI hopes that will also, eventually lead to a reduced capital resources requirement and a reduction in the level of fees levied for supervision of their activities. A risk based approach to regulation will also, ultimately, help lead to increased confidence on the part of consumers in the financial markets and the financial services industry. However, the ABI also wishes to point out that the new approach to supervision must be founded on an approach which clearly demonstrates the application of the principle of proportionality. The FSA has stated that proportionality is one of its seven principles of good regulation; ABI believes that it is important for the rules contained in the PSB to be clearly proportionate to the desired objectives and for all the FSA’s supervisory teams to demonstrate a consistent approach to the interpretation of the PSB in the exercise of their day-to-day responsibilities.

2.2 The concepts of scenario and stress testing, while familiar to life insurers, break new territory so far as statutory or quasi–statutory requirements for general insurers are concerned. ABI considers that it is essential for the FSA to provide additional guidance on what is expected of all its member companies, both life insurers and general insurers, in order to comply with the relevant requirements and to ensure consistency of compliance and supervision. CP 115 rightly emphasises the need to ensure that firms have adequate notice of systems changes. ABI would therefore, wish to see a draft of this guidance at the

earliest possible moment, and preferably no later than the end of the first quarter of 2002.

2.3 ABI notes that the PSB places a strong emphasis on the documentation of policies and the introduction of systems of control to monitor the implementation of those policies; this is clearly best practice, but it may bring with it additional costs in for monitoring compliance and we are not clear from the PSB what criteria the FSA will use to decide whether policies are documented adequately and whether they are implemented and monitored effectively. It is important that consistent rules are put in place across all sectors of financial services, that the guidance relating thereto is consistent and that the monitoring thereof is also consistent. In the PSB it is at each firm’s discretion to define how much is enough to satisfy both the firm and the high level principles set out by the FSA.

3 INTERNATIONAL COMPETITIVE POSITION OF THE UK INSURANCE INDUSTRY

3.1ABI has concerns about the FSA’s desire to introduce “super equivalence” in some areas of its supervisory requirements and we urge the FSA to consider very seriously its obligation to have regard to the international competitive situation of the UK financial services industry. The last thing which the insurance industry in the UK would wish is to see business leaving this country due to regulatory arbitrage by multinational groups going to a less rigorously regulated home office environment. We believe that FSA would also share this concern and therefore, we urge caution in introducing super - equivalent regulation.

3.2ABI notes that, for insurers, the principal area in which super-equivalent regulation is to be introduced are in the area of capital adequacy. These additional requirements will build on requirements in a number of areas where, due to the manner in which EU Directives have been implemented, a super-equivalent situation already exists. ABI notes that it is intended to introduce the changes which result from Solvency 1 without, in the present draft, any utilisation of the transitional provisions allowed by the Directives. That could lead to problems for some smaller firms. ABI also has serious concerns that if an approximation of Solvency 2 is introduced ahead of completion of the European legislative processes, UK regulated firms could be subject to higher capital requirements and capital costs for some years ahead of their competitors in the remainder of the EU. The consequence of such action could be two-fold; first, two sets of systems changes to comply initially with FSA requirements and then to comply with EU requirements. Second, and far more important, there is the possibility that firms would seek authorisation in other member states and conduct their UK business through branches which, due to the passporting rules, are subject to home state supervision, with implications for the UK’s GDP and for UK jobs. This could result from an assessment by firms of the cumulative impact of the several rules which are super-equivalent.

A further area of super-equivalence is the requirement for firms to assess their capital resources requirement having regard to the nature of their business and to subject that decision to appropriate scenario and stress testing. The guidance on what is expected in this regard included in the PSB is of a very general nature. ABI has already indicated that full guidance on stress testing is needed; we would further suggest that it would only be reasonable to describe in some detail the framework within which such decisions are to be taken. It is not reasonable, given the personal consequences which may ensue, to expect Approved Persons to make decisions on capital issues in the absence of full guidance from the regulator. Before super-equivalent regulation is introduced, there must be a clear demonstration of the benefits to consumers and the industry, relative to the cost involved.

4 STRUCTURE AND CONTENT

4.1 It should be said at the outset that the PSB cannot be considered a document which is easy to use and easy to understand. Whilst form is no substitute for substance, ABI believes it is worthwhile commenting on the overall structure of the PSB and its content. As ABI have stated, ABI supports the concept of risk based supervision, but considers that the version of the PSB presented in CP97 does not make for easy navigation or understanding of the Rules. ABI amplify these comments in our response to Questions 2 and 3. While ABI supports the concept of an integrated set of Rules and Guidance covering all sectors of financial services and applying common criteria to each sector, divided according to categories of risk, we draw to the FSA’s attention the form of its Authorisation Pack, which includes sections which are sector – specific. ABI urges the FSA not to shrink from introducing sector – specific material, either as Modules or as chapters of Modules if such an approach aids understanding and facilitates use of the PSB.

5 IMPLEMENTATION AND RELATED ISSUES

General

5.1 ABI notes that, as envisaged in CP115, it is the FSA’s intention to implement as much as possible of CP97 as applicable to insurers on 1 January 2004. ABI understands the rationale for this approach, and welcomes the statement at paragraph 3.1 ii in CP 115 that the FSA intends to allow firms good time to make systems changes and to allow at least a year. It is, therefore, essential that the intended date for implementation, 1 January 2004 is not brought forward. It is important that there be no slippage in the pace of the work undertaken by the FSA in order to achieve this objective. In particular, ABI urges the FSA to proceed at full speed with the exposure of the draft chapter on Liquidity Risk, which at present is missing from the draft Rules.

5.2 ABI also wishes to point out how important it is that the industry has adequate time to review the FSA’s proposals for changes to financial reporting

requirements, and other guidance promised in CP97 and touched on in more detail in Annex B of CP 115. Depending on the extent and nature of the proposed changes, it may be necessary for the industry to have more than twelve months notice of the made text in order to introduce what may be significant systems alterations.

5.3 Implementation of the PSB will bring with it a duty on the FSA to monitor its implementation by regulated firms. ABI and its member companies are, of course, clear as to how the FSA is currently carrying out its statutory responsibilities in this area. We agree with the change in the structure of supervision which has been implemented in recent months, whereby a single team is responsible for monitoring compliance with both prudential supervision requirements and conduct of business rules. However, the PSB will bring with it an entirely different approach and, accompanying it, changes to the Supervision Manual. ABI would hope that the changes to the Supervision Manual within the FSA Handbook of Rules and Guidance will be exposed for comment at an early date.

5.4 ABI would also seek clarification as to the manner in which FSA will monitor its newly acquired functions. Our concern is whether shortcomings which are identified in the course of a post – PSB monitoring visit which were compliant with the rules of the Interim regime will be regarded as a breach of the PSB and subject to discipline on that basis. ABI would welcome confirmation that the FSA’s approach to monitoring compliance will be directed to the raising of standards for the future, not the retrospective application of current rules. In addition, ABI is also concerned that, since much of the PSB comprises guidance which is intended to amplify SYSC, the FSA’s supervisory teams will apply this guidance, during the period ending 31 December 2003 as though it were ‘made’ text. During that period, firms will be preparing to implement the PSB and it would be wrong for FSA to pre-empt its introduction.

5.5 Moreover, two EU Solvency I Directives are due for implementation over the next two to three years, and we note that the PSB takes the implementation of these Directives as read, a conclusion with which the ABI concurs. However, as currently drafted, the PSB does not include any transitional provisions relating to the increased solvency requirements, although these are included in the Directives. This needs to be addressed in the next iteration of the PSB.

5.6 Finally, ABI is sure that the FSA recognises that, since it intends to implement the PSB in stages, the end product is unlikely to be a perfectly formed and fully integrated set of Prudential rules. Given the past history of financial services regulation, it would be remarkable if this were to be the case. Therefore, ABI seeks assurance from the FSA that, in bedding down the PSB in the years immediately following 1 January 2004, it will apply a practical, flexible and pragmatic approach to the way in which firms comply with the new requirements placed upon them. In particular, ABI would expect the FSA to

operate a supervision regime based upon sound, considered judgement, rather than a routine, tick box approach. ABI would also appreciate receiving comments from the FSA on whether, as a result of all the work carried out to reach and implement N2, there are any significant changes to FSA’s approach to its responsibilities of which ABI is not aware, and which it intends to carry into the PSB.

International Developments

5.7 Recognising that at 1 January 2004, the EU Solvency 2 Review is unlikely to have been adopted as EU law, ABI would also wish to stress the importance of a smooth implementation of changes to financial resources requirements not only for insurers, but for all sectors of financial services. There are four major international consultation exercises under way at present. There is the EU Solvency 2 Review; perhaps equally important for insurers the introduction of an International Accounting Standard for Insurance Companies, the draft EU Directive on the Supervision of Financial Conglomerates and also the revised Basel Accord on banking capital adequacy. All of these will bear strongly upon the text of the PSB, and will undoubtedly involve changes in reporting requirements and significant changes to systems of regulated firms. ABI cannot stress too much how important it is that all of these significant changes are implemented on an integrated and seamless basis.

6 FURTHER WORK

6.1 ABI notes that within CP97, further issues remain outstanding. These include the omission of a chapter on Liquidity Risk, without which it will not be possible to introduce any form of phased implementation whether for insurers or other financial services sectors; the review of insurance reporting requirements, which, whatever the outcome will undoubtedly have significant systems implications for insurers, and the absence of guidance notes on non insurance activities, (known to the insurance industry as “Section 16”). With regard to the review of reporting requirements, while we note the comments in Annex B of CP115, ABI draws the attention of the FSA to the need to consider in that review what material will, in future be in the public domain and what will be held on file by the FSA. It is also vital that the review of regulatory reporting is linked to the work on the development of an International Accounting Standard for insurance companies. We urge the FSA to produce draft material in all of these areas as quickly as possible, so that a full and considered response can be given by affected parties, and well thought out, well drafted rules developed in good time for the introduction of the PSB.

7 THE ABI RESPONSE

7.1 The PSB covers an extremely broad canvas in a great deal of detail. In this response, ABI is responding to and commenting only on those questions and rules which directly affect the insurance industry in its role as insurers and investors. We have left to other sectors those questions and rules which affect insurers as users of banks and other financial institutions and no doubt the FSA will receive full input from the trade associations representing such institutions. We also provide comments, both on matters of principle and on matters of detail, on the various Modules of the PSB as those Modules concern the insurance industry.

7.2 Finally, ABI would welcome an opportunity to discuss this response with

appropriate officials within FSA, as quickly as possible after the New Year and to develop an interactive process for taking forward the development of the next draft of the PSB. This is particularly important in view of the very tight timetable for implementation, referred to earlier.

2.22.2

DETAILED COMMENTS AND RESPONSES TO QUESTIONS

INTRODUCTION

1 INTRODUCTION

QUESTIONS AND RESPONSES

Q1 Is our proposed timetable for the implementation of the PSB a practical approach in view of the current wide-ranging discussions on international standards and the uncertainties of their timetables? Are we right to aim to implement on1 January 2004?

1.1 If one accepts that the intention of introducing the PSB is to move from the transitional stage of Interim Prudential Sourcebooks, which recognises the realities of the existing regulatory position, to a fully integrated risk based approach to prudential supervision, then the only logical outcome would be to defer implementation of the PSB until all of the various international developments have reached conclusion. Realistically this is unlikely, given the complexity of the regulations surrounding the Basel Capital Accord, the EU Solvency 2 Review and the draft Directive on the supervision of financial conglomerates. Therefore, an approach to implementation which recognises that we do business in an imperfect world is sensible, provided that FSA recognises the complications which may arise, particularly in the area of systems changes, from a staggered implementation.

1.2 Certainly, no earlier date than 1 January 2004 should be contemplated and even then, it will need a considerable allocation of resource by both FSA and regulated firms if this date is to be met. Given the volume of systems changes which may be anticipated, the extent of ongoing changes which will be under consultation during 2004 and the additional training which companies will have to introduce in order to ensure compliance with the PSB, it is essential that the text of the PSB is settled by 31 December 2002. Thereafter, to enable implementation to proceed efficiently, there can be no tinkering at the edges during 2003; the next set of amendments must be those which become effective in 2005.

Q2 Do you think the general layout of the PSB is appropriate, including the organisation of material within eight modules? Do you see a case for including all the systems and controls material in a single module?

Q3 Does the draft PSB direct firms clearly to the material applicable to them?

1.3 ABI considers that these are best answered together. Given the concept of risk – based regulation, with which we concur, we agree that the overall structure of the PSB is appropriate. However, it must be said that navigation of the PSB in its current form is far from straightforward and that, in its next iteration we would expect to see a considerable improvement. It will be apparent to the FSA from the content of this response that there are many areas in which improved, clearer drafting would benefit all users of the PSB. In addition, the inclusion of links to enable a user to move rapidly across all parts of the FSA Handbook of Rules and Guidance should be a standard

feature of the PSB and all other parts of the Handbook. These links should be supplemented by Tables which identify clearly which Rules apply to which Category of firm, building on the very useful start made in the Contents listing.

1.4 A particular area which needs substantial effort and improvement is the Glossary of Definitions. There are numerous examples in this response which indicate where definitions are unclear, lacking in content or non – existent. Additional work is required to ensure consistency and correctness of application of the terms used in the Glossary, and to make it much easier to trace the source of a defined word. For example, the FSMA is now supported by numerous Statutory Instruments which include definitions, some of which may be included in the PSB but with slightly different shades of meaning. It is extremely important to be able to trace the source and meaning of defined terms and to understand their meaning. ABI is available to assist in this task if need be.

1.5 As to the question of whether it would be beneficial to group all the Systems and Controls materials together as a separate module, this has considerable attraction; but if this would delay the issue of the next edition of the draft PSB, and provided that the next issue included links and Tables as requested above, ABI would be content with the present structure. To answer Question 3 directly, with proper use of links and Tables -- ‘ Yes’.

Q4 Do you have any comments on our proposed approach to Section 150 of the Act (which gives a right of action for damages where a person suffers loss as a result of a rule breach by an authorised person)?

1.6 Since there is no change to established FSA policy, ABI concurs with the proposed approach.

.

OVERVIEW

2. OVERVIEW


Q5 Have we achieved a balance between setting standards at the appropriate level and having regard to international competitiveness? Have we selected the appropriate risks to address with ‘super-equivalent’ standards (ie standards higher than those required by EC directives)?

2.1 As stated earlier in this response, ABI has concerns that the introduction of ‘super equivalent‘ standards may lead to an outflow of business to other markets which are regulated to less stringent standards. We are aware that there have been occasions in which reinsurance has been used to facilitate regulatory arbitrage and this is a practice which is unlikely to go away as a result of introducing the PSB. Our other concerns relate particularly to the proposals to require firms to set their own level of financial resources, the manner in which group supervision is carried out and the extent to which some aspects of insurance supervision are already super equivalent.

2.2 Our concern in relation to capital is that the movement away from meeting prescribed minimum capital requirements to self assessment above the minimum could lead firms to holding excessive amounts of capital in order to prevent regulatory intervention; an inefficient use of shareholders funds (or, in the case of mutual societies, policyholders’ funds). In addition, should the FSA decide to apply capital requirements broadly equivalent to EU Solvency 2 ahead of the formal adoption of the eventual Directive(s) and the passage of the period allowed for introduction into member states’ laws, there could be a capital strain, particularly on smaller companies to which competitors in other member states are not subject.

2.3 ABI recognises that the Rules dealing with Group Risk represent, for insurers, the second stage of the implementation of the Insurance Groups Directive. We believe that in some areas of detail, the relevant rules go beyond the provisions of the Directive; we deal with this in comments on this Chapter of the PSB.

2.4 It has long been the case that although the EU Third Directives apply admissibility limits to the assets representing technical provisions, UK regulatory practice has been to apply the limits to all assets of the business. In the new regulatory climate of the PSB, this approach should be monitored and reviewed in conjunction with the other super equivalent proposals, to ensure that the FSA fully complies with its statutory duty to maintain the international competitive position of the UK financial services industry.

2.5 There are many areas of the PSB where rules, some of which carry forward existing regulations, are super equivalent. ABI has concerns that the aggregate effect of the super equivalent approach could be that overseas firms locate their businesses elsewhere in the EU and develop new methods of conducting

business with UK consumers which are not subject to direct supervision by the FSA. This would be detrimental to the long term interests of the UK financial services industry, for the UK GDP and for jobs in the UK. ABI would welcome the opportunity to discuss these issues with FSA.

Q6 Are the distinctions set out here a sensible and practical approach? How might we meet any concerns about sharp changes in regime? Could insurance, in combination with other areas of the new regulatory structure, deliver the same or more consumer protection?

2.6 The distinctions set out are sensible; concerns about sharp changes in regime can be met in two ways. First, by giving the sectors concerned as much notice as possible of the intended changes, and then not making further changes until the sector concerned has been able to implement them – as described in our response to Question 1, and secondly by the use of extended transitional periods, which is particularly important for smaller firms in relation to capital requirements.

Q7 Have we achieved an appropriate balance between rules and guidance?

2.7 This question refers to the balance between rules and guidance in relation to the PSB overall. ABI believes the answer is ‘yes‘ provided that guidance is regarded as guidance by the FSA and not treated by the supervisory teams as quasi-rules, which is how some of the guidance reads. There has been a tendency in the past for this to occur, and it is not a tradition which should be perpetuated.

2.8 There are places in the PSB where we consider that some Rules should be guidance and vice versa; some places where we consider that additional guidance is required. These concerns are addressed in our detailed comments on the draft Rules and in our Drafting Comments. But overall, the balance is about right.

Q8 Have we made clear where we expect to be notified or approached for a waiver or individual guidance? Is the approach to the treatment of non-standard instruments appropriate?

2.9 Yes.

COMPATIBILITY

3 COMPATIBILITY


Q9 Do you consider the Cost Benefit Analysis in Annex B to provide a fair estimate of the benefits of the PSB and to have quantified the incremental costs?

3.1 ABI considers that Annex B does not accurately estimate the potential cost to the industry which will be incurred to implement the PSB; we have three specific areas in mind; first, the number of staff expected to be employed on prudential compliance; it is not clear whether the estimated number includes finance staff or the staff of a risk assessment function but we have doubts as to whether the numbers are realistic and whether staff with the appropriate skills are available for redeployment to this area. Second, the costs which may be incurred to carry out stress and scenario testing at a group level for those groups (and they are increasing in number) which include banks, insurers, collective investment scheme managers and investment management within their portfolio of businesses. Third, we believe that the estimated costs of implementation set out in Annex B significantly underestimate the costs of implementation.

3.2 Those estimates consider the ‘ introduction’ costs and then amortises the estimated total. Ongoing additional costs are ignored. Annex B states the typical cost for an insurance company will be £167500, which is amortised to an annual cost of £39173. We believe that ongoing costs alone will be much higher. That sum would approximately pay for one additional person – a low grade clerk – after allowing for his/ her overheads. ABI believes that FSA would expect insurers to assign people of somewhat higher calibre to this important task. Moreover, no account is taken of the higher costs which are likely to be levied upon insurers, as stated in The Future Regulation of Insurance. Thus ABI considers that, without taking any account of the introduction costs, the likely ongoing additional costs will exceed the estimated annual cost as set out Annex B; we are also doubtful that an allowance of £30K for IT systems costs is realistic, particularly for a general insurer developing a stress testing model capability.

3.3 In addition, ABI stresses to the FSA how important it is for the costs which will be incurred by the industry in the implementation of the PSB to be proportionate to the benefit. We do not believe that this has been demonstrated adequately in Annex B, particularly for small and medium sized firms.

3.4 There is also an opportunity cost for all sectors of the industry, in that the scarce resources (both financial and human) which will be required to implement the PSB could otherwise have been deployed in the development of firms’ businesses.

Q10 Have we given a full and fair account of the effects on competition, including on the international competitive position of the UK, of the proposals in this Consultation Paper? How significant do you think the adverse effects on competition identified in the paper to be? Are there other ways to mitigate these?

3.5 ABI’s views on the international competitive issues have been expressed in our response to Question 5.

APPLICATION AND GENERAL REQUIREMENTS (PRAG)

4 APPLICATION AND GENERAL REQUIREMENTS (PRAG)

DETAILED COMMENTS.

PRAG 1 - Applications, purpose and contents

4.1 This Chapter sets out the overall structure and intention of the FSA in regard to the PSB. ABI believes it accurately fulfils its purpose in that regard; As we have indicated elsewhere, it is essential for ease of use that the PSB, in electronic form, includes extensive use of hyper links to enable rapid and lucid navigation across the PSB, and the structure will be assisted by the inclusion of additional tables to make it clear and precise which rules apply to which category of firm.

PRAG 4 - Adequacy of financial resources

General

4.2 This Chapter sets the background and general tone for the approach to capital adequacy which is amplified in other parts of the PSB, particularly Modules PRCA and PRIR. It also builds on the high level requirements for systems, controls and management arrangements set out in Module SYSC of the FSA Handbook of Rules and Guidance.

4.3 Before commenting on PRAG 4, ABI would emphasise that all proposals relating to adequacy of financial resource should aim to improve consumer confidence in the financial services industry and reduce the risk of future insolvencies while recognising the necessity to make requirements which are not so onerous as to effectively ensure a zero failure regime. In addition, ABI would draw attention to the importance of ensuring that any requirements arising under PRAG 4 are consistent and dovetail with forthcoming EU Directives, including the outcome of the Solvency 2 Review.

Stress and Scenario Testing

4.4 The principal new requirement introduced for general insurers by PRAG 4 is the obligation to carry out appropriate stress and scenario tests to determine whether overall financial resources are adequate to comply with PRAG 4.3.2R. The requirement is to hold adequate financial resources at all times which are sufficient to ensure that there is no significant risk that liabilities to customers will not be met. The equivalent obligation in IPRU(INS), requires insurers at all times to maintain at least the Required Minimum Margin of solvency; the requirement in PRAG4 is clearly stronger than the present Rule.

4.5 Where PRAG 4 departs from existing regulation is that there is no current guidance on how an insurer should determine whether or not its overall financial resources are likely to be sufficient to meet the liabilities of the business. In some respects, the approach in PRAG 4.3.2R conflicts with the overall approach being taken by the FSA in its risk-based approach to its responsibilities as set out in “A New Regulator for a New Millennium”. On the one hand, the FSA seeks to move away from a prescriptive approach to rule-making and to place the onus on regulated firms to demonstrate compliance with its Rules (and to subject them to discipline if they do not). On the other hand, the PSB in PRAG 4.3.2R prescribes requirements to demonstrate compliance but leaves it to the regulated firm to decide what it needs to do in order to comply with the prescribed requirements. ABI believes that FSA should provide clearer guidance on compliance with the prescribed requirements.

Detailed Comments on PRAG 4

4.6 Moving on to more detailed issues which stem from the draft Rules and Guidance in PRAG 4:

Additional guidance is required on what is considered to be “significant risk” (see PRAG 4.3.1R) – should insurers be considering a 50 year event or a 200 year event? It would be helpful if the FSA were to provide illustrations of what it considers to be “significant risk”.

The previous regulators for the life assurance industry supplied guidance to life assurers on the levels of shock which should be considered through “Dear Appointed Actuary letters” and the guidance issued by the actuarial professional bodies. While recognising that there is at present no requirement for the appointment of an actuary by general insurers, some equivalent guidance on the levels of stress to consider would be helpful for general insurers.

The issuance of guidance on the lines described above would assist actuaries, other relevant persons and companies to comply fully with PRAG 4.3 in circumstances where the application of a certain optional stress test would show a deficiency.

PRAG 4.3.5.G suggests that the nature, depth and detail of the analysis depend in part on the firm’s capital strength and the robustness of its risk prevention and risk mitigation measures. It is not clear how this would operate in practice; further guidance would be helpful.

These requirements are all directed at the individual regulated firm – how do these requirements operate at group level having regard to the implementation of the Insurance Groups Directive?

PRAG 5 - Valuation

Overriding Comment

4.7 Before considering the detail, ABI has an overriding comment to make. If IAS rules are introduced for UK reporting, as the Stock Exchange will require, these rules may cascade down to insurance companies. It follows that PRAG 5 should be consistent with and led by IAS/UK GAAP. Further, we question the need for significant exceptions to UK GAAP/IAS for valuation of assets.

Valuation Rules

4.8 This Chapter sets out valuation rules for all categories of firm. It is amplified by admissibility rules in Chapters PRCR, PRMR and PRIR. Rules PRAG 5.3 and 5.5 apply to insurers. PRAG 5 makes a significant change of practice so far as insurers are concerned, in that, after almost 30 years of extremely prescriptive regulations on the valuation of assets and the determination of liabilities, going forward assets are to be valued and liabilities are to be determined in accordance with the Companies Act 1985 and UK GAAP. ABI notes that, per PRAG 5.3.2G, the ABI SORP is deemed to provide important guidance on the application of UK GAAP to insurance business.

4.9 PRAG 5.5 applies specific rules to assets held in insurance funds and includes, at Annex 1R a list of those assets which are to be regarded as admissible – the admissibility limits are, as noted, prescribed elsewhere.

Cross-Referencing

4.10 It is assumed that the specific rules for the valuation of assets included in insurance funds apply to fund bases of accounting based on underwriting year accounting. Confirmation would be useful;

4.11 Turning now to specific issues, while we note that PRAG 5.2.2 G states that “this chapter has the same purposes as PRCA1”, FSA should be aware that tracing the various cross references is not straightforward, and the drafting should be clarified.

Realisation Costs/Market Value

4.12 PRAG 5.3.1 R and PRAG 5.5.8 R are concerned with the valuation of assets. The pre-consultation drafts included a requirement that the value of assets should have due regard to realisation costs. This would have meant valuing listed equities at their bid value rather than at mid-market value.

4.13 Current practice relies on Schedule 9A of the 1985 Companies Act and the ABI SORP both of which use the term "market value" loosely without defining which price

should be used. PRAG 5.5.8 R introduces a new term – "fair value in accordance with UK GAAP". This too may or may not allow a mid-market valuation. ABI would appreciate confirmation from the FSA that it is not it’s intention to revert to the bid value basis of valuation as discussed at the pre – consultation stage.

Derivative Instruments

4.14 One welcome development in relation to derivative instruments is that although an approved derivative is still not an “admissible asset”, it can now have a value in its own right (PRAG 5.5.1 R). PRAG 5.3.5(3) G is unnecessary, as it is covered by (2). If (3) is retained, the words “.other than an approved derivative” should be added at the end of (3). However, PRAG 5.5.3 G states (wrongly) that in the prudential returns the value of the derivative is to be attributed to the connected admissible assets. This treatment would have the impact of giving excessively central importance to the connected assets especially in circumstances where derivatives are held to reduce risks in connection with liabilities, for example, guaranteed annuity options.

PRAG 6 - Prudential Systems and Records

Overview

4.15 ABI’s general impression is that the content is appropriate and should be capable of being complied with by a well run insurance company. Ensuring that all requirements are adequately documented will involve a degree of checking of existing records throughout insurance companies. In practice it is important that the FSA should not impose an unnecessary bureaucratic burden on insurers, and that all requirements should help to address the key areas of risk insurers face. In addition, business management of large groups is not necessarily organised on a legal entity basis, and prudential systems and controls may be demonstrated through various organisational layers and committees. Provided these address the key areas of risk, insurers should not be subject to a regulatory strait jacket, which is not suited to the structure and organisation currently in place.

Risk Assessment Function

4.16 ABI has an issue with PRAG 6.8.3 G, in relation to FSA’s expectation that firms in Prudential Category 2 will establish a separate risk assessment function. Whilst we accept that a separate risk assessment function can be beneficial, there is a danger that it becomes so remote from the business that it becomes a mere bureaucratic exercise. We propose, therefore, that the guidance should make it clear that other models for the assessment and management of risk are acceptable.

4.17 For example, although the FSA regulates each legal entity in a group on a stand alone basis, subject to some over-arching requirements applicable to the group (eg PRGR), many groups of companies make use of centrally provided services to service all of their operating companies. Such services may include personnel policy, company secretarial and finance. Such services could also well include business continuity, risk management and risk assessment, which, when applied at group level would eliminate duplication of effort and ensure that risk is assessed on an overall, group, basis which takes into account interest wider than those of an operating subsidiary. Risk assessment and management is clearly a matter of good corporate governance and it may be that the guidance should acknowledge that a separate function at group level combined with adequate management practices in the operating subsidiaries may be sufficient to satisfy the rule.

4.18 Other areas of this guidance that require clarification as to definition and scope, are:

sufficiently independent – what does this mean in the context of risk assessment,

it is debatable whether the guidance in Rule PRAG 6.8.3 G is guidance, it appears to be a rule. What is the position on this?


Q11 Is it clear which firms fall into which category for the purposes of the PSB?

4.18 In principle the answer is yes, and the intentions are clear. To the extent that the Prudential Category may be dependent upon the Part IV permission held by a firm, it may not be totally clear, due to the excessively complicated approach taken to the permissions which a firm may require in order to be able to continue an activity which was defined in much simpler terms under predecessor legislation. In particular, insurers are granted permission to accept deposits and to manage investments; but that does not, we trust, make a general insurer subject to the full rigour of the areas of the PSB intended to apply to firms whose main or only business is accepting deposits or managing investments.

Q18 Is it appropriate to require firms to take their own view on whether they have adequate financial resources to meet their risks? Do you agree that firms to which the requirement to carry out appropriate stress and scenario testing would apply already carry out such tests? Do we give sufficient (or too much) guidance on what we would expect such tests to involve? Should PRU category 5 firms be subject to this requirement at all?

4.19 Question 18 covers four distinct issues. With regard to the first of these, whether it is appropriate to require firms to take their own view of the adequacy of their financial resources, the FSA’s view is clear, that firms should do so. Such an approach is in line with that currently adopted by the banking industry. This involves firms identifying and measuring all their risks and developing their own view on the organisation’s required resources. Whilst this local responsibility would possibly be welcomed by insurers there is a high degree of potential for subjectivity and inconsistency across the industry and it is unclear as to how the FSA propose to monitor/enforce compliance. The following areas appear to require further understanding/clarification:

Is the FSA intending to provide some more detailed guidance of a non-prescriptive nature?

It is unclear how the FSA are looking to enforce compliance – what processes for checking compliance and what sanctions for non-compliance are envisaged?

Is there an explicit requirement for the models/calculations to be audited? Is so will this require additional understanding/access to activity and records for external auditors ( which will undoubtedly incur additional costs) ? Even if there was no FSA requirement would CEOs want to have a third party audit, which would, of course, incur further additional costs for their firms?

How do the FSA propose to manage the “consumer/market confidence” aspects – the onus is on the local firm to apply and comply with PRAG 4 requirements but, without external review/verification, there would appear to be no guarantees that this has been effectively carried out.

4.20 With regard to stress and scenario testing, it is highly likely that the majority of general insurers currently undertake a review of the risks which they perceive might impact upon them either as a tool to better manage and drive their business and/or in monitoring and managing solvency throughout the year.

4.21 However, it is not certain that each firm would currently have in place robust stress and scenario models to identify “realistic adverse scenarios” and would currently be able adequately to demonstrate a clear consideration of each type/combination of defined risk. It is more likely that any current activity focuses on highly probable scenarios rather than being based on extensive “what if” scenarios. In addition, in line with PRAG 4.3.8 and PRAG 4.3.9 it is unlikely that many firms currently formally model the correlation between different types of adverse risk.

4.22 In order to answer the question fully, we would need detailed information as to what the FSA perceives “realistic adverse scenarios” to be. As matters stand, there is plenty of room for debate.

4.23 As to the third leg of Question 18, whether sufficient or too much guidance is given on resilience and scenario testing, ABI considers that the guidance provided in PRAG 4 is quite open and subjective; although the document highlights the key areas of risk to be considered it does not provide any high level principles upon which firms can set consistent standards. In particular, the impact of the Insurance Groups Directive on the stress and scenario testing requirements is not clear – can the evaluation of adverse scenarios benefit from leverage of a group position or does the evaluation need to be undertaken by each individual group company in isolation? In addition, the following areas appear to require further understanding/clarification:

The frequency of risk and scenario modelling is not specified in the draft rules – is the FSA planning to issue guidance on this?

There is no definition of “significant risk” – this is left open to potential inconsistent interpretation.

The draft rules do not specify what level of cover is acceptable – what level would the modelling require?

4.24 With regard to the absence of a definition of significant risk it is worth pointing out that there are many places in the PSB where terms such as “reasonable”, “adequate”, or “significant” are used without there being any definition of what these terms mean. Given the current problems which have arisen with a small,

but important number of insurers, and given that regulatory action is almost inevitably backward looking, it would be helpful and assist the industry to gain a full understanding of what is required of it, if the PSB could include amplification of what is meant by subjective terms such as those mentioned.

4.25 The fourth part of this question is addressed to Prudential Category 5 firms (IFAs with no client money). It is outside the scope of this response but the answer is probably “No”.

Q19 Is the requirement to value assets and liabilities in line with Companies Act requirements and UK accounting standards (UK GAAP) with identified exceptions appropriate? Should the FSA, in respect of trading book business, require standard valuation approaches?

4.26 ABI believes that general insurers would welcome this move. It should simplify the valuation of assets and liabilities, simplify any stress and scenario modelling and make the reconciliation between underlying statutory accounts a simpler process thus speeding up the preparation and review of balance sheets for regulatory purposes.

4.27 5.3.3 suggests that the split/sub-analysis of assets and liabilities required by the FSA will be in line with the Companies Act/UKGAAP – the assumption would be that this is as per the notes although this is not explicitly stated.

Q20 Does the material in this chapter expand usefully on material in SYSC, by setting out the relevant systems and controls requirements in the prudential context?

4.28 The guidance provided in PRAG 6 does give an adequate expansion to the high level material contained SYSC. However, within the PSB there is guidance on systems and controls not only within Module PRAG but also in each of the other modules eg PRCR, PRMR, PROR and PRIR. This makes it difficult to navigate easily around the PSB and obtain a complete understanding of the PSB requirements for systems and controls across a regulated business. The PSB is structured to reflect the FSA’s risk-based approach to regulation and therefore is divided into relevant risk modules. We have already emphasised how important to aid navigation through the use of hyperlinks and Tables of application by sector. If that cannot be achieved, it would be helpful if all of the Systems and Controls requirements could be moved from the various risk Modules and combined into one Module covering all systems and controls requirements. If this is not possible, then a Table setting out the precise location of each systems and control requirement should be included.

Q21 Are the proposed requirements on record-keeping appropriate, particularly the requirement to retain records for a minimum of six years? Is it clear what records are subject to this requirement?

4.29 In principle, the requirements should not cause difficulties for insurers, since most records of a prudential character are already subject to a six year retention period under other legislation. However, it would be helpful to include a Table setting out all the record-keeping requirements, cross-referenced to the appropriate rule.

4.30 Further discussion may be required in relation to record-keeping so as to ensure that it is not unduly onerous. Extensive and strict record-keeping requirements will not, of themselves, prevent another insurer insolvency.

CAPITAL (PRCA)

5 CAPITAL (PRCA)

DETAILED COMMENTS

PRCA 1 - Calculation of capital resources requirements

5.1 The greater part of the requirements in Rule PRCA 1 depend upon clarification to be provided in Rule PRIR 2, and such comments as we have on PRCA1 are included in our response to PRIR 2.

PRCA 2 - Capital resources

5.2 We note that PSB effectively introduces to insurance companies the Tier concept of regulatory capital which has long been applied to banks. In principle, this does not cause difficulties due to the restrictions on capital which have been included in the previous legislation.

QUESTIONS AND RESPONSESQ22 Is it clear which capital resources requirements apply to each category and

sub-category of firms?

5.3 Yes

Q29 Does the table in PRCA 2.4.3.R explain clearly the required calculation of capital resources?

5.4 Yes

CREDIT RISK (PRCR)

6 CREDIT RISK (PRCR)

DETAILED COMMENTS

PRCR 1 - Credit risk systems and controls

Application of PRCR 1

6.1 ABI notes that apart from a definitional rule, PRCR1 consists entirely of guidance and amplifies PRAG 6 in the area of credit risk with the aim of setting minimum standards for management, systems and controls in that area of risk, and that, in turn, PRAG 6 builds on the high level requirements set out in SYSC. One principal concern for insurers will be to ensure that all necessary procedures are in place, appropriately documented and implemented and that compliance therewith is properly monitored. A second area of concern is that FSA will be applying subjective criteria to assess what is deemed compliant. ABI and its members require guidance on what is required and assurance that the supervision teams will adopt a consistent approach.

Criteria for assessment of counterparty risk

6.2 On specific issues, ABI would comment that in PRCR1.3.5 G there is no reference to the amount involved as one of the criteria to be taken into account in assessing whether to enter into relations with a counterparty; yet this must surely be a key factor in deciding the amount of controls needed. PRCR 1.3.11 G appears to provide a significantly less stringent approach compared with subsequent guidance in Rule PRCR 1.3 (cf 1.3.24 G).

PRCR 1.3.24 – Applicability to insurers

6.3 ABI seeks clarification on whether it is intended that the guidance set out in PRCR 1.3.24 G apply to insurers, since the context appears to be more applicable to the exposures of a credit institution. If this guidance does apply to insurers, then we would comment that the expectation in PRCR 1.3.24 G for firms to be able to measure exposure to counterparties on at least a daily basis is, at the least, ambitious for firms with worldwide exposures, since it suggests that some more frequent measure (eg hourly?) should be the norm. ABI accept that the requirement refers to the firm having the capability to carry out this frequency of measurement daily, or more frequently. Nevertheless, it will be necessary for firms to have systems which could do so, in order to demonstrate that they have the capability to do so. Additional guidance on what the FSA expects in practice or, preferably, confirmation that it is inapplicable to insurers would be very helpful.

PRCR 10 - Credit risk in insurance funds

Limitation of exposures

6.4 The new rules reduce the number of large exposure limits to which firms are currently subject. The rules regarding the acceptability of collateral have also been simplified. However the draft rules seek to impose a general requirement that firms must limit and diversify exposure to counterparties. To do this, the proposed rules require firms to make a “prudent allowance” for credit default so far as such loss is reasonably practical. Firms will be required to assess this allowance, taking into account both exposures to individual counterparties and groups of counterparties – eg grouped by type or geographical location. In practice, the assessment of this allowance will be difficult to separate from the similar allowance required under PRMR 11.

6.5 The rules require firms to limit counterparty exposure to the percentages of total assets set out in 10.3.14. The guidance states that exposure does not include exposure from assets to which the firm has attributed no value. Can it therefore be assumed that any holding in excess of the prescribed limits is simply inadmissible rather than a breach of the rules? The intended effect has to be that an excess holding is simply inadmissible; it would make no sense for a company that was comfortably solvent to begin with to be deemed to have breached a rule because it raised additional capital which was held with an institution for which the counterparty exposure limit had been breached. ABI would be interested to understand why this complicated approach has been taken. This also points up a, possibly unintended, difference of approach for insurers relative to other institutions which make deductions from total capital resources, and which sits awkwardly in an integrated approach to supervision. Additional guidance would be helpful.


Q31 Do you have any comments on the overall level of detail and balance between rules and guidance in the material on credit risk systems and controls? Is the relationship between this chapter, PRAG 6 and SYSC clear?

6.6 ABI considers that it is clear how the guidance provided builds on PRAG 6.

Q41 Is the level of detail and balance between rules and guidance material on credit risk in insurance funds appropriate? Is it appropriate to presume that adequate claims reserving for credit insurance and marking to market for credit derivatives will indirectly take into account current expectations of credit default?

6.7 The guidance should make it plain that exposures in excess of the limits set out in PRCR 10.3.14 are simply inadmissible and not a breach of the rules. So far as credit insurance and credit derivatives are concerned, ABI believes that the current valuation rules take account of the risk of credit default.

MARKET RISK (PRMR)

7 MARKET RISK (PRMR)

DETAILED COMMENTS

PRMR 11 - Market risk in insurance funds

PRMR 11.3.9

7.1 Current guidance allows for an investment shock on the valuation date which is a crucial assumption if the current Forms 57 are to be completed meaningfully. PRMR 11.3.9(1) and the associated guidance, however, suggests something other than such a shock. ABI would appreciate confirmation that no change to Form 57 is proposed, or alternatively an early opportunity to comment on a proposed replacement.

7.2 The guidance in 11.3.10 suggests that, following a fall in equities, firms would sell to prevent exposure to a further fall. DAA 15 and 15A were anxious to avoid this. ABI suggests that the ‘words take action to prevent exposure to further change’ need to be reconsidered.

7.3 ABI considers that the words ‘what reasonably might happen’ in PRMR 11.4.6 G are too wide; there should be some indication of the acceptable level of probability.

7.4 Rule PRMR 11.4.17 R and the provisions in PRIR on reserving for terminal bonus do not sit well together. It would be extremely difficult to calculate amounts of future terminal bonus using the basis in this rule.

PRMR 11.4.9 R

7.5 ABI notes that the 97.5% reduction factor will apply to the risk – adjusted yield as calculated in accordance with PRMR 11. 4,17 R, and in PRMR 11.4.9(2) includes the effect of the reinvestment rate restriction. This is more stringent than is the case under the Interim Prudential Supervision regime, under which the 97.5% reduction factor applies only to the current yield on assets. Is this change intentional?

PRMR 11.4.14 G

7.6 This guidance defines the yield on equities which was included in the Interim Prudential Sourcebook for Insurers (IPRU(INS)) as a consequence of CP84. FSA’s response to CP84, recognising that earnings yield data may not be readily available, agreed that appropriate approximations could be used in calculating the yield. ABI requests that the guidance should confirm that approximations are acceptable and, when instructions for the completion of Form 48 or its equivalent are drafted, that these too will permit the use of suitable approximations (or, by default, the dividend yield). If required, ABI can provide further justification on cost/benefit grounds for this request.

7.7 ABI also proposes that the definition of the yield on an equity (with suitable caveats about the use of approximations) should be a Rule in the PSB and not merely guidance.

PRMR 12 - Derivatives in insurance funds

Overall Approach

7.8 The use of derivatives is a fast moving area. The products available and the way in which they are used change rapidly. It is therefore important that the rules and guidance are flexible, otherwise there is the risk that the UK industry will lose its competitive edge. There is also a risk that the use of derivatives and product structures may become increasingly opaque as new structures are set up to produce the desired effect within the constraints of the rules and guidance.

7.9 However, ABI also recognises that companies need specific skills and expertise to use derivatives, as well as other complex financial structures, in a flexible way. We would therefore propose the development of a two-tier approach to the regulation of the use of derivatives.

Experienced companies who are able to satisfy FSA that they have adequate systems and controls and adequate experience should be able to use derivatives flexibly, subject to the overall directive and other constraints.

Other companies could opt for, or be required to adopt a rule based approach to regulation constraining the use they can make of derivatives.

7.10 This two-track approach would have the advantage of fitting in with the FSA’s risk based approach to supervision, and the increasing emphasis on companies developing their own systems and controls. At the same time it would allow increased flexibility.

7.11 ABI would like to look further at the balance between financial and product regulation, particularly with a view to promoting a level playing field between business written in and into the UK.

Legacy Effects

7.12 The current derivatives rules were developed as part of the Insurance Companies Regulations 1994. Subsequently, the rules were interpreted through developing guidance and regulatory decisions, some of which were narrower that the intention of the original regulations. Some of the welcome relaxations in the current draft will not be fully effective unless it is clear that their interpretation will not be constrained by the previous regulatory decisions.

Solvency 2 Review

7.13 ABI recognises that in some cases FSA may at present have little flexibility as they are constrained by European Directive requirements such as Article 21 of

the EU Third Life Directive. In particular, options, futures and swaps are not expressly defined as admissible assets, rule (iv) states that:

"derivative instruments such as options, futures and swaps in connection with assets covering technical provisions may be used in so far as they contribute to a reduction of investment risks or facilitate efficient portfolio management. They must be valued on a prudent basis and may be taken into account in the valuation of underlying assets."

7.14 It would be simpler and more logical to allow derivatives which contribute to a reduction in investment risk or facilitate efficient portfolio management (and possibly satisfy other conditions) to be admissible assets in their own right rather than only in connection with admissible assets. For example, guaranteed annuity options given to policyholders should be able to be hedged with a call option without resorting to 'packaged' structures or looking for assets with which to match a derivative if purchased directly.

Quasi Derivatives

7.15 The definition of “quasi derivatives” as set out in the draft is confused:-

Quasi derivatives are specifically excluded from the list of admissible assets in PRAG 5 Annex 1R.

The definition of “quasi derivatives” in the glossary refers to “assets falling within any descriptions in PRAG 5 Annex 1R”.

PRMR 12.3.25 G specifically includes quasi derivatives as admissible assets.

7.16 Quasi derivatives are instruments which have the characteristics of derivatives although they are not derivatives – the definition in PRAG5 Annex 1R should be amended to remove the reference to “quasi derivatives”.

7.17 More fundamentally, the definition in the glossary is linked to IAS 39. The treatment advocated in IAS 39 may be more restrictive than the current treatment. If this is the case, this may place the UK industry at a competitive disadvantage.

7.18 ABI would be happy to work with the FSA to develop an acceptable definition.

Nature and Layout of Guidance

7.19 Diagrams and worked examples would be a useful addition.

Forward Currency Contracts

7.20 The current Rules provide that forward currency contracts are not to be treated as derivatives where they are held for the purpose of settling the sale or purchase of an asset and are to be effected within a short period as defined in the current Rule. ABI cannot see that this exemption has been carried into the PSB and assume that this was an unintentional omission. Please confirm.

‘Spot’ Transactions

7.21 ABI notes that references to ‘spot transactions’ have been generally removed, which we welcome. One reference in PRMR 11.6.9 has been overlooked.

'Approved Counterparty'

7.22 ABI welcomes the extension of the definition of approved counterparty to include insurance undertakings which may be authorised under the Insurance directives. ABI would like to see the definition extended further to include non-European counterparties of appropriate solvency without a place of business in the EU or which do not conduct business through an EU branch such as US insurers and Australian banks.

Repo Transactions

7.23 The current rules include provisions exempting stock lending and repo transactions from the requirements on derivatives. These provisions do not appear to have not been carried into the PSB. Is this intentional?

Reduction of investment risk and the efficient portfolio management test (PRMR 12.3.3 to 12.3.9)

7.24 This section poses fundamental issues.

7.25 There is asymmetry between the two tests set out in PRMR 12.3.5, in that in 12.3.5(1) the increase in risk should be “small and reasonable” and in 12.3.5(2) it should be “unforeseeable”.

7.26 It is unlikely that a risk is ever totally “unforeseeable”, particularly with the benefit of hindsight. This may mean that a position which is acceptable under the current guidance (which referred to “reasonably foreseeable significant adverse risk consequences”) may not be so under the revised test. Is this what FSA intends by the new rule?

7.27 Under the previous Regulations, ‘ Reduction in Risk ‘ was defined primarily in relation to cash, whereas in the PSB, it is defined in relation to liabilities. Thus, if a liability could be expressed as £10m of bonds and £5m are held, under the previous regulatory regime Reduction in Risk meant a short bond position, hedging the asset only, whereas under the PSB it means a long bond futures position, hedging assets less liabilities.

Individual cover (PRMR 12.3.12R)

7.28 PRMR 12.3.12(2)(b) is unclear. If a derivative is included in the financial statements at market value, there should not be a need to set up an insurance liability or provision for a cash obligation. For example, for a bought call option, under (4) the exercise price is a cash obligation for the purposes of (2), so a liability or provision would be required, even though the derivative value is only the market value of the option. There is no equivalent requirement in (1) for a non-cash obligation.

7.29 PRMR 12.3.12(3) allows obligations to pay a monetary amount or transfer assets to be covered by offsetting transactions with different counterparties. The rationale for this, as set out in 12.3.21 R, is difficult to follow. Sub paragraph (4) of this paragraph is unworkable in that small market movements may mean that an option may move from being in the money to out of the money.

The “in connection with” test (PRMR 12.3.25)

7.30 ABI understands that the intention is to relax this test in circumstances where derivatives are held to hedge liabilities, and cover is not required as there is never an obligation on the insurer. This would be a sensible extension of the existing regime and we shall look forward to seeing this relaxation carried forward into the next draft.

7.31 The final sentence of PRMR 12.3.25 G makes it clear that specific identification of assets is not required. However, 12.3.24(3) R, taken alone, appears to imply full identification. Should the guidance become part of the rule?

7.32 In any event, attributing the value of the derivative to a portfolio in the prudential returns is an unusual treatment.

Over the Counter Transactions – PRMR 12.3.26 and 12.3.27

7.33 ABI considers that it is unnecessary to insist on weekly valuations if there is also a requirement in the contract between the firm and the counterparty for the counterparty to provide a valuation at any time, at the firm’s request.


Q42 Do you have any comments on the overall level of detail and balance between rules and guidance in the material on market risk systems and controls? Is the relationship between this chapter and SYSC clearly explained?

7.34 The overall balance between rules and guidance is broadly correct. As will have

been noted, we have numerous detailed comments, some of which may result in a shift in the balance. The relationship with SYSC is clear.

Q48 Do you have any comments on the overall level of detail and balance between rules and guidance? Are there areas where actuarial or industry guidance material could be developed to support the practical application of these rules (eg in relation to resilience tests)?

7.35 So far as general insurance is concerned, ABI considers it important that guidance on resilience reserves is made available. Since the concept may be new to some of our members, this guidance ought to be detailed and, perhaps, supported further by educational material. ABI does not believe that it can be provided by the industry, not least because consumers would argue that a trade body cannot take a suitably objective view. Nor does ABI believe that the actuarial profession is appropriate since general insurers are not required to appoint an actuary. ABI also understands that the profession would be reluctant to offer detailed guidance to its members. No doubt various consultancies will be able to offer advice, but only at a price which may not satisfy cost – benefit restraints and which would certainly be an unwelcome additional overhead for our members.

7.36 The provision of guidance for life insurers is equally important, in order to avoid the inconsistencies which arose after resilience reserves were first introduced and before the Government Actuary’s Department offered examples of suitable scenarios. Again, ABI understands that the actuarial profession would be reluctant to offer the detailed guidance currently available in Dear Appointed Actuary letters, within the existing structure of regulatory authorities and professional bodies.

7.37 On balance, ABI believes that, within the existing structure of regulatory authorities and professional bodies, the FSA is the best source of guidance for both life and non – life insurers. The continuance of Dear Appointed Actuary letters to life insurers and the introduction of an equivalent for general insurers would give confidence to consumers that that all insurers are being regulated to the same standard. It is difficult to see how guidance from any other source could give the same degree of confidence.

7.38 ABI suggests that an acceptable way forward would be for the FSA and Actuarial professional bodies to establish a joint working group which could produce the necessary guidance for regulated firms. ABI is willing to discuss the problems with FSA, the actuarial profession and any other interested parties.

Q49 Are the requirements applying to the use of derivatives by insurers clear? Do you have any comments on the overall level of detail and balance between rules and guidance? Do the requirements differ from those applying to banks and investment firms only to the extent necessary to reflect differences in the underlying market?

7.39 Subject to the detailed comments we have made, the requirements are clear, and ABI welcomes the relaxations which have been made from the current Rules. Again, subject to the detailed comments we have submitted, ABI believes that the balance between rules and guidance is correct. ABI has not made a detailed study of the equivalent rules for banks and investment firms; we would say, however, that as far as possible within the constraints which result from the Third Life and Third Non – Life Directives, the requirements for insurance firms should be as similar as possible to the requirements for other categories of financial institution. They should be, but we are not certain that this is the case at present. In addition, ABI believes that the rules should make it clear that derivatives may be held by insurers in connection with both assets and liabilities.

OPERATIONAL RISK (PROR)

8 OPERATIONAL RISK (PROR)

DETAILED COMMENTS

PROR 1 - Operational risk systems and controls

8.1 This Chapter of the PSB is, in many respects, the least specific and also the most wide – ranging part of the PSB. That is not a criticism; the areas which fall within the definition of operational risk will, necessarily vary considerably as between firms. It is not clear how firms are expected to allocate their operational risks into the categories suggested; as drafted the approach seems to be ‘one size fits all’ with no differentiation based on the particular business. The important thing, in accordance with the general approach of the PSB, is that those actions must be documented and that systems for monitoring those risks and identifying changes in those risks must be put in place. As with other

systems and controls rules ABI’s only concern is that there is consistency across the industry in the way in which FSA applies its role as regulator, to ensure that the way in which firms approach Operational Risk is fully understood and consistently applied.

PROR 2 - Outsourcing

2.1 – Application

8.2 There is an issue of principle which requires clarification. Some functions may be undertaken by someone else but are not outsourced. Other functions may be the firm’s responsibility and cannot be delegated but are outsourced. For example, the management of the assets representing technical provisions by a regulated investment firm. It is not clear whether responsibility for investment management remains with the insurance company, which therefore has to comply with all relevant regulatory obligations together with the rules on outsourcing, or whether it is sufficient to rely on the regulation of the asset management firm by the FSA. Perhaps the answer lies in the permissions held by the insurer. If an insurer does not have permission to undertake the management of investments, it has no function to outsource and falls outside the scope of PROR 2. If that is a correct reading of the permission, additional guidance to that effect would clarify the position considerably.

8.3A further issue of principle concerns the regulation, or not, of an outsourcer by the FSA. If an outsourcing supplier is regulated by the FSA, there can be duplication of effort if the supplier is subject both to FSA compliance requirements and also to inspection by its clients. This is particularly the case if both client and outsourcing supplier are in the same group, as is often the case with investment management. Some suppliers may well supply similar services to a number of regulated firms, We suggest that regulated firms should be expected to take account of the regulated status of its suppliers, assess the compliance capability of the supplier and scale the extent of supervision accordingly.

8.4 The definition of outsourcing refers to the provision of ‘customised services to a firm’. This appears to extend to all services, whether or not connected with insurance business, which have an impact on the insurers’ overall risk profile. Is this the case? Guidance on the nature of the services or functions which, if outsourced, fall within PROR2 would be helpful.

2.3 – The firm’s obligations when considering outsourcing

8.5 There will be difficulty in determining when outsourcing is material in the absence of more detailed guidance. There is, therefore, a danger of inconsistent application

8.6 The definition distinguishes between “outsourcing” and “material outsourcing”, with part of the distinction between the two being an analysis of the impact of the arrangement on its customers. ABI considers that this should comprise an assessment of the impact on customers as a whole, rather than on individual customers and it should be made clear in the drafting.

8.7 Where there are few potential providers of a service, a regulated entity may sometimes have concerns about the ongoing financial viability of a service provider but nevertheless wish to enter into an outsourcing arrangement. Clearly the interests of customers might be prejudiced if a supplier were to become insolvent, but good and detailed contingency planning within the regulated entity and appropriate indemnities should address the issue.

8.8 2.4.1 refers to new material outsourcing arrangements or significant amendments of existing arrangements. It should be made clear that existing arrangements may be grandfathered until such time as significant amendment is needed. Companies may otherwise face significant costs in renegotiating existing arrangements.

8.9 2.4.6 refers to vetting of the supplier, which is essential for material outsourcing. Some indication of the steps to be taken might be appropriate

2.5 – The contract with the supplier

8.10 ABI notes that many of the issues in this paragraph should be covered by standard contracts.

8.11 2.5.2 refers to ‘rights of access equivalent to those provided to auditors by Section 341 of the Financial Services and Markets Act’. However, Section 341 refers to rights of access to authorised persons. Material outsourcing arrangements may relate in part to non-authorised business. Also, the supplier may provide services to more than one company, including other authorised persons and commercial competitors of the regulated entity. ABI would therefore suggest that paragraph 2.5.2(1) is qualified by the addition of the words “in respect of the outsourced service” after “rights”

8.12 2.5.2(2) requires the supplier to notify the firm of “any developments” which may affect its ability to meet its obligations. This should be qualified by a materiality criterion –suppliers should not be expected to inform the firm of minor or short term developments. 2.5.2(2) should be qualified by the addition of the words “in a significant way” after “obligations”. Transparency of relations with suppliers is important; however, there is the risk that over onerous requirements will result in regulated entities paying more to suppliers for no additional benefit.

8.13 2.5.5 requires firms to have the right to terminate a contact with the supplier if a range of circumstances occur, including change of ownership or control. Again, a significance criterion should be added. It should also be recognised that many suppliers are parts of large multi national groups and changes of ownership or control may occur at a higher level in the group. The supplier may have no control over these developments.

8.14 2.5.6 requires the retention of work or records relating to material outsourced services but does not make it clear how long the records are to be retained. An alternative would be for the records to be passed to the regulated firms for their retention. Are electronic copies acceptable?

Informing the FSA

8.15 At what point would the FSA anticipate being informed? Some guidance might be helpful.

8.16 Paragraph 2.8 is confused between the firm’s and the suppliers’ contingency plans. A supplier’s contingency plans in the event of an arrangement being terminated will generally not be relevant to the authorised entity.

2.8.5 – Sub-contracting

8.17 Again, materiality criteria should apply. The supplier may sub-contract a very small part of its activities which do not affect the provision of services to the regulated entity.


Q50 Does the proposed chapter on operational risk reflect the main prudential risks to firms in this area? Do the requirements add usefully to the general material on systems and controls in SYSC? Should the chapter be more detailed – as, for example, the chapters on credit risk and market risk systems and controls?

8.18 ABI believes that PROR 1 has identified the main prudential risks to firms in the area of Operational Risk and to that extent builds on SYSC. Given the wide ranging nature of the risks identified and the way that these risks will differ in importance as between firms. It would be helpful if the guidance could include material to assist firms to analyse their operational risks according to the needs of their business.

8.19 One other matter on which ABI would appreciate confirmation from the FSA is in relation to Operational Risk and the EU Solvency 2 Review. We understand that the Basel Accord, both the current version and the yet to be finalised version, includes a capital requirement which is intended to take account of Operational Risk. ABI finds it difficult how this concept would fit with current European solvency requirements and therefore seeks FSA’s confirmation that this is not in mind for the revision of the PSB which will undoubtedly be made to take account of the revised Basel Accord.

Q51 Does the proposed approach to outsourcing reflect the main prudential risks to firms in this area? Do the requirements add usefully to the general material on systems and controls in SYSC? Should the chapter be more detailed – as, for example, the chapters on credit risk and market risk systems and controls?

8.20 In general, subject to the detailed comments ABI has made and the clarifications we have sought, we consider that the approach to outsourcing does reflect the main prudential risks to firms in this area and adds appropriately to SYSC. Subject to our detailed comments additional detail is not required.

INSURANCE RISK (PRIR)

9. INSURANCE RISK (PROR)

DETAILED COMMENTS

9.1 ABI wishes to preface its detailed comments on PRIR and its responses to the relevant questions in CP97 by pointing out that, since this Module of the PSB is the only sector – specific part of the PSB, and that sector is insurance, ABI has not applied the principle of proportionality. Our comments on this Module are, therefore of greater length and in more detail than ours comments and responses on other parts of the PSB.

PRIR 1 - Insurance risk systems and controls

9.2 The guidance provided builds usefully on the high level material in SYSC, albeit remaining at relatively high level and not overly prescriptive. This accords with the overall approach of the PSB. The issue is the way in which the FSA will supervise compliance compliance, so as to ensure that the guidance is applied consistently by regulated firms.

PRIR 2 - Financial resources for insurance business

Solvency margin for Permanent Health Insurance

9.3 ABI appreciates that the introduction of a revised required minimum margin for Permanent Health Insurance business is a requirement of the EU Solvency 1 Directive and we welcome the relief provided in PRIR 2.5.10 and PRIR 2.5.12 for contracts under the conditions set out in PRIR 2.5.26. However, we believe that case can be made for at least partial relief for contracts which satisfy the first five conditions of PRIR 2.5.26 but not the sixth condition. ABI can provide further justification if required.

9.4 Article 2 of the Solvency 1 Directive allows a five or seven year transitional period for undertakings to comply with the new requirements. Historically, UK legislation has incorporated such transitional arrangements when implementing EU Directives, and ABI urges FSA to ensure that this is the case with the implementation of Solvency 1. We are not sure whether the transitional provisions should be incorporated in the PSB or be the subject of secondary legislation.

Adequacy of new business premiums – general insurance

9.5 On the general insurance side, we have concerns about Rule 2.3 and the way in which it will be implemented. This is a new requirement which we do not recall being featured in any of our pre–consultation discussions. While we recognise that it was introduced for long- term insurance as part of the implementation of the Third Directive, (Section 35B of the Insurance Companies Act 1982 implemented Article 19 of 3LD), there is no equivalent provision in the Third Non–Life Directive. This appears to be a further example of super–equivalence, and one which was not directly alluded to in the body of the Consultation Paper. While we accept that the rules do include some guidance on what is expected of firms in this area, it is far from clear whether the rule applies policy by policy, or to the rating structure for broad classes of business. Some general business, mainly personal lines, is conducted on the basis of rating structures which are applied across an organisation; other business, mainly large commercial, is subject to individual rating by the underwriter. Additional guidance on what is intended would be helpful. Moreover, there is no indication as to how FSA intends to monitor compliance. This new requirement is particularly significant for underwriters whose portfolio is constantly exposed to a changing legal and economic environment and ABI would welcome an opportunity to discuss this issue in more detail.

PRIR 3 - Mathematical reserves

Expense Provision

9.6 ABI believes that some redrafting is required in Rule 3.3.31 R. 3.3.31(1) deals with the adequacy of the expense provision for a particular contract. 3.3.31(2)(b) refers to the aggregate effect of closing to new business 12 months after the valuation date; presumably this is a reference to the separate requirement to ensure that there are adequate margins to meet the cost of writing and then closing to new business and then servicing existing business. Making sub-paragraph 1 dependent upon sub-paragraph 2(b) seems inappropriate.

Margin for adverse deviation

9.7 It is not necessarily easy in practice to establish the margins described in Rule 3.3.7R(1) and (2). Whilst Test 1 (the premium basis test) is reasonable and should be workable, Test 2 (the reinsurer/derivative test) would in some cases present considerable practical problems in obtaining suitable data. In particular, reinsurers’ or counterparties’ rates already include margins for adverse deviation and/or profit and may therefore be over prudent. Moreover the market may not be competitive and it may be unclear whether the terms quoted are genuine commercial terms. ABI considers that this concept would be better dealt with as guidance to 3.3.3R and not as a rule.

Future premiums

9.8 PRIR 3.3.22(1) defines accumulating with profits but the term is not used explicitly. It would aid clarity if the term were included in the definitions and used where appropriate, like ‘ traditional with – profits insurance contracts ‘. In PRIR 3.3.23 R it is stated that future premiums must be left out of account unless they cause future valuation strain, whereas IPRU (INS) states that they may be left out of account. Is this an intentional change? This could be an issue for some contracts whose classification as accumulating or traditional with profits is unclear.

9.9Rules 3.3.22(3) and (4) misconstrue the nature of net premiums. The effect to sub-paragraph 4 would require net premiums to be fixed at the issue of a contract instead of allowing them to vary with a change of valuation basis. The solution may be to make the net premium a defined term instead of trying to define it within a specific rule.

9.10 ABI would also point out that this rule and 3.3.32G illustrate how much clearer the rules could be if accumulating with-profits contracts were a defined term.

Discretionary benefits – provisioning for terminal bonuses

9.11 Rules PRIR 3.3.56 R and 3.3.57 G – 3.3.59 G are concerned with the new requirement to include a provision for the anticipated cost of terminal bonuses or, as they are described in the ABI’s ‘Raising Standards Initiative‘ ‘final bonuses’. With regard to rule 3.3.56 R, we note that that paragraph 10.22 of the consultation paper refers to the quantification of terminal bonus on the basis

of a best estimate on reasonable assumptions. The rule, however, appears to go beyond the spirit of the PSB in requiring some degree of prudence and not merely a best estimate. ABI believes that ‘best estimate’ is consistent with the concept of the Consultation Paper and we welcome the FSA’s statement in paragraph 10.22 that final bonus is not a guaranteed liability and that there is no intention on the part of FSA to guarantee that it is. ABI is not opposed in principle to reserving for final bonuses which are undoubtedly part of policyholders’ reasonable expectations. However, care is required in drafting rules and guidance to ensure that the resulting provisions are not unduly prudent. ABI would welcome the opportunity to discuss the issue further with FSA either in the context of CP 97 or the FSA With – Profits Review.

PRIR 4 - Equalisation provisions

9.13 The draft rules reflect existing requirements and ABI has no specific comments upon them.

PRIR 5 - Internal Contagion Risk

With-Profits Reporting and Disclosure

9.14 At this stage, ABI wishes to enter a reservation with regard to Chapter 5.6, in that ABI and its members wish to carry out a more detailed study of the extent to which the proposals for with-profits business go beyond current regulation and practice, and to submit a supplementary response when that study has been completed as part of its response to the With-Profits Review. In the meantime, ABI has the following comments.

With-Profits Business Issues – Application of Surplus

9.15 PRIR 5.6.1 R says that firms can only use with – profits assets for other than with – profits business if those assets represent an established with – profits surplus and other conditions are fulfilled. This requires that a valuation has been performed within the previous three months, and appears to preclude a firm from, for example, writing non – profit business involving an initial strain except within the three months period following a valuation. Since part of the three months period following a valuation date will be taken up with the determination of the amount of the established with profits surplus the period in which this non –profit business can be written is very restricted indeed. Or would the writing of such business count as using the assets for with – profits business? Will FSA please clarify the position.

9.16 The third sentence of PRIR 5.6.2 G states that ‘An established with–profits surplus excludes amounts of unallocated surplus carried forward‘. This appears to conflict with the relevant definition; is it not possible to have an unallocated surplus carried forward in which policyholders are nevertheless eligible to participate—whether or not they actually do participate. The overall treatment and description of different types of surplus etc would benefit considerably from clarification of the drafting.

9.17 5.6.8 G suggests that someone who deliberately effects a with-profits policy in the expectation of a windfall from the free assets may have a legitimate expectation of that windfall. We do not agree with this concept, which appears to support the unwelcome practice of “carpet bagging”.

9.18 The concept in 5.6.9(5) of when the surplus first arose is unhelpful. Whilst undistributed surplus has normally arisen over a long period, an insurer will not necessarily know how much of it first arose in, for example, 1954.

The 90:10 Presumption

9.19 Regarding 5.6.10E, whilst a 90:10 distribution is common practice, ABI questions whether it is necessary or desirable to enshrine it in the FSA Handbook of Rules and Guidance. Fairness to customers and market forces would make it hard for an insurer to go beyond 90:10. Product innovation may also make the 90:10 model for proprietary offices redundant.

9.20 The guidance in 5.6.11 G appears to go beyond its related rule 5.6.10 E, which states that a firm must not apply the ‘excess portion‘ for purposes other than with–profits business, whereas 5.6.11G states that the firm must allocate at least the ‘excess portion‘ to policyholders. What would be the position if the firm decided not to allocate part of the surplus at all? We consider the use of the term ‘excess portion‘ is not very clear; it would be preferable to rename it as ‘policyholder distribution percentage‘ and rename ‘distribution percentage’ as ‘last policyholder distribution percentage‘.

Non-Insurance activities

9.21 Regarding 5.3.4 G, ABI has been discussing with FSA and predecessor regulators for some years what non-insurance activities should and should not be permitted. We hope that this issue can be brought to a swift conclusion.


Q55 Do you have any comments on the overall level of detail and balance between rules and guidance in the material on insurance risk systems and controls? Is the relationship between this chapter and SYSC clearly explained?

9.22 Overall, the balance between rules and guidance is acceptable, but as indicated in our Detailed Comments and in also in our Drafting Points, there are a number of places at which guidance should be made into Rules and vice versa, and other places where there is either too much guidance or too little.

Q56 Should insurance firms be allowed to rely on available resources other than those arising from the contract itself and related reinsurance arrangements in determining the adequacy of the terms for new business? Is the extension of these requirements to non-life insurance appropriate? Are the general rules and guidance relating to technical provisions and related assets appropriate?

9.23 ABI refers the FSA to the remarks made in our Detailed Comments on Rule 2.3. Subject to a firm maintaining at least the Required Minimum Margin, the answer to the first question is ‘ yes’. The answer to the second question is ‘no’. The general rules and guidance about technical provisions and related assets are helpful, provided that the clarifications we have sought are given and the changes we have suggested are made.

Q57 Are the EC minimum capital requirements set out in the chapter appropriate for both direct insurance and reinsurance business? Is it appropriate to extend EC minimum capital requirements to small mutuals and friendly societies that are outside the scope of the EC Directive?

9.24 ABI considers that it is appropriate to apply the EC minimum capital requirements to both direct insurers and to reinsurers. We have argued that this should be the case for many years and, in any case, previous regulations have never made the distinction. We have no view on the second question.

Q58 Are the rules and guidance for mathematical reserves appropriate and complete? In particular, do you have comments on the proposed approach to the setting of margins for adverse deviations?

9.25 ABI’s views on this question are set out in our detailed comments on PRIR 3. In essence, we can foresee a problem in the approach to margins, because the “risk premium” that a reinsurer might charge may well include factors (including margins for profit) other than the pure risk involved.

9.26 In addition, the reference in 3.3.7(2)R to an unconnected reinsurer may be difficult to comply with, or might give an inappropriate result. This is because

there may not be a reinsurance market on the scale of some of the medium to large life companies.

Q59 Should provision for terminal bonuses should be included in mathematical reserves?

9.27 ABI is not opposed in principle to the inclusion of provisions for terminal (or ‘final‘ as we would prefer to describe it) bonus in the mathematical reserves. Policyholders’ final bonus expectations contribute to insurers’ constructive liabilities and it is not in the public interest for insurers to be able to overstate their true solvency margins by understating their liabilities. Under the current regulatory regime, FSA knows (or ought to know) the true position and it is difficult to argue that this knowledge should be kept out of the public domain.

9.28 However, in putting the principle into practice FSA must ensure that the reserving requirements are not so onerous that they unnecessarily restrict insurers’ investment freedom to the detriment of their with – profits policy holders. The following paragraphs explain some of the issues which concern us. ABI would welcome the opportunity to work with FSA to develop workable rules and guidance.

9.29 It would be highly undesirable if offices were to be required to set up mathematical reserves that included a full allowance for terminal bonus, and for a resilience reserve and solvency margin to be superimposed on it. In general the inclusion of margins for solvency (or for prudence) does not seem appropriate for reserves for terminal bonus.

9.30 If it is to be done, the requirements for margins could need attention, as reserving for safely-large (ie big) terminal bonuses would seem inappropriate. There is an interaction between the cost of guarantees for one policy and the amounts available for terminal bonuses for the remaining policies: this means that somehow the margins present in the valuation of guarantees should result in smaller amounts of terminal bonus being reserved for. This interaction also means that any reserves for terminal bonus probably need to be produced on a “portfolio” basis and not by separate calculation for each policy.

9.31 For instance, in the case of conventional with-profits policies the net premium basis is – in many financial conditions at least – a strong basis in itself. There may be little or no scope for future terminal bonuses if future financial conditions were to reflect the valuation assumptions. It is not at first sight easy to see what observers could read into the size of the resulting reserves.

9.32 The position is different for accumulating with-profits business, but the limits on the future rate of investment return that can be assumed in the valuation would, unless relaxed where reserving for terminal bonuses was concerned, still be likely to have some effect in increasing reserves.

9.33 Any inclusion of allowance for terminal bonus in reserves could obscure the true degree of solvency of an office if it is not accompanied by separately shown reserves based only on the guaranteed levels of benefits.

9.34 Attention would have to be paid to how the surplus emerging each year was to be measured for the purpose of determining the size of transfers to shareholder funds. Inclusion of future terminal bonus in reserves would greatly reduce the future surpluses if they were to be measured on the basis of those reserves.

Q60 Is the approach to resilience reserves appropriate? Should such reserves be held as on-balance sheet provisions or as required capital?

9.35 It would seem more logical to present the reserves as required capital. This would have a secondary effect of not requiring additional capital to be calculated on top of the amount of these reserves. It would provide a consistency of treatment between life and general insurers which does not apply at present.

Q61 Should changes be made to the calculation method for equalisation reserves are needed? If so, please describe the changes you propose?

9.36 ABI does not propose any changes to the calculation method for equalisation reserves.

Q62 Is the overall approach to internal contagion risk appropriate? Do you have any comments on the specific proposals relating to non-insurance activities, long-term insurance assets. with-profit funds, linked assets, overseas firms and deficits in related insurance firms?

9.37 ABI has significant concerns about the drafting of Section 5.6. As a result we are not clear exactly what its impact would be.

9.38 For instance, 5.6.1 R involves “with-profits assets” even thought many companies do not have a separate fund purely for with-profits business. For mutual companies the assets in the long term fund cover both with-profits and non-profit business, and are not attributed to one or the other.

9.39 5.6.10 refers to the “assets representing the excess portion of an established with-profits surplus”, but it is unlikely that specific assets are earmarked to that surplus.

9.40 5.6.10(4) does not take into account that part of surplus will be distributed in ways (in particular as terminal bonus) that do not increase mathematical reserves.

9.41 It is somewhat difficult to comment on ‘ specific proposals relating to non – insurance activities ‘ when there are none!

GROUP RISK (PRGR)

10 GROUP RISK (PRGR)

DETAILED COMMENTS

PRGR 1 - Introduction

10.1 Our examination of the Group Risk Module of the PSB leads ABI to the conclusion that the requirements which apply to Prudential Category 2 firms ( ie insurers) are a replacement of the relevant material in IPRU (INS) strengthened in some cases, as previously trailed in CP50. To that extent our comments are mainly of a drafting nature and included in Appendix 1. There are some instances where it is not clear whether a change is intended or not, and these have also been raised in Appendix 1.

PRGR 2 – Systems and Controls

10.2 PRGR 4.3 states that PRGT 2 applies to every member of a firm’s group. This appears excessive; should not the scope be limited to the information about those companies which is available and necessary in order for the regulated firm to fulfil its obligations under PRGR 2.2.2(2)?

PRGR 4 - Capital requirements: insurance and reinsurance groups

10.3 There appears to be an inconsistency between 4.2.1 and 4.2.18 in that for companies established in an EEA member state, monitoring of group solvency is a continuous requirement, whereas the requirement for a non–EEA ultimate parent insurance undertaking, the requirement in 4.2.18 is an annual calculation.

10.4 It appears impractical to impose an obligation on a subsidiary to require its parent undertaking to pass the test at all times by itself maintaining adequate capital resources. There is no equivalent requirement in 4.2.1 for insurers incorporated in non–EEA countries.

10.5 The existing concession for insurers in respect of counterparty/asset class exposure limits appears to have been omitted from 4.2.1. Is this change intentional?

10.6 In 4.2.13, the draft Rule requires local valuation for companies in the territories listed in PRGR 4.3.2R, whereas there is currently a choice between using the UK valuation basis and the local basis.

PRGR 5 - Capital requirements: cross- sector groups

10.7 The wording of PRGR 5.3.8.R suggests that it is necessary to delete an item from capital merely because it appears elsewhere in a different PRU category (eg the revalution reserve for a Category 1, 3 or 4 firm is omitted for a Category 2 firm but a Category 2 firm would include it in audited reserves).


Q63 Is the purpose of setting group risk requirements and their relationship to the integrated groups arrangements clearly explained?

10.8 Yes. Q64 Is the relationship between this chapter and SYSC clearly explained?

10.9 Yes.

APPENDIX 1

DRAFTING COMMENTS

PRAG 4

In PRAG 4.3.8(2)(a), ‘guarantee to third party‘ should read ‘guarantee to a third party‘.

PRAG 5

There is an inconsistency with PRCR, Rule 10. PRAG 5.5.9 G says that 5.5.8 R prohibits the use of amortised cost. PRCR 10.3.1 G(2), referring to Schedule 9A of the 1985 Companies Act, says that "(some assets) are valued at cost (or amortised cost)".

In PRAG 5.5.1(3), ‘admissible asset’ is mis-spelt.

Sub-paragraph (3)(c) of the schedule in Annex 1R to PRAG5 should say "for general insurance business only, deferred acquisition costs." Deferred acquisition costs do not currently represent an admissible asset for long-term business.

PRCR1

The words ‘ include within ‘ are duplicated in the third line of PRCR 1.3.12 G.

It would be helpful if the amount of the change to be assumed in PRCR 1.3.17 G could be quantified.

PRMR 11

PRMR 11.3.1

1. It would be better to refer to a resilience reserve, not a provision, in accordance with standard accounting usage of the words.(It occurs too in 11.3.7, 11.3.8, 11.5.5 PRIR 3.3.8 and 3.3.50).

2. In view of the number of references to it, a definition of resilience reserve (cross referring to PRMR 11.3.8) would aid clarity.

PRMR 11.3.6

We question whether this guidance adds anything to PRMR 11.3.1(3)R.

PRMR 11.3.7

The cross reference should be to PRMR 11.3.8R. The whole of this Rule should be moved to follow PRMR 11.3.8R.

PRMR 11.3.8R

The cross reference in this rule should be to PRMR 11.3.1R(3). PRMR 11.4.11(3)

A presentational point – the rule contains an implicit definition of real estate, namely “(ie land, buildings and immovable property rights)”. We suggest that the term be defined in the Glossary of Definitions. Alternatively, perhaps the term – which appears 7 times in PRMR 11 and once in PRCR 2.5.4(9) (whose banking readers are assumed not to require further amplification) – does not need defining at all.

PRMR 11.4.13

Should not the words ‘before deduction of tax‘ also apply to repayments of capital?

PRMR 11.4.17 R(1)(a)

“Long-term gilt yield” ought to be italicised and included in the definitions section.

PRMR 11.4.17(3)

We do not understand why the word ‘ Principles ‘ uses a capital letter.

PRMR 11.6

Neither the heading (“Equity position, real estate and other market risk”) nor the guidance are relevant to rules PRMR 11.6.3, 11.6.5 and PRMR 11.6.9. A logical sequence would be:

Some asset risk can be virtually eliminated. Some of them must be eliminated so far as is reasonably practicable.

Property-linked liabilities must be (very) closely matched. (11.6.3).Index-linked liabilities must be (fairly) closely matched. (11.6.5)Derivatives etc must be covered. (11.6.9).Other asset risks must be covered by a resilience reserve. (11.3.8).

We consider that the chapter should deal first with the certainties of close matching and derivative cover in 11.3 then deal with the uncertainties of the resilience reserve in 11.4

We also consider that the words ‘ as far as reasonably practicable ‘ in 11.6.3 are unclear and the related guidance does not help interpretation. We are concerned that the requirement is too onerous or could be so interpreted. The test should relate to the materiality of any financial mismatch against the size of the company’s resources.

PRMR 11.6.8

We are unclear as to the meaning of ‘safe levels’ and are not sure whether it is used elsewhere. The cross-reference should be to PRCR 10, not PRCR I0.

PRMR 11.7.3 G

Some of the wording of this guidance is so definite that it should be a rule or tuned into a definition.

PRMR 11.7.7(2) R

We find the use of the term ‘non–eligible collective investment scheme’ an odd mixture of the defined and undefined which could lead to confusion.

PRMR 11.7.8 R

The words ‘relating to aggregate exposure‘ are unnecessary and should be deleted. The cross reference to PRMR 11.7.2 R(2) should be to PRMR 11.7.7(2) R.

PRMR 11.7.12 R – 11.7.17 G

We consider that these rules which deal with derivatives would be better included in PRMR 12.

PRMR 11.7.12(2) R

‘PRIR‘ should read ‘PRMR‘.

PRMR 11.7.14 R

The test in this rule appears rather crude. For a contract nearly at–the–money, the effect will be that the cover requirement gets switched on and off as the underlying price moves.

PRMR 11.7.15 G

An improved wording would be ‘Where under PRMR 11.7.12 R a purchased option is not covered, it cannot be an approved derivative’. However, the drafting could be improved further by combining PRMR 11.7.13, 14 and 15 and stating ‘ Where the

transaction involves a right exercisable at the firm’s option, cover is not compulsory, but unless the option is covered the transaction cannot be an approved derivative,

PRMR 11.7.17 G

The two rules which are cross referenced do not exist. They should have been cross referenced to PRMR.

PRMR 12

PRMR 12.3.17 R

The exclusion in (2) in the case of a synthetic future needs to be more general. Cover in respect of one transaction should be usable for another to the extent that the conditions which would require the cover to be present do not overlap.

PRMR 12.3.22 G

PRMR 12.3.22(3) should refer to a bought contract for differences.

PRMR 12.3.22(4) includes a reasonableness test which is in turn linked to the individual cover requirements in PRMR 12.3.12(1)(B). This formal link should be avoided - the firm should ensure that the relationship between the portfolio and the index is reasonable.

PROR 2

PROR 2.6

Paragraph 2.6.2 covers the content of service level agreements.

In sub-paragraph 2 “appropriate” should be inserted before “remedial”.

In sub-paragraph 4 “supplier” should read “firm”.

Paragraph 2.6.4 refers to the level of resources to be specified in the service level agreement. The existence of adequate contingency planning is implicit in the requirements for minimum resources, and we would suggest that the end of the sentence, after ‘service’ is deleted. However the outsourcing entity may wish to review the suppliers outsourcing arrangements and we therefore suggest that paragraph 2.8.2 should be moved to after 2.6.4

PRIR 1

In PRIR 1.1.1 R the categories in the heading should be reversed to read “…..PRU Category 1 that carries on insurance business and any firm in PRU

PRIR 2

2.3.1 R and 2.3.2 E

We are doubtful that the evidential provision adds strength to this rule. It would be sensible to transfer the additional words in 2.3.2 E to 2.3.1 R and delete 2.3.2 E.

2.4.5 G

The words ‘ insurance business ‘ should not be italicised, since they are part of the full title of the ABI SORP.

2.5.1 G

The third cross reference should be to PRCA1.8.1 R, not to 1.7.1 R.

2.5.2 R(2)

The cross reference should be to 2.5.8 R.

2.5.5 G

The word ‘claim’ should read ‘premium’.

2.5.9 G

The cross references are incorrect.

2.6.5 G

The second ‘dealt with‘ should be deleted. However, it would be sensible to state ‘there is no explicit risk margin for other insured risks (longevity, marriage, birth etc)’ These are not covered by the expense margin. Longevity should be provided for by using suitably prudent mortality assumptions; marriage and birth are immaterial for UK insurers.

2.5.14 “Gross adjusted claims”

In 2.5.14 R(2) we believe the reference to Section 2.5.24 R should read 2.5.26 R.

2.6.8 R

We believe that in the fifth line of sub paragraph (1) the reference to “more than five years” should be to “less than five years”. We believe that if this is not the case then we need to give considerably greater attention to the proposed change. There should also be an additional provision that, if the conditions for (1) apply, the calculation under (3) is, nevertheless, used if lower. Otherwise, the less onerous contract could attract the higher solvency margin requirement.

PRIR 3

The second cross reference in 3.3.8R should be to PRMR 11.3.1(3) and not to PRIR 11.3.2.

The reference in the first line of PRIR 3.3.18 R should be to 3.3.17(3) R.

The cross reference in 3.3.20 R is incorrect. The section intended runs from 11.4.9 R to 11.4.18 G

The cross reference in PRIR 3.3.23 R should be to 3.3.22 R

Rule 3.3.31(2)(b) clearly transfers from the Insurance Companies (Accounts and Statements) Regulations 1996, Schedule 4 Paragraph 10(4). However there is no reference to the requirement in Schedule 4, Paragraph 10(3) about margins to cover the current year’s new business costs and to remain open to new business thereafter. Although the guidance in 3.3.36 suggests that the omission is deliberate, this is not clear and confirmation would be appreciated.

The word ‘firm’ should read ‘firm’s‘ in rule PRIR 3.3.31(2)(c) R. In the following paragraph, the opening word ‘ An’ should read ‘A‘.

The word ‘ need ‘ in the sixth line of rule PRIR 3.3.32 G should read ‘ needed ‘,

Is it intended by rule PRIR 3.3.33 G that the implicit provision for expenses where no value is attributed to future premiums but the firm is entitled to make deductions from future premiums is to be restricted to contractual future premiums, or could a prudent level of future recurrent single premiums be assumed? The guidance on this subject should clarify what is permitted.

The word ‘a‘ should be deleted from the second line of rule PRIR3.3.42(3)(a) G.

We question whether it is necessary to provide further guidance on AIDS, in rules 3.3.43 G to 3.3.45 G.

Rule 3.3.47 G should state “an option exists where a policyholder may choose alternative forms of benefit…”. We note, incidentally, that the terms ‘options’ and

‘underwriting’ are defined in their fund management context when italicised in other chapters. Should these terms also have specific meanings for the insurance risk Module?

The second sentence of rule 3.3.50 G suggests that the provision for a contract with an option should include the time value of the optionality, ie it would exceed the greater of the values calculated assuming that the option is exercised either way. Is this break with the tradition of a ‘deterministic‘ approach to valuation deliberate? The word option in this rule is erroneously italicised four times.

At first sight, the guidance provided in rule PRIR 3.3.55 G appears significantly stronger than the rule to which it relates. If the third sentence were to begin ‘ In effect, PRIR3.3.51 R – 3.3.54 R ‘ the matter would be clarified. In the second sentence, the word ‘firm’ should read ‘firm’s‘.

The opening reference in rule 3.3.58 G should be to traditional with-profits contracts.

There is a rule numbered PRIR 3.3.59 which appears in the margin halfway down 3.3.58. It does not exist as a rule and should be deleted, with consequential renumbering for the remainder of PRIR 3.3.

The comma after ‘requires‘ in the fifth line of rule PRIR 3.3.60 should be deleted.

The cross-reference in rule 3.3.62 should be to PRCR 1 and PRCR 10.

The cross reference in rule 3.3.64 R should be to PRIR 3.3.63(2) R not G. The word ‘or ‘ in the second line should read ‘ nor’.

The second cross-reference in rule 3.3.65 G should be to 3.3.64 R not G.

PRIR 5

We note that there are five defined terms within this rule which include the words “with profits”, although with-profits itself is not defined. Phrases which include those words in this section, some of which is italicised and some of which are not, do not necessarily match the definitions. A considerable clean-up of this text and rationalisation of the defined terms is required.

Rule 5.5.5 disapplies rule 5.5.3 so it would be clearer if it were to form part of 5.5.3.

The first sentence of 5.5.7 G is slightly inconsistent with the definition of ‘established long-term insurance surplus’ where, by implication, ‘in-date‘ means ‘within three months of the valuation date‘ and not ‘until an abstract of the investigation is deposited with the FSA‘.

Rule 5.6.3, amplified by 5.6.5 G(1) also appears to require the documentation of the existence or likelihood of new business expense overruns.

Although the phrase “with-profits insurance policyholders” in 2A is italicised, it is not actually a defined term.

The opening words of 5.6.1(2) should read ‘ the use of those assets ‘. The word ‘ or’ at the end of (a) should read ‘nor‘.

We suggest that 5.6.3(b) should cross refer to PRIN 6 which is the source of the “duty to treat customers fairly”.

Consideration should be given to inserting the word ‘fund‘ after ‘with–profits‘ in the first line of 5.6.5 (1)(d) G. A word or words appears to be missing from the beginning of 5.6.5(2)(b) G.

The numbering of 5.6.6 is incorrect. There are two sections numbered (2). Within the first of these, (c) and (d) are missing which will require consequential changes in the present (3) and (4).

The sub paragraphing in 5.6.9 begins at (3).

5.6.10 E should include a qualification “subject to 5.6.14 E” which allows a Court to waive this provision.

A similar provision should be included in rule 5.6.12 E. We refer to our earlier comments on establishing when surplus first arose, it is not possible to establish when surplus first arose as demanded by 5.6.12(2)(a).

The cross reference in 5.6.11 G,line 6 should be to 5.6.10 E

Rule 5.6.12 E(3)(a) implies that Rule 5.6.10(4) R defines “allocated”; the reference should be to 5.6.10(4) E. The word ‘up‘ in the fourth line of 5.6.12(4) should read ‘on‘.

The cross reference in the second line 5.6.16 G should be to 5.6.14 E.

The second reference to ‘insurance undertaking in rule 5.9.1 R should be deleted.

PRGR 1

Should PRGR 1.1.1 G be a rule rather than guidance? PRGR 1.4.1 G includes a defined term’ participation’. But the definition of that word in the Glossary of Definitions does not include an application of the definition to PRGR.

PRGR 1.4.3states that PRGR 2 applies to every member of a firm’s group. This appears excessive; should not the scope be limited to the information about those companies which is available and necessary in order for the regulated firm to fulfil its obligations under PRGR 2.2.2(2)?

PRGR 5

There is no definition of ‘on and off balance sheet business’ in PRGR 5.3.2(3)(c).

It appears incongruous to define ‘main‘ through the guidance in PRGR 5.3.3 G rather than in rule PRGR 5.3.2 R.

APPENDIX 2

DEFINITIONS

DETAILED COMMENTS -- DEFINITIONS

1 Accumulating with-profits insurance contracts

There is no definition of this category of policy, but there should be, because it is a cross reference in the definition of ‘traditional with- profits insurance contracts‘.

2 Advising on investments (except pension transfers and pension opt-outs )

Is a definition necessary? Defining the phrase by removing the brackets and inserting‘ in respect of‘ seems unnecessary. On the other hand ‘pension transfers’ pension 0pt – outs‘ are italicised, so ought to be (but are not) defined.

3 Advising on pension transfers and pension opt-outs

See above comments.

4 Customer

The definition ‘a client who is not a market counterparty‘ begs the questions ‘what is a client?’ and ‘what is a market counterparty?’ The answer may be that an ordinary word like ‘ customer ‘ should not have to be defined.

5 Deposit back arrangement

The definition should read ‘Deposited by the reinsurer with the cedant’.

6 Implicit item

Is it also necessary to define the terms ‘future profits’, zillmerising’ and ‘hidden reserves‘ used as part of this definition?

7 Index linked benefits

Is the definition adequate? Current regulations refer separately to indices of the value of property and to retail price indices in Zone A states. The latter has been omitted. Should the definition be expanded to include earnings indices, to cover the possibility of new types of contract under which the benefit is linked to an earnings index?

8 Long term gilt yield

This term should be defined but is not.

9 Long-term insurance capital requirement

The acronyms IDRCC etc should be included as such in the definitions and not only in their expanded form ‘insurance death risk ….’ Etc.

10 Long –term insurance business

This is incorrectly defined as ‘the business of effecting general insurance contracts’.

11 Option

This term is defined in a derivatives context, but is defined again in PRIR 3.3.47G in its long-term insurance sense.

12 Policy, Policyholder

The definitions for these terms should follow the wording used in the relevant Statutory Instrument (SI 2001 No 2361).

13 Premium (General Insurance Business)

Having regard to the complex nature of some of the intermediary relationships which arise in the conduct of general insurance business, the words ‘by the policyholder’ in paragraph (i) should be omitted.

14 Property linked

The cross reference is incorrect. PRIR 8.6.2R does not exist.

15 Property linked benefit

The definition is incomplete, but probably requires only the addition of the word ‘description‘.

16 Real estate

This term is not defined but we believe it would add clarity to PRMR if it were.

17 Secured Policyholder loan

The words ‘surrender value‘ in this definition should be italicised.

18 Surrender value

The definition includes the word ‘surrender’ which seems circular; similar comments may be made in respect of the definitions of ‘ money’ and ‘ commission‘.

19 Terminal bonus

We consider that this definition requires careful consideration by the actuarial profession so that it captures all the elements of a terminal bonus.

20 Traded endowment policy

The definition covers TEPs bought by a firm. Is there a need for a definition of a TEP purchased by an individual?

21 Traditional with–profits insurance contracts

The definition of a traditional contract being one which is not an accumulating with–profits contract seems to be potentially useful but there is no parallel definition of accumulating with-profits contracts (AWP) (see earlier comment). PRIR 3 appears to deliberately avoid the use of the expression. PRIR 3.3.32 R defines AWP without using the term; PRIR 3.3.23 says ‘ where PRIR 3.3.21 R (which should be 3.3.22 R!) does not apply to a with profits contract…‘ when it could more elegantly say ‘ for traditional with–profits contracts…’

22 Underwriting

As with ‘Option‘ (see earlier), this word is defined in the context of a new issue but is also used, unitalicised, in its insurance sense. Does this create any problem for the drafters?

23 With–profits fund

The definition has been left blank which is unfortunate, since the completion of separate Forms 13 and 14 for with – profits business as required by IPRU (INS) remains a grey area; in particular in relation to the identification of how many with – profits sub – funds there are.

24 Working day zero

This definition appears out of alphabetical order.

25 In PRAG 5 Annex 1R Moreover, PRMR 12.3.5 G specifically includes quasi derivatives as admissible assets.

Approved counterparty

26 It would be sensible to extend the definition of ‘Approved counterparty’, to include insurers regulated under the Insurance Directives and other insurers whose home state regulator is considered by the FSA as providing an equivalent level of supervision.

New cash

27 A modified definition of ‘near cash’ is needed to ensure that Rule PRMR 12.3.15G works as ABI believes that FSA intends it to work.

Approved financial institution and approved security

28 The definitions of ‘approved financial institution‘ and ‘approved security‘ are unsatisfactory.

Principle

29 Principle is defined as one of the principles in PRIN2.1.1 R. Adding "of the FSA Handbook" to the definition would aid clarity.

30 A definition of resilience reserve (cross referring to PRMR11.3.8) would aid clarity.

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RESPONSE TO FINANCIAL SERVICES AUTHORITY€¦ · Web view3.1 ABI considers that Annex B does not accurately estimate the potential cost to the industry which will be incurred to