This chapter considers the new regulatory regime for the insurance sector in the UK, which is expected to come into force in 2013. It provides an overview of: the old regime, including its characteristics and alleged failures; an overview of the reform proposals, including the splitting of the functions of the FSA between the FCA and the PRA; the regulatory objectives of the reform, including the supervisory approach of the PRA and the interventionist approach of the FCA; detailed aspects of the reforms; the new emphasis on the wholesale markets; and the crucial importance of behavioural and cultural change for the reforms to have their effect.
This article is part of the PLC multi-jurisdictional guide to insurance and reinsurance. For a full list of contents visit www.practicallaw.com/insurance-mjg.
The new regulatory regime for the insurance sector is expected to come into force in early 2013. It replaces the current regime for the regulation of insurance in the UK, which was created on 30 November 2001 when the Financial Services and Markets Act 2000 (FSMA) came into force. The government has proposed radical changes to regulation, and legislation has now been published that fundamentally transforms and strengthens financial regulation in the UK. On 27 January 2012 HM Treasury published the Financial Services Bill and policy document: A new approach to financial regulation: securing stability, protecting consumers. This is the latest stage in the development of the new proposed UK regulatory architecture.
The government's policy document and draft Bill follow three detailed consultations published over a two year period:
A new approach to financial regulation: judgement, focus and stability (July 2010 consultation paper).
A new approach to financial regulation: building a strong system (February 2011 consultation paper).
A new approach to financial regulation: the blueprint for reform (June 2011 consultation paper).
The last consultation document included draft legislation which was subject to pre-legislative scrutiny between July and December 2011 and gave further opportunity for interested persons and Parliamentarians to engage with and improve the Bill prior to its formal introduction to Parliament. The government is firmly committed to securing passage of the Bill by the end of 2012, so that the changes can be implemented early in 2013. The timing of the reforms, however, is uncertain. This article discusses how the government's proposed new regulatory regime will affect the insurance sector. It provides an overview of:
The old regime, including its characteristics and alleged failures.
An overview of the reform proposals.
The regulatory objectives of the reform, including the approaches of the new regulators.
Detailed aspects of the reforms.
The new emphasis on the wholesale markets.
The new reforms: the crucial importance of behavioural and cultural change.
FSMA granted to the Financial Services Authority (FSA) the power to act, among other things, as prudential supervisor for all firms authorised to effect and carry out contracts of (re)insurance. The responsibilities which it took over at this time also included the supervision of the conduct of investment business, which in turn includes long term insurance products with an investment element, such as unit-linked and with-profits policies.
The FSA started to supervise sales of non-investment insurance business in January 2005 when the UK transposed into UK law Directive 2002/92/EC on insurance mediation (Insurance Mediation Directive). Non-investment insurance includes:
All general insurance (such as motor insurance).
Long term products, such as mortgage protection and payment protection insurance (PPI), which do not generate a surrender value.
Unlike many of its continental counterparts, the FSA is an insurance regulator as well as a supervisor, since it has extensive rule-making powers. These usually allow it to change the regulatory rules in accordance with a statutory procedure, without having to resort to the powers of Parliament.
Apart from insurance the FSA also supervises and regulates other financial sectors, such as banking and investment.
One of the purposes of FSMA was to create an integrated supervisor. The lack of such a supervisor had been identified as a factor in the problems experienced by the Equitable Life Assurance Society, where the effect of conduct issues in prudential matters was arguably not fully understood. The Equitable closed to business in 2000 and substantially reduced the benefits to many of its with-profits policyholders (with-profits business in a fund in which premiums paid by policyholders are pooled and investment returns on the fund are shared among the policyholders). This followed an adverse decision against it in the courts (Equitable Life Assurance Society v Hyman [2000] UKHL 39).
The FSA has been criticised for serious failings in relation to the regulation of the banking sector. These problems led to significant injections of capital into the sector from public funds to prevent a collapse of some of the largest banks.
The new government took the view that a major reason for the FSA's failure was that it was exercising prudential as well as conduct of business functions. It had adopted a "tick the box" approach to prudential supervision and had failed to ensure that adequate resources were allocated to that function.
The government therefore proposed a radical reform of the regulatory regime. A key feature of the reforms is the splitting of the functions of the FSA between two proposed new supervisors:
The Financial Conduct Authority (FCA).
The Prudential Regulation Authority (PRA).
Although the legislation creating those new supervisors is not expected to be passed before the end of 2012, the FSA will begin operating a dual or "twin peaks" supervisory model from 2 April 2012.
The PRA will prudentially supervise banks, (re)insurers and larger, more complex investment firms in a way that goes beyond monitoring of compliance with requirements. It will also supervise the groups of which these entities are members. The PRA will take a judgement-led approach to supervision through engagement, scrutiny of business models, and forward-looking assessments of risk. It will move to new premises and will be a subsidiary of the Bank of England.
The FCA will remain at Canary Wharf. Its responsibilities will include the regulation of retail and wholesale conduct of business, covering the insurance sector among others, as well as prudential regulation of firms not regulated by the PRA, including insurance intermediaries.
In his speech of 6 February 2012, Hector Sants, Chief executive of the FSA set out the key characteristics of the new model, which include:
Supervisors making their own, separate, set of regulatory judgements against different objectives.
Independent but co-ordinated regulation designed to allow internal co-ordination between both conduct and prudential supervisors to maximise the exchange of information relevant to their individual objectives, but with supervisors still acting separately when engaging with firms.
Retaining the principle of seeking to ensure that regulatory data is only collected once.
Each supervisor will be responsible, among other things, for authorising the firms which it prudentially supervises. So far as permissions for specific regulated activities are concerned, the position will be more complex. So, for instance, only PRA supervised (re)insurers will have permissions to effect and carry out contracts of insurance. These permissions will be granted by the PRA. Insurers selling their own products, however, will also require other permissions, for example, for insurance mediation activities, for which the FCA is the "appropriate regulator". The process of granting such permissions will therefore require co-operation between both supervisors.
A new Financial Policy Committee within the Bank of England will be the "macro-prudential" regulator, monitoring the financial stability of the whole system.
Splitting the FSA's functions will require large-scale changes to FSMA, including changes defining, among other things, the functions of the new bodies and the way they are to communicate, consult and co-operate with each other in the course of supervision and enforcement. The PRA can veto the FCA's exercise of its powers where financial stability issues arise. A memorandum of agreement will be entered into between both supervisors covering communication and co-operation issues.
The general approach under the new regime can be illustrated by the example of the Lloyd's market (see box, Lloyd's under the new regime). However, the new regime recognises that the regulation of with-profits business (that is, an insurance contract that participates in the profits of a life insurance business) does not easily split between prudential roles and conduct of business (see box, Regulation of with-profits business).
Historically, the FSA's regulatory objectives have had a significant influence on how it establishes its operational priorities and exercises its functions:
FCA. Under the reforms, the FCA must, so far as is reasonably possible, act in a way that is compatible with its strategic objective of ensuring that the relevant markets function well. It must also act in a way that advances one or more of its operational objectives. These objectives are:
securing an appropriate degree of protection for consumers;
protecting and enhancing the integrity of the UK financial system;
promoting effective competition in the interests of consumers in the markets for regulated financial services.
The FCA will have also have regard to the responsibilities of senior management in relation to a firm's compliance with requirements under the legislation, including requirements that affect consumers.
PRA. The PRA's general objective is to promote the safety and soundness of PRA-authorised persons, by avoiding adverse effects on financial stability and minimising adverse effects from the failure of such persons. This re-asserts the "non-zero failure" principle (that is, that it is impossible to eliminate risk entirely) illustrated by the insolvency of, among others, the Independent Insurance Company in 2001 and Lehman Brothers in 2008.
For (re)insurers, the PRA's "insurance objective" is given equal status to its general objective, defined as "contributing to securing of an appropriate degree of protection for those who are or may become policyholders". Under FSMA, a "policyholder" includes a beneficiary to whom a policy has been assigned or for whose benefit a policy has been taken out. It does not, however, include third party claimants, such as victims of road traffic accidents.
The insurance objective is partly inspired by Article 27 of Solvency II. That article provides that protecting policyholders and beneficiaries is the main objective of supervision. Financial stability is secondary. This may influence the PRA where there are conflicts between the objectives. The Directive 2009/138/EC on the taking-up and pursuit of the business of Insurance and Reinsurance (Solvency II) regime is due to create a new harmonised European regime for the prudential supervision of insurers, reinsurers and insurance groups from the beginning of 2014. The details of the regime are still under negotiation within the EU (see box, Solvency II and timing).
Some old objectives of supervision will disappear under the new regime:
The original objective of "promoting public understanding of the financial system" has disappeared.
Reducing financial crime is demoted to a matter that the FCA is to "have regard". It will be interesting to see what the FCA's approach to financial crime will be going forward. In the past, the FSA has focused a lot of its efforts in this area and much of it has been directed at the insurance sector, for example:
the FSA's Dear CEO letter in 2007 and subsequent thematic review in May 2010 and enforcement actions against insurance intermediaries in relation to anti-bribery systems and controls in 2009 (Aon) and 2011 (Willis);
the thematic review of systems and controls in relation to compliance with financial sanctions in 2009 which resulted in criticism of the insurance sector's approach in this area.
The original requirement to have regard to "the international character of financial markets and the desirability of maintaining the competitive position of the UK" has disappeared, despite some support for its retention within the Treasury's consultation in 2011.
On the other hand, the FCA's obligation to promote competition has been firmed up both within the Bill and in the proposals that articulate what will be the FCA's policy.
This section will now consider:
The supervisory approach of the PRA.
The new interventionist approach of the FCA.
PPI and the FCA's proactive approach.
The FCA's new competition role.
A paper published jointly by the FSA and the Bank of England in June 2011 (The Bank of England, Prudential Regulation Authority - Our approach to insurance supervision), indicates that the PRA will apply effective, and where necessary, intensive supervision, focusing the most intensive supervision on the riskiest firms. The approach to supervision will be judgement-led and forward looking.
Firms will be expected to approach compliance, taking into account the spirit as well as the letter of the rules. The aim, explained Hector Sants, chief executive of the FSA, is to "reduce the prospect for regulatory arbitrage, or so-called creative compliance, and allow us to challenge transactions based on their substance". In theory, this is already the position because the existing rules say "every provision in the Handbook must be interpreted in the light of its purpose".
However, with some of the existing rules, the literal meaning, as well as the spirit, is not easy to determine. This may change when Solvency II comes into force and replaces most of the existing prudential rules (see box, Solvency II and timing). The intention is, in any event, that PRA rules will be set out with a clear statement of the purpose of the rule. An illustration of the new approach may be found in the first draft of the FSA's proposed Prudential sourcebook for Solvency II Insurers (SOLPRU), published in November 2011.
The Treasury's February 2011 consultation paper promised that the FCA would take a "fundamentally different approach to the FSA in the way that it intervenes to mitigate risk". The key elements of this new approach were elaborated on in the FSA's June 2011 consultation paper. At the heart of the government's proposals is the idea that the FCA will take a forward-looking and preventative approach to regulation. This will encompass what the Treasury has referred to in its paper as an "issues-based" approach to supervision.
In the Financial Services Bill, the Government has provided the FCA, with both a clear mandate (supported by appropriate mechanisms for accountability) and the appropriate tools to:
Promote effective competition as a key means of delivering better outcomes for consumers.
Intervene earlier in tackling emerging risks and minimising consumer detriment (but, importantly, not to pursue a zero-failure regime).
Look at product design and governance as well as information disclosure and sales processes.
Have a presumption in favour of transparency and disclosure as a regulatory tool.
Back up its regulation with a credible deterrence strategy.
The FCA will identify, at an early stage, issues within sectors or groups of firms that may affect consumers and will then ensure that appropriate supervisory action is taken. The identification of these issues will be achieved through the use of market and consumer intelligence as well as engagement with external stakeholders. Once identified, the FCA will then take a proactive, interventionist approach to dealing with these issues before they have had the opportunity to cause significant detriment to consumers. Essentially, the Treasury and the FCA are talking about a change in regulatory behaviour and culture. Going forward, the insurance sector will have to deal with a regulator that is more intrusive and that asks more questions. Because the FCA will be bolder and will make earlier interventions, the insurance sector will also have more engagement with the FCA. Martin Wheatley, CEO designate of the FCA has also promised that there will be more challenges and earlier decisions.
One of the major driving factors behind the development of the FCA's more proactive approach is the FSA's recent experience with PPI. In its June 2011 consultation paper, the FSA noted that overall "its response to the mis-selling of PPI should have been stronger". The paper states that the FCA will need to spot issues earlier and intervene early to improve standards at specific firms or in a wider context.
Nevertheless, the PPI issue has not just been a driver for the move towards a more proactive approach. It has also led to the insurance sector being used as an early testing ground for some of the powers needed to adopt such an approach (see below, Detailed aspects of the reforms: Enhanced powers of the FCA). The FCA will, no doubt, build on some of the practices and techniques that were developed by the FSA during its handling of the PPI issue when attempting to prevent future problems. For example, the FSA's use of mystery shopping exercises to identify practices that it considered were causing consumer detriment is likely to be more widely used by the FCA in future.
The FCA will have specific duties and objectives relating to competition. This is one of the most significant changes in the new regulatory regime. One of the FCA's operational objectives states that it will "promote effective competition in the interests of consumers". This operational objective will be complemented by a list of factors that the FCA may consider in determining effective competition. A separate competition duty is also retained in the Bill with the aim of facilitating competition-led intervention in markets by the FCA. This is intended to make the FCA's competition mandate stronger and much more explicit. The revised objectives will provide a mandate for the FCA to take the initiative to use its powers to tackle competition problems, for example by:
Promoting switching.
Removing barriers to entry.
Addressing asymmetries of information.
Clearly, competition is at the heart of the new regulatory regime (see Financial regulation reform: the role of competition). One consequence of this is that the FSA, in its June 2011 consultation paper, considered that it may be necessary to give the FCA price-intervention powers. In its January 2012 policy document the Government confirmed that while the FCA will not be a price regulator, it will look at comparative prices, among other things, as possible indicators of where competition is flawed and consumer detriment may arise as a result. This will involve the FCA making judgements about the value for money of products.
One example of the type of intervention the FCA might consider would be to intervene to prevent misleading price structures, where a low headline price (to attract new customers) is offset by high ancillary charges, for example by charging very high prices for changes to personal details or to cancel aspects of a product. The insurance sector needs to be careful of intervention in this area as it has already faced criticism from the FSA over the value for money of some of its existing products. For example, in October 2009 the FSA entered into an agreement with mortgage payment protection insurance providers in which they agreed an industry-wide package of measures for consumers, including refunds of premium as a result of increases in premiums and reductions in cover in 2009.
This section considers detailed aspects of the new reforms:
Whether recovery and resolution plans will be introduced.
The rules relating to supervision of foreign insurers and reinsurers.
Regulatory powers over unregulated holding companies.
The enhanced role of the Financial Ombudsman Service (FOS).
The enhanced powers of the FCA.
Recovery and resolution plans (or living wills) were introduced in the banking sector, to ensure that financial institutions had effective recovery plans in place in the event of a crisis. It is uncertain whether similar plans will be introduced in the insurance sector.
The paper published jointly by the FSA and the Bank of England in June 2011 said that "The PRA will consider whether and how recovery and resolution plans might be introduced for insurers" (The Bank of England, Prudential Regulation Authority - Our approach to insurance supervision). This indicates that a decision whether to extend recovery and resolution plans to the insurance sector may not yet have been taken. On the one hand, no significantly sized life insurance firm has required compensation from the FSCS. On the other, Equitable might have benefited from a "living will" in the 1990s, which might have had the effect of:
Reducing the bonuses which it subsequently declared.
Increasing its technical provisions.
Any such arrangements must be devised in line with the Solvency II regime. This provides for a "ladder of intervention" where firms are in breach of capital requirements (for example, firms can normally continue to take on new business for at least six months). However, the following might be imposed as part of the supervisory review process under Article 36 of Solvency II:
A living will.
A premium income limit.
A requirement to close specific product lines.
A general requirement to go into run-off.
UK branches of non European Economic Area (EEA) insurance companies will be subject to prudential regulation by the PRA, and conduct of business regulation by the FCA, although they may be required to ring-fence capital within the EEA.
Currently, an insurer or insurance intermediary whose head office is located elsewhere in the EEA, and which is authorised to conduct insurance business or insurance mediation activities by its home state regulator, is entitled to establish a branch in, or provide cross border insurance services into, the UK (passporting). These arrangements will continue; the PRA will be responsible for passporting by (re)insurers and the FCA by intermediaries.
Under European law, the PRA will have limited jurisdiction over UK branches of EEA insurers. It can report concerns to the home state supervisor. Under Solvency II it will also participate in supervising the group of which the passporting insurer is a member through the college of supervisors when the branch is "significant", that is, where the gross written premium income of the branch exceeds either:
5% of that of the group.
5% of premiums for all relevant business of the insurer in the UK.
The Bill proposes that the PRA and the FCA be granted a power to impose requirements on unregulated parent undertakings of certain UK-authorised persons, including (re)insurers. This additional power is not required for regulated parent companies, since the FSA already has the power to impose requirements on those companies. The paper gives an example of where the power might be exercised: during a crisis situation, the different priorities and responsibilities of the board of a parent undertaking relative to the regulated company boards can be exposed. If the unregulated holding company disagrees with the regulatory assessment of the actions that need to be taken, the FSA does not have legal powers to require action at the level of the parent undertaking. This could mean dismissal of a number of potential recovery options. For example, it may be appropriate for the parent undertaking to provide additional capital or liquidity to improve the position of the regulated entity.
This seems to be a further example of the corporate veil being pierced. The holding company of an insurance group, for instance, might be required to support its members when under no other legal responsibility to do so and when it might otherwise be willing to allow the member concerned to fail.
The FOS will also play a much greater role in the new regulatory regime. The FCA will engage with the FOS to help it identify issues at an early stage. The Treasury's February 2011 consultation paper proposed that a formal mechanism be put in place by which the FOS "will be able to support the FCA in its preventative and issues-based approach to regulation". This formal mechanism will include a requirement for the FOS to pass to the FCA any information which could be important in "helping to promote better consumer outcomes". There will also be a requirement for the FCA to have regard to information it receives from the FOS when fulfilling its objectives. Finally, there will be a statutory obligation for the FOS and the FCA to publish a memorandum of understanding, building on the voluntary memorandum of understanding that is already in place between the FOS and the FSA. This will set out how the FOS and FCA will work together, especially on issues where individual FOS cases have wider implications. In the past the FOS has sometimes been critical of insurance firms' handling of customer complaints and firms should think now about whether they need to do more to improve this area of their business.
Consumer redress. The FCA will build on the approach taken under the previous regulatory regime in relation to consumer redress. In October 2010, the FSA was granted rule-making powers to require firms to establish and operate compensation schemes for consumers who suffer loss as a result of firms' widespread and regular failure to comply with their regulatory obligations. These powers existed prior to this date but with the important distinction that the FSA was required to apply to HM Treasury for authorisation before exercising them. The FSA has already used its new powers on an industry-wide basis in relation to PPI (see above, Regulatory objectives of the reform: PPI and the FCA's proactive approach), but it has also used this power against single firms on several occasions in 2011. The FSA's June 2011 consultation paper made clear that the FCA will continue to use these powers, stating that it will "be willing to establish such schemes" and that they should "prove to be a valuable tool which the FCA can use to secure good outcomes for a large number of consumers" (Financial Conduct Authority Approach to Regulation, FSA, June 2011). We are likely to see an increased use of these powers by the FCA as a result of its proactive approach. The FCA's more intrusive interactions with external stakeholders is likely to highlight areas where there is a need for large-scale and prompt consumer redress and the insurance sector needs to anticipate this, and where possible take steps to mitigate this risk now.
However, as well as making greater use of powers already available to the FSA, the FCA will also be granted a number of new powers to pursue its proactive approach that are likely to have a significant impact on the insurance sector (see below).
Product intervention. The Financial Services Bill will give the FCA power to ban or impose requirements on products. The FCA's rules in relation to product intervention can remain in force for a period of 12 months without the FCA having consulted on them. However, beyond this the FCA will need to consult in the usual way.
These proposed new powers (which were first discussed in an FSA consultation document in January 2011) have caused much concern in the insurance sector as they allow the FCA to make decisions instantly and without consultation that could have a very significant effect on firms' business. These concerns were addressed by the House of Commons Treasury Committee in its January 2012 report in which it supported the introduction of product intervention powers but stated that their use "should be sparing and the merits of each case very carefully considered before intervention". The government has now confirmed in its 2012 policy document that it does not expect the FCA to use this routinely in its work and Martin Wheatley, FCA chief executive officer (CEO) designate in a speech on 25 January 2011 confirmed that product banning would be "a last resort".
However, the insurance sector has already been used as a testing ground for product banning powers, although this will be the first time that they will have now been put on a statutory footing, For example, while handling the PPI mis-selling issue the FSA, in a "Dear CEO" letter in February 2009, requested that firms should stop selling single premium PPI with unsecured personal loans before 29 May 2009. This followed work conducted by the Competition Commission and was in effect a product ban although, in the case of PPI, it was not imposed until, according to the FSA, significant detriment had occurred to retail consumers. In December 2011 the FSA published guidance on traded life policy investments (or death bonds) which recommends that "these products should not reach ordinary investors in the UK". This announcement effectively imposes a ban on firms selling such products to retail investors as to do so would be a clear breach of FSA guidance.
The FCA will provide further clarification on the making of temporary product intervention rules in a policy statement. However, going forward, the insurance sector can expect to see these powers used to:
Ban the sale of a particular type of product to all customers, or to certain categories of customer.
Require the inclusion or exclusion of specific product features.
Allow sales only in certain specified situations, for example, only selling the product if:
it includes or excludes specified features;
sales are limited to particular categories of customer, or through particular distribution channels.
Powers in relation to misleading financial promotions. The FCA will also be given the power in the Financial Services Bill to require a firm to withdraw or amend a misleading financial promotion with immediate effect, and to publish the fact that it has done so. Unlike the product banning powers (see above), the practice of publishing notices to withdraw misleading financial promotions is novel. Some members of the insurance sector have expressed concerns that the FCA's use of this power could result in firms suffering reputational damage. The government believes, however, that giving greater visibility to the regulator's actions will increase consumer confidence in the FCA and will improve practice across the market by making firms' misconduct more visible. Clearly a balance will need to be struck between these competing interests and safeguards will need to be imposed to ensure that the FCA exercises these powers in an open and transparent way.
Early publication of enforcement action. FSMA had initially prevented the FSA from publishing any notices relating to enforcement action. This position changed following the implementation of the Financial Services Act 2010, which permits the FSA to publish decision notices. However, the Financial Services Bill takes this even further and permits the FCA to publish the fact that a warning notice has been issued against a firm together with a summary of that notice. The FCA will be required to consider the impact of the disclosure on the person subject to the warning notice and must also publish the fact that it has issued a "notice of discontinuance" if it later does so. These changes are a further attempt to increase the visibility of the regulator's actions. The government believes that this will have the effect of highlighting potential issues to consumers at an early stage and will signal to firms what behaviour the regulator does and does not consider to be acceptable.
However, as with the power to publish misleading financial promotion notices, the concern for insurers and others operating in the insurance sector is the potential for reputational damage to a firm if warning notices are published. Warning notices are often issued against members of the insurance sector, sometimes with factual inaccuracies. Many warning notices are also subsequently dropped as the FSA decides there is in fact no enforcement case to pursue against the firm. The publication of warning notices is a real and significant concern for the insurance sector. The reputational damage (including loss of profits and impact on shareholder value) that firms can suffer can be significant. The publication of a notice of discontinuance at a later stage will do little to repair the reputational damage caused to a firm.
In recent months the FCA's focus has also shifted to wholesale markets. In particular, the June 2011 FSA paper makes clear that the FCA will "put greater emphasis on wholesale conduct and the risks attached to activities in the wholesale markets" and that this will apply to wholesale insurance markets (Financial Conduct Authority Approach to Regulation, FSA, June 2011).
The reason for this new focus on wholesale markets is that conduct here can have consequences that go beyond the confines of the market itself. There is recognition that although retail consumers do not participate in the wholesale markets, these markets can have an impact on the products that are available to them. This leads the FSA to conclude that "intervention at the top of the value chain, targeted at product governance, must be considered to the extent that wholesale products filter down or are distributed to retail consumers". In relation to this, the FCA:
Expects wholesale firms to be more open about their regulated activities and will harness the power of transparency to achieve greater market discipline.
Will be prepared to intervene where it sees potential damage to market integrity or where market structures result in market participants being disadvantaged.
This approach was recently confirmed in a speech on 25 January 2012 by Clive Adamson (Director of Supervision, Conduct Business Unit, FSA). There will be an evolution of the FSA's approach to wholesale conduct but the FCA will do more and it will focus on the integrity and resilience of the wholesale markets. In particular, it is likely to go beyond the "caveat emptor" principle where there is potential damage to market integrity and intervene itself.
The FCA's proposed focus on transparency in the wholesale markets could directly affect the insurance sector in light of the work that has already been conducted by the FSA on the transparency of the commercial insurance market.
The FSA initially became interested in this area in 2007 when it published a report looking into whether disclosure of brokers' commission was justified. The report concluded against this on the grounds that it would be too costly but highlighted concerns about a lack of transparency in the commercial insurance market. In response to this the FSA published a discussion paper in March 2008 and then a feedback statement in December 2008. In its feedback statement the FSA listed a number of outcomes it wanted to see achieved for commercial customers in the insurance industry. Broadly speaking, these included the fact that they should:
Have clear and comparable information about the commissions that intermediaries receive and the services that they provide.
Have clear information about the capacity in which an intermediary is acting.
Be made aware where there is a chain of intermediaries.
Be aware of their right to request commission information.
As a result of this consultation paper, the British Insurance Brokers' Association published guidance in 2009 on these issues which was given "Industry Guidance" status by the FSA. However, the FSA re-visited this area in 2011, producing a report on its research in this area in October 2011. The report concluded that, although there had been progress in some areas, commercial consumers were still not being informed of their right to request commission information and were still not being informed where there were chains of intermediaries. The FSA has not proposed making changes to the rules in the Insurance: Conduct of Business sourcebook (ICOBS), but has reminded insurance intermediaries that they are required to provide clear and comparable information to commercial customers.
If insurance intermediaries do not change their business practices in this area there is a danger that the FCA might intervene to require transparency of commission disclosure arrangements on the grounds of promoting market integrity and maintaining level playing fields. This could be one of the FCA's early forays into the regulation of wholesale markets.
The new regulatory regime in the UK will inevitably result in a number of significant changes for the insurance sector. The move to a twin peaks regulatory approach will require careful handling by firms and will undoubtedly result in increased compliance costs. From the regulators' perspective, twin peaks regulation will require behavioural and cultural change: a move from the old style reactive approach to a new forward-looking, proactive approach.
From the firms' perspective, there will also be a need for behavioural and cultural change. Firms will be expected to recognise the importance of aligning their goals with those of the regulators and society as a whole. Senior management responsibility will be at the heart of compliance with the new regime, particularly in relation to requirements that affect consumers. But for the insurance sector, the FCA's new interventionist approach will not come as a complete shock. In many instances it has already had to grapple with earlier versions of the FCA's new powers and has already been used as an early testing ground for the new regulatory world.
"Our philosophy is one of trying to work smarter, we think it is consistent with the approach we are setting out today, that we want to be a more analytical, thinking Regulator, we want there to be less box checking and routine activity."
Many, including the current government, clearly believe that the FSA failed to follow Sir Howard's philosophy. Whether the two new regulators will achieve a change in regulatory approach remains to be seen, and will depend on the capacity of regulators and insurers to achieve behavioural and cultural change.
The intention is that the new regulatory regime should come into force in early 2013. This is about the same time when it was intended that the Solvency II regime should come into force. The full implementation of Solvency II is, however, now likely to be delayed to at least January 2014. It remains to be seen whether implementation of the new regulatory regime is also delayed. Significant delays are common (for example, with the original FSMA itself) when such radical, extensive and controversial reforms are proposed.
HM Treasury is consulting separately on further significant changes to FSMA to adapt it to Solvency II. These changes will be made by a statutory instrument under the European Communities Act 1972. Among other things, new procedures are proposed aimed at the approvals that firms and groups will need under Solvency II. So, for instance, getting an internal model approved for the purpose of calculating the Solvency Capital Requirement should no longer require the cumbersome procedure of a rule waiver or a variation of permission.
The general approach under the new regime can be illustrated by the position of the Lloyd's market. The PRA will prudentially supervise, and the FCA will supervise as to conduct of business:
The Society of Lloyd's itself, which is an authorised insurer in its own right.
Lloyd's managing agents in relation to the syndicates which they manage.
Lloyd's brokers will be supervised by the FCA as to both prudential and conduct of business issues. Lloyd's members will continue to be prudentially supervised by the Society itself, as they are not authorised insurers in their own right.
The new regime recognises that the regulation of with-profits business does not easily split between prudential and conduct of business. This is illustrated by the problems in supervising the Equitable. The with-profits policyholder bears the most investment risk in with-profits funds. The management of capital and assets that back liabilities to policyholders directly influences customer returns.
For insurers carrying on that form of business, therefore, the PRA's responsibility will include responsibility for measures designed to secure an appropriate degree of protection for those who are or may become policyholders in relation to decisions by insurers relating to the making of payments under with-profits policies at the insurer's discretion. This includes decisions:
Affecting the amount, timing or distribution of those payments.
The entitlement to future payments.
This will require the PRA to make what will, in effect, be conduct of business rules for insurers who effect direct sales of such products. These rules will in turn dictate or otherwise influence the rules on the same subject applied by the FCA to intermediaries and independent financial advisers.
T +44 20 7832 7242
F +44 20 7108 7242
E ali.sallaway@freshfields.com
W www.freshfields.com
Qualified. England and Wales, 1997
Areas of practice. Financial institutions disputes; global investigations.
T +44 20 7832 7478
F +44 20 7108 7478
E james.smethurst@freshfields.com
W www.freshfields.com
Qualified. England and Wales, 1998
Areas of practice. Financial services regulation.
T +44 20 7832 7010
F +44 20 7108 7010
E michelle.bramley@freshfields.com
W www.freshfields.com
Qualified. England and Wales, 1991; Hong Kong, 1991
Areas of practice. Financial institutions disputes; global investigations.
T +44 20 7716 4544
F +44 20 7108 4544
E jonathan.goodliffe@freshfields.com
W www.freshfields.com
Qualified. England and Wales, 1974
Areas of practice. Insurance; financial services.
T +44 20 7785 2977
F +44 20 7108 2977
E rhys.corbett@freshfields.com
W www.freshfields.com
Qualified. England and Wales, 2011
Areas of practice. Financial institutions disputes; global investigations.
