Global Financial Leadership Forum
Le Meridien, Piccadilly
19 April 2004
Speech by Callum McCarthy

There is an ancient Chinese blessing – some claim a curse – "May you live in interesting times". These are certainly interesting times for the life insurance industry: times of opportunity, of threat, and of clear need for change. So today, I would like to look at some of the opportunities; and to discuss one particular threat which is emerging from Europe. I will do so from a British stand point. You have among your members and speakers many who can speak with far greater knowledge and expertise than I on other markets and other countries. But a British view is never, I hope, a parochial one : London is the most international of all the capital market centres in the world; I am told that one third of the EU insurance market is regulated by the FSA.

The opportunities

2. Let me start with the opportunities. There are three which are particularly important influences: demographics; the shift to greater personal responsibilities for individuals; and improved understanding of and a better regulatory framework for the life insurance industry.

3. You all know the basic of demographics: we now live longer, and we have fewer children. The most important economic issue in every advanced economy is how to come to grips with the realities of an ageing population: in personal terms how to allow those at the end of their working lives to live with dignity and in comfort. In Britain, by 2031 the life expectancy for men will be 81 years and for women 85; by 2031, over 30 per cent of the population will be over 60, compared with 20 per cent today; there will be 4 million more of pensionable age than children. The need for provision for retirement has never been greater.

4. This demographic movement is accompanied by a movement, certainly in Britain and I believe elsewhere in the world, to place greater responsibility on the individual to take decisions about the provision for his or her own future. A series of financial decisions – about higher education, about health care, about pensions – which used to be taken for us as by either government or by employers – are increasingly being transferred to the individual consumer.

5. These movements – demographics on the one hand, an increased reliance on individuals rather than institutions for investment decisions on the other – represent an enormous opportunity for the life insurance industry. And, for exactly that reason, they place equally important responsibilities on all concerned: to make sure that the products are in fact suitable for those to whom they are sold; that the companies or societies have assets which match their liabilities; that customers are given information that enables them to make responsible decisions; that both customers and companies face up to those responsibilities.

6. The third important change is to the understanding of and regulation of life insurance, where in Britain there are substantial changes in progress, both in respect of the conduct of business – how we make sure customers of the life insurance industry are treated fairly – and in respect of prudential behaviour – how we ensure that insurance companies are properly funded to meet their liabilities. Let me say a little about each.

7. Our concern in respect of conduct of business regulation is to establish the flow of information between provider of financial services and customer needs in an efficient market. Much of that is no more than codification of what is already done by the many good firms in the industry. It covers the sales process, where we look for the product being offered to be described in a way which is free from jargon; and with clarity as to what its characteristics – including risks – are. More significantly, it requires a lifting of the veils which have traditionally obscured what was actually on offer in a with-profits policy: in future, we expect information to be made available – comprehensibly – on how a firm manages its with-profits funds, its approach to payouts (on maturity and on surrender), its smoothing policy, its investment strategy and any changes to asset share. This is the information needed if a customer is to make an informed choice between competing companies – and, for that matter, between competing investment opportunities.

8. On the prudential side, we are introducing realistic reporting – a realistic assessment of with-profit liabilities to determine whether companies require additional capital, over and above statutory reserves, to cover those liabilities. The basic principle – that liabilities should be identified and quantified – is one it is hard to argue against, in any commercial activity. In life insurance, where liabilities are so long term, and where it is therefore necessary to think through how they can change over time, implementing this basic principle is even more important than in other commercial fields.

9. Lastly, as you would expect of an integrated regulator, we are bringing together the implications of conduct of business and of prudential regulation. The assessment of liabilities made by any company must include an assessment of those liabilities it has created via its general promises as well as by its specific guarantees. We need to have clarity in the product offering not only so that customers can understand what they are buying, but also so that firms can identify and provide for the liabilities they are entering into.

10. Now, I know it is not usual for regulatory change to be seen as presenting opportunity. More often, any regulatory change is seen as harmful and threatening – just as, too often, all regulation is represented as hindering innovation and efficiency. Regulatory blight can, of course, occur: in a moment I want to discuss a regulatory initiative which I believe represents just this sort of danger. But the changes we at the FSA have initiated in the UK are very different. They are designed to produce a market for life insurance products which works efficiently: where there are better informed customers, able competently to make the important decisions increasingly required of them, and recognising the importance of those decisions and the need to think about them; where companies recognise the need to work hard to make clear and comprehensible the description of what their products offer, and the risks associated with them; where companies recognise that they have a responsibility to treat their customers fairly, and to prevent mis-selling by their salesforces rather than incentivising unacceptable practices through inappropriate commission systems; and where the match between liabilities and assets of companies is encouraged by realistic regulatory rules and accounting, rather than being distorted by inappropriate rules which if they do not encourage at least permit behaviour which fails to recognise the real obligations of life companies. All these changes represent opportunities for responsible and well run companies. They are designed to encourage, not to hinder, the development of an efficient market in life products.

A specific threat

11. Not all regulatory initiatives are of this nature. The FSA is much concerned about a European initiative which is likely to hinder the development of an efficient life – and general – insurance market. This is the proposed new EU directive on equal treatment of men and women in the supply of goods and services within the EU, which includes, as Article 4, a requirement that Member States should prohibit the use of gender as a factor in the calculation of premiums and benefits for insurance and related financial services in any new contracts. Now I should make clear that my concern is in no way based on opposition to actions to prevent gender discrimination. I am a committed and public opponent to this form of discrimination, as to others. The FSA's concern is entirely different. It is first a concern whether the wholly laudable aim of preventing gender discrimination can be practically achieved by a statement which overrides realities, and second whether the implications of what has been proposed have been thought through. It is worth spelling out some of the likely effects of what is proposed.

12. Under the proposals, in future it will not be possible for EU based insurance firms to differentiate by price between men and women. This will in particular affect annuities, life insurance, income protection insurance and motor car insurance. The effects will be, in all cases, to require insurers to depart from realistic assessment of risk – a principle which runs counter to good sense. The effects of departing from realistic assessment of risk would be various – sometimes they would advantage women, sometimes men. Our present estimates, which we will be seeking to refine, show that, for annuities, the result of ignoring – or overriding – the reality of different life expectancies for men and women would be to increase the annuity a woman would be able to purchase at age 60 by 2 per cent; and to reduce the annuity a man aged 60 could purchase by 3 per cent. Conversely – and for exactly the same reason – namely the overriding of the reality of life expectation for men and women – the premium payable by a woman aged 40 for life cover is likely to increase by 16 per cent, against a fall in a man's premium at the same age of 8 per cent. For motor car insurance, young women drivers are likely to face an increase in premiums of between 10 and 30 per cent. These are our present estimates; clearly at this stage it is difficult to be precise. But all these changes will be driven not by the correction of any error in the present actuarial assessment of risk, but by the opposite – by a deliberate design for a good social objective to override realities of life expectancy or of actual behaviour. It is not surprising that the results of such a policy would have such arbitrary consequences for men and women – sometimes favouring men, sometimes women, but in no case corresponding to the underlying reality.

13. There is a wider consequence of a regulatory intervention, such as that proposed, which is that any regulatory intervention which runs counter to an underlying reality imposes costs. The FSA would expect, as well as rather arbitrary effects on both men and women, that the proposed directive would increase the overall cost for consumers of buying insurance cover. This is because firms will not know in advance the proportions of men and women who might in the future buy their non-gender differentiated products. They are therefore likely to include margins in their pricing of products to cover the risk that their assumption is incorrect; and they may also be required to hold more capital to cover this risk. Although over time we would expect insurance firms to assess this risk reasonably accurately, it would remain a risk, which would to be reflected in pricing and in capital. We would expect insurance prices to have to increase by some percentage points to cover this; and for an increase in capital for the insurance industry. This could be considerable, and come to and even exceed £1 billion.

14. I very much hope that the Government, which like the FSA is committed to cost benefit analysis of any regulatory initiative, will require this proposal to be closely examined. Regulation works best when it recognises, rather than overrides, reality.

Conclusion

15. I started by saying we live in interesting times. Rather than ending on the note of threat, and the dangers of seeking to depart from an approach to insurance based on realistic assessment of risks, let me return to the opportunities for the industry. The market need is there, in terms of the basic demographics; there is a growing role being allocated to the private sector to meet these needs; the wider economy is more favourable, and this is being reflected in equity prices. In Britain, the consequences of a greater expertise in insurance regulation and of a more realistic regulatory regime are being worked through. It is clear that this process is far from finished. It is a process which will have consequences for both shareholders and policyholders in life companies. But, once these transitional costs have been met, there is the prospect of an industry which is better equipped to respond to the need for their products and services which has never been greater. I do not expect those products and services to be necessarily the same as in the past; indeed, I expect considerable innovation in both the design and the delivery of those services. The aim we have is firms whose capital structure and assets are well matched against their realistic liabilities; firms which set out clearly, and with as little jargon as possible, what they offer policyholders; and firms which do not mis-sell their products. The business environment in which firms are now operating – which includes the FSA – means that increasingly all of these are in the long-term interests of the firms themselves – as they are in the interests of the customers of those firms.

More Speeches: