Principles-based regulation in action: FSA publishes principles for insurer capital adequacy
Briefing Note 27/06
18 September 2006
The Financial Services Authority (FSA) has today published a set of principles that will help firms determine their capital adequacy under the new principles-based approach to regulation.
In 2004, the FSA introduced the Individual Capital Adequacy Standards (ICAS) regime requiring insurers to make their own calculation of the level of capital they believe is appropriate for the scale and nature of their particular business. Since then, the FSA has been working with the industry to introduce principles and guidance for the ICAS process which are included in today's Consultation Paper. The principles and guidance will give firms a better understanding of the FSA's expectations of how the ICAS process should work in practice.
With the introduction of the risk-based ICAS regime, the FSA has been able to review the standardised capital requirements used by all insurers alongside ICAS. In 2004, the FSA introduced new 'realistic' capital requirements for with-profits business written by life insurers. These 'realistic' requirements mean that the capital supporting with-profits insurers is more closely matched to the risks of the business that they write.
Today's consultation proposes extending these more 'realistic' requirements across to life insurers' non-profits business. These changes would 'free-up' capital by eliminating many of the existing areas of 'super-equivalence' in current FSA requirements compared to the EU Life Directives. They also propose removing areas of super-equivalence for with-profits business where this does not reflect risk. The changes would 'free-up' approximately £4bn of capital across the life insurance industry. This would produce savings of approximately £140m per annum. All insurers will, however, still be required to meet the 99.5% confidence levels set as part of ICAS. This will help ensure that insurers have sufficient capital so that they are able to honour their policyholder liabilities as they fall due.
Sarah Wilson, the FSA's Sector Leader for Insurance said:
"The FSA has worked hard with industry to develop capital requirements for life insurance business that reflect the nature of the business that insurers write. We have done this through developing the ICAS process and introducing principles and guidance. In turn this has enabled us to remove areas of super-equivalence.
"This demonstrates our desire to achieve proportionate regulation and is a real-life example of our move to a more principles-based approach to regulation."
The issues in this consultation paper have been discussed extensively with industry. With industry support, the FSA is reducing the consultation period to six weeks, rather than three months. This will enable the FSA to make final rules before the year end which will allow firms to benefit from the proposed changes when preparing their annual returns for 2006.
Notes for editors
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CP06/16 Prudential Changes for Insurers including Feedback Statements for Chapter 3 of CP05/14; Quarterly consultation (No. 6) and CP06/12: Implementing the Reinsurance Directive.
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The feedback statements provide feedback on the FSA's proposals for two other aspects of insurance regulation: financial reinsurance and Insurance Special Purpose Vehicles (ISPVs).
Financial Reinsurance: in 2005 the FSA consulted on rules requiring greater disclosure of the use of financial reinsurance by firms (see CP05/14). The FSA's Board will be asked to make rules which will apply to financial years ending on or after 31 December 2006. The rules will require disclosure in firms' annual returns of the existence and financial effect on their capital resources of any material financial reinsurance contracts or similar arrangements. The FSA has also consulted on a general principle of disclosure as part of its implementation of the Reinsurance Directive.
Financial reinsurance is a term that refers to certain types of reinsurance arrangements. Typically these arrangements are used to improve, or sometimes to smooth, reported profits, or to improve the reported balance sheet position.
ISPVs: subject to final Board approval, the FSA plans to introduce a regime for ISPVs in time for firms to set up ISPVs for inclusion in their 2006 year-end reporting. The FSA consulted on proposals for ISPVs in June as part of the introduction of the EU Reinsurance Directive in CP06/12. The FSA's proportionate approach to the regulation of ISPVs with the emphasis on the ceding insurer, will provide insurers with easier access to the wider capital markets and will help them to manage their capital more efficiently. ISPVs must meet the definition laid down in the Reinsurance Directive which is as follows:
"any undertaking, whether incorporated or not, other than an existing insurance or reinsurance undertaking, which assumes risks from insurance or reinsurance undertakings and which fully funds its exposure to such risks through the proceeds of a debt issuance or some other financing mechanism where the repayment rights of the providers of such debt or other financing mechanism are subordinated to the reinsurance obligations of such a vehicle". -
The FSA regulates the financial services industry and has four objectives under the Financial Services and Markets Act 2000: maintaining market confidence; promoting public understanding of the financial system; securing the appropriate degree of protection for consumers; and fighting financial crime.
- The FSA aims to promote efficient, orderly and fair markets, help retail consumers achieve a fair deal and improve its business capability and effectiveness.
