President's dinner, CII
16 March 2004
Speech by John Tiner

Good evening Ladies and Gentlemen.

  1. May I say what a great pleasure it is to be among so many professionals of the insurance industry this evening. Your Institute continues to do a great job in improving the educational and competency standards in the industry and I am quite sure this is set to continue. Also, I am very pleased to note your leading and valuable contribution to the development of a new set of examinations to improve standards throughout the industry, under the auspices of the new Financial Services Skills Council. Your Institute has also been proactive in developing standards for the new regulatory regimes covering mortgage and general insurance, and so helping firms new to the world of FSA regulation.

  2. At a time when confidence in the insurance industry is at a low ebb, the quality, expertise and standards of the people who work in the industry, and who serve the needs of its customers day in day out, must come shining through. You fulfil a vital role in the economic and social fabric of the United Kingdom with every business, local authority, government department, dare I say regulator and, of course, every citizen, depending on you in one way or another. Your responsibility is therefore enormous and every single one of these customers look to you to step-up to that responsibility. Tonight, I don’t want to dwell on the past where that responsibility has, on too many occasions, been found to be wanting -- but to look to the future and to explore how, all working together, we can reassure the customer that they will get a fair deal from the insurance industry.

  3. I can imagine that you may feel your industry is under siege -- from Government, select committees, regulators, the media and public opinion more generally. It is probably true to say that they can’t all be wrong and I think the more enlightened quarters of the marketplace accept this and have the passion and desire to do something about it. In doing so, I suggest that those companies which succeed in generating returns from out performing competitors through more effective business models, better pricing related to risk, lower costs and superior customer services - before, at and after the point of sale are more attractive to shareholders than those that may look to exploit the weaknesses of customers, because they don’t know as much as you do, or simply capitalising on customer inertia. It has been reported, wrongly, that I have said that firms should put customers before shareholders. This is far too stark a comparison and massively over simplifies the economies of the customer relationship. But I do say, and without apology, that a business which is well run and which wins the loyalty and trust of its customers and is never willing to compromise its fair treatment of them, must surely present a more attractive proposition to shareholders. So I think there is a genuine convergence of interest between customers and the providers of capital.

  4. Now in thinking about what I might cover tonight I had no shortage of topics to consider - IMD, capital adequacy of general insurers, Sandler, With - Profits, realistic reporting, Penrose, and stochastically modelling the probabilities of Leeds United remaining in the Premiership, where irrespective of the number of simulations I run – I find it difficult to arrive at an outcome I like. But I am told the actuaries could always fix that for me. So maybe there is some read across to life insurers here as well! Anyway, I thought 15 minutes on each might do the job. I am assured the toast master will keep the stirrup cup going until the early hours.

  5. But given recent events, including today’s appearance of Lord Penrose and Ruth Kelly before the TSC, I do want to say a few words on the FSA’s regulation of life insurance.

  6. As you all know only too well, we are making great strides in delivering root and branch reform of the regulatory regime for life insurance firms. This has left not one stone of the old regime unturned. The regulatory system we inherited was, bluntly, dilapidated and deficient. It was neither responsive nor nimble enough to respond to movements in market conditions or to the realities of a low inflation world and it allowed the senses of listening to customers and speaking to regulators to be switched off. Whilst no one would expect a regulatory system to have developed ESP, it is, I think, reasonable to expect a regime to be in control of its faculties.

  7. So we have had a radical rethink. But radical is a comparative term and I would challenge anyone to justify the following as radical rather than good common sense and business sense. Firms maintaining the hard financial backing to cover the promises they make to policyholders; firms being open with their policyholders about how they manage their money and calculate returns; and senior management overtly recognising their responsibilities to their customers and to the regulator, including the imperative to communicate with us on an open, timely and frank basis. So, not rocket science then. In the main, firms have responded positively to the reforms, appreciating the long-term gains that they will bring.

  8. Those of you have dipped into your piggy bank and paid the £79 for your personal copy of the now infamous 818 page report that was published last week, may appreciate that much of what I have just said will have struck a chord. All of our reforms predate the Penrose Inquiry; the genesis of modernisation can be found in our response to an earlier report into Equitable Life - the Baird report, the FSA’s own internal investigation. Commissioned to examine regulation of Equitable Life post 1999 when the FSA assumed responsibility of life offices, Baird concluded (as did Penrose) that, for existing policyholders, the “die was cast” by January 1999. In our response to Baird, we said that, with the benefit of hindsight, it was clear that a number of issues could have been handled better. The lessons that we took from that effectively sowed the seeds of what is now a radical programme of reform and our drive to ensure that day-to-day supervision of insurance firms is more proactive, effective and risk-based. Nevertheless, we note that Lord Penrose endorses this programme of change when he says that the FSA "…has sought to anticipate many of the lessons drawn by the inquiry" and that the work so far "…has reflected a major comprehensive assessment of the requirements of an efficient regulatory system for the insurance sector."

  9. The past and, indeed the present, solvency test focuses only on the firm's legal obligations and does not require firms to back other promises with hard financial resources and it ignores some significant non-contractual promises or practices completely, such as policyholders’ expectations that they would receive a fair terminal or final bonus. Even for other promises, such as contractual options or guarantees to pay minimum annuities, the requirements of the statutory regime were found to be remiss.

  10. Although complex in the detail, as I have said, the overall aim of our capital proposals is simple: to ensure that firms reserve properly for all of these liabilities, guaranteed or otherwise, and to hold sufficient capital so their liabilities can be met in adverse market conditions. Here the devil is in the detail, particularly what constitutes adverse market conditions. But this principle of financial management is no more or less than would be expected in any other industry. The approach will require life insurance firms to make a realistic assessment of their with-profits liabilities to determine whether they need additional capital on top of statutory reserves to cover expected discretionary payments. Initially, we planned to introduce this “realistic” accounting regime by the end of this year. We still intend to do this for all life firms with with-profits liabilities exceeding £500m. But under considerable pressure to sell equities when the markets fell in 2002 (and again in early 2003) many of the larger firms requested a waiver from the statutory regime enabling them to operate on a realistic basis immediately, thereby providing them with greater flexibility in the face of fluctuating market conditions. Those firms that were granted waivers will be publishing for the first time their realistic balance sheets as part of their year-end submissions to us later this month.

  11. Having lauded the introduction of realistic reporting some eighteen months ago, some firms have since appeared to have had selective amnesia, claiming that it requires them to hold considerably greater capital than previously. Other firms have openly welcomed the new approach. The reality is that in the process of getting their own houses in order, some firms have realised that they had been too slow to adjust the management of their business to a low inflation world. Employing sophisticated stochastic modelling techniques to prepare their realistic balance sheets, many firms have discovered that the costs of the guarantees that are embedded in their with-profits products are likely to be higher than they had thought, and in some cases, significantly so. As a consequence, some are proposing to introduce or increase charges against asset share to make up this difference. We are not opposed to the charging for guarantees per se, so long as it is done in a way that is fair to policyholders. The nub of this issue is whether such charges conflict with the principles of treating customers fairly; charges that are set too high or are retrospective are likely to give rise to such a conflict. We appreciate this is a complex area and are working with a number of firms to help resolve any arising difficulties.

  12. It has been said that this new approach will reduce returns to policyholders over the longer-term as firms will allocate less of their portfolio to equity asset classes. It is not clear to me that this observation takes full account of the move to a lower inflation environment. That said, it should not come as a surprise that those life companies which have given substantial guarantees to their policyholders may find that they can better match these commitments by investing in the bond markets. For the investors, there is a price to pay for certainty and perhaps that is the equity market premium. But, once again, this phenomenon is not unique to the insurance industry. Even if there is a shift from equities to bonds when our realistic reporting regime is implemented fully, we nevertheless anticipate that equities will continue to form an important component of firms' asset allocation. The life insurance industry will therefore continue to be a major provider of equity capital to UK Plc. In some countries regulators limit explicitly the amount of equity market exposure of life companies. If we look to the US life companies, their equity weightings are about 4% of assets. And yet the US equity market is the deepest and most diverse in the world, fuelled, of course, by a huge mutual fund sector, an equity hungry private investor and significant foreign investment. For the avoidance of doubt, we do not plan such absolute limits in the UK.

  13. From the end of April, firms will also be required to produce a document setting out the way in which they run their with-profits business. The Principles and Practices of Financial Management (PPFM) will include details on a firm's approach to setting annual and final bonus rates, smoothing, investment strategy and the management of any inherited estate. Complementing the new realistic accounting regime, firms will also be required to include in their PPFM details on any charges to policyholders to cover the costs of guarantees. The PPFM will be a technical document which can be used by sophisticated investors and IFAs enabling them to compare with-profits funds before making decisions on suitability. Since these have not been designed primarily for consumers, we also think that firms should produce a consumer friendly PPFM, which would include key summarised and understandable information so that consumers understand how a fund is operated and enable them to compare funds if they so wish. We are currently carrying out some consumer testing and hope to introduce these by the close of the year.

  14. A particular group of policyholders who we feel need more help in achieving a fair deal are those in closed funds. Out of a total of £340 billion invested in with-profit funds, some £97 billion is invested in funds no longer accepting new customers. While closure of a fund may not necessarily be in conflict with a policyholder's interests, some firms could be doing a lot more to keep their customers informed. As such, we would like firms to let their policyholders know when a fund closes to new business and then to provide them with information about the reason for closure and the implications for themselves. This would include future bonus prospects and the options open to policyholders. Firms will also have to submit a run-off plan to us, showing how they will ensure a full and fair distribution of their closed with-profits fund, including any relevant inherited estate.

  15. Before closing I would like to say just a few words about the independent reviews into corporate governance of mutual life offices, the actuarial profession and accounting standards, announced last week by the Financial Secretary to the Treasury, Ruth Kelly. On the former, clearly from our perspective there is no difference in the way we regulate firms with a mutual structure to those with a proprietary one. In relation to corporate governance specifically, the issues surrounding effectiveness, skills and experience of Non Executive Directors, particularly on the question of whether they provide sufficient and robust challenge to the boards that they sit on are a core part of our risk-based approach to supervision. Indeed, we have already encouraged firms to introduce some independent judgement into the governance of with-profits business. Whilst we are not persuaded of the merits of an FSA ‘monitor’ to advise a firm’s board, as recommended by Lord Penrose, we look forward to contributing to Paul Myners’ review. On the actuarial review, due to be led by Sir Derek Morris, again we welcome the opportunity to share our experiences and knowledge of the profession.

  16. And finally, on the third, the accounting review - - I can only say this is long overdue. In the past the accounts and regulatory returns have proved impenetrable and any reconciliation between them impossible. This is a hopeless situation for investors and, like we have been fixing the regulatory regime, I hope the domestic and international standard setters will move rapidly to address the accountancy system. My plea is that out of this we have much greater alignment between financial statements and regulatory accounts.

  17. Much has been written about the current lack of consumer confidence – undoubtedly, levels of confidence have sustained a number of blows over the years. This is a worry given the need to promote long-term savings, particularly in the face of an ageing population. Some may be inclined to see what we are doing as undermining confidence further, as our proposed rules expose further problems. But as I'm sure you would agree, it would be totally wrong and irresponsible to hold back on these reforms. The only thing worse than no confidence, is confidence that is misplaced.

  18. I’m not going to say to you: “modernise or die”. That would be too crude. What I will say though is that this is not, as some might have it, about introducing a regime that effectively means death by a thousand cuts for with-profits. With-profits products have performed well for many, many consumers, and we do not want a regime in which the features which have enabled it to serve long-term investors well, have fallen by the wayside. Rather it is about building a sustainable, more transparent framework that will secure a future for a sector that I believe should have a lot to offer. With that robust infrastructure pretty much in place, it is now over to you, the industry, to ensure that that future becomes a reality. This is, in short, about evolution, not revolution.

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