Reform of the insurance industry
Speech by John Tiner
Insurance Sector Conference
7 April 2005
Introduction
1. May I start by welcoming you all to this, the first Annual Insurance Sector Conference run by the FSA, which, by no accident of planning, coincides with the publication of our Insurance Sector Briefing on delivering the Tiner Insurance Reforms. We had planned for Stephen Timms, Financial Secretary to the Treasury, to join us today, but his diary has understandably been reprioritised following Tuesday's announcements. At the end of today you will all have a copy of the Report so I do not plan to cover its contents in detail. Suffice to say, collectively the reforms mark change of the highest order in the insurance industry; responsible reforms that will deliver more responsible firms. I commend it – and its aims – to you.
2. First, and at risk of sounding like the groom at his own wedding – mindful that there's a rather important wedding on Saturday - I'd like to say a few "thank yous". Thank you to David Strachan and his team for organising today; thank you to all our guest speakers for providing us with their own insights into what reform of the insurance industry has meant and will continue to mean for their business; and finally, but most importantly, thank you to you all for participating in what has no doubt felt like a long, hard slog to get to where we are today.
3. So, moving on to what's happened and what's been accomplished.
4. A quick recap takes us back to the autumn of 2001, when the FSA Board asked me to initiate a programme of reform to overhaul the way in which insurance companies were regulated. This was to address the deficiencies in the regime we had inherited. To do so, it was clear to me that change across all fronts was needed.
5. The modernisation of the insurance regime has been all encompassing. And I cannot imagine a more challenging set of market circumstances and commercial pressures to coincide with a wholesale reform of regulation which goes to the heart of firms' business models, operating practices and relationships with their customers. For life insurers, these include the continuing shift from public to private pension provision, a deep bear market, the erosion of consumer confidence in the long term savings industry and with it the increasing unpopularity of the with-profits product, greater market concentration and the emergence of closed with-profits funds consolidators. For general insurers, the period has included the aftermath of the tragic events of 9/11, catastrophes such as the hurricanes in the US and the floods closer to home, significant consolidation in the reinsurance industry and the implementation of a conduct of business regime following the Insurance Mediation Directive. Of course, on the positive side the general insurance market has enjoyed a strong run of pricing over the past two to three years. But, in short, since 2001 the operating environment for the insurance industry has undergone nothing short of a seismic shift.
6. Once thought of as the poor cousin of financial services regulation, insurance regulation in the UK is now broadly consistent with, and perhaps in some areas is even leading, the regulation of other sectors. In particular, the new requirement for all insurance companies to assess how much capital they actually need to support the risks of their business, and then hold commensurate financial resources, is a radical departure from the previous one-size fits all model. It marks the welcome much closer alignment of economic and regulatory capital and emphasises the importance we place on senior management for taking responsibility for their firms' financial soundness and treatment of customers.
7. Change has been apparent within the FSA as well. We have taken a long hard look at the way in which we regulate the insurance sector. We have focused on ensuring that supervisors give the right level of attention to a firm's financial condition, the way it is managed and the interaction with its customers, throughout the insurance product life-cycle. We have also restructured ourselves with the aim of tailoring our approach to - and focusing on the right risks in - the markets we supervise. This was achieved by the creation, exactly one year ago, of our three business units covering wholesale markets, retail markets, and regulatory services, and supported by our sector teams.
Our philosophy and approach to regulation
8. But the design and delivery of regulatory change inevitably carries with it some risks: there is the risk that it doesn't do what it says on the tin; the risk that consumers' expectations of regulation are such that they forget or fail to take responsibility for their own affairs; and, importantly, the risk that regulatory intervention is not based on proper analysis of market failure. I am confident that our robust approach to open consultation, cost benefit analysis and proportionality – all of which have featured heavily in designing the reforms - mitigate against all three of these risks.
9. Furthermore, our philosophy and approach to promoting efficient, orderly and fair financial markets – one of our two strategic aims - is based on sound theory and practice. Our policy is to intervene only when we are confident – and can demonstrate – that there is a market failure which targeted regulatory intervention is likely to correct or mitigate, and the expected benefits of the intervention exceed the costs. In this respect, we prefer to work with the grain of the market wherever possible and wherever appropriate. This approach is particularly relevant to the wholesale markets – where professional sellers and professional buyers get together to complete, often complex, financial transactions. Our regulatory regime and associated policy - whether we are talking about the investment banking, capital markets, or commercial insurance sectors - are based on this approach. Indeed, the concept of 'market counterparty' and the freedom from prescriptive regulation that this concept brings has been fundamental to the modus operandi of the securities market for almost two decades.
10. In the world of insurance, you will have seen two very clear examples of this approach in our response in recent months to some very topical issues: first around the whole question of transparency and disclosure, and second in our challenge to the market to achieve contract certainty.
11. We recognise that these two subjects cannot be seen in isolation. We recognise that some shifting, shuffling – and in some cases shouting - is taking place within the market as wholesale brokers rethink and renegotiate their business models and underwriters respond in kind. And we also recognise that a large and important part of this market is new to statutory regulation.
12. So we do not believe that now is the time for regulatory intervention, especially in the field of mandatory commission disclosure. I know that there are mixed views about the rationale of our decision here, so let me clarify our thinking.
13. First, we consulted extensively on our policy in this respect. Some, it is true, felt strongly that mandatory disclosure and the prohibition of certain types of commission arrangements were necessary. Others, however, did not share this view.
14. On balance, and after careful consideration and contemplation, we decided to make commission disclosure mandatory only where commercial customers request it. At the time, this was broadly accepted, including by some of those who had argued for mandatory disclosure. We also said that we would keep this policy under review in the light of supervision experience. Our current work on conflicts management and unfair inducements across both the wholesale and retail markets is designed to help us do just that. In the meantime, it would not make sense to bend like a reed in the wind and change our policy in response to calls from some quarters for us to do so, no matter how loud or authoritative the voices.
15. But more importantly, we do not believe that mandating commission disclosure will necessarily strike at the heart of the problem. There is no doubt in my mind that commission arrangements between underwriter and broker have the potential to create conflicts of interest and, in the worst case, such conflicts may improperly influence the direction of business flows. And that is why we believe that addressing the cause, rather than addressing the symptom by writing a prescription, is vital here and why we believe that proper, rigorous conflict management is the starting point. Full disclosure would not in any event be a panacea, nor provide a safe harbour from the need to manage conflicts: they would still be present and they would still have to be managed.
16. The management of conflicts is not the responsibility of the regulator Management responsibility lies with the people in the firms. It lies in the culture of the firms, in the operations of the firms and in the business models of the firms. It lies with you. Our responsibility is to set the principles and provide the guidance for complying with those principles. We did the latter in early February. And we are, right now, assessing compliance with our principles and standards through our work on conflicts management. If we find serious breaches or ignorance of our requirements, we will take appropriate action against individuals and firms.
17. There is of course an alternative: in line with our approach to soft commissions in the investment market and contract certainty in your market - where we are looking for market-led solutions with regulatory review - we will also support any efforts the industry makes to solve its perceived problems. The market is welcome to use this opportunity and collaborate to agree a code of conduct on disclosure. To do so will take effort and commitment by all in the insurance chain – the underwriters, the brokers and the insureds. I understand that some think that too much market power rests in the hands of the brokers and that we should intervene in a more dirigiste fashion to counter this. But where are the underwriters and where are the insureds? The insureds, after all, are not shy retiring types, but are often huge powerful global companies who are in a position to punch their weight in the market. Each part of this insurance chain has a right to improve the structure and efficiency of the market. But with these rights also come the associated responsibilities. I know that there are already some industry initiatives here, such as AIRMIC's 'questions to brokers' and the work of the 'Beazley group' if I can give it that name. Of course, we support these market-led initiatives.
18. The door is not closed on regulatory intervention, but in a world where there are calls for less regulation generally, calls for less gold-plating of directives and calls for less prescription overall, immediate regulatory intervention without clear evidence of market failure would be incompatible with the approach and philosophy I've described today.
19. Consistent with our desire to rely on market solutions where appropriate, I'd like to finish by giving you my own thoughts on the very topical subject of financial engineering. My colleague Tom Huertas will go into more detail on this later this afternoon.
20. There cannot – or at least should not – be one single person in this splendid room who is unaware of the potential impact on a company, its management, its shareholders and its customers, of even the slightest suggestion by a regulator that the company has taken steps to manipulate its balance sheet to improve its results. We saw the devastating effects of such activity in the collapse of Enron in the States and the failure of HIH in Australia. The outcome of the US regulators' interests in AIG is yet to be determined but already the impact on its share price and its senior management team is clear for all to see.
21. Our aim to promote efficient, orderly and fair markets and our statutory objective to reduce financial crime gives us a very clear responsibility to ensure that our markets are free from abuse. We have set out clearly our approach to financial engineering and have published disciplinary action when taken. Our current work and recent information requests to general insurers in the UK are first intended to determine the extent to which financial engineering – and specifically financial misengineering – is prevalent in this market and second to determine whether regulatory intervention is necessary. Our starting point is that regulatory intervention might rely on our policy-making powers in the form of enhanced disclosure by insurers – but consistent with the seriousness with which we treat cases of abuse, we will use our enforcement powers where appropriate and if necessary.
22. Before concluding, my message today is clear: you have a golden opportunity to seize the moment and, where there is the need, put your own house in order and take advantage of your position in our regulatory spectrum. The wholesale insurance market is a grown-up and professional market; a market where we will only intervene where it is appropriate to do so; and a market in which we are prepared to rely on market solutions where there is a real chance that they will work.
Conclusion
23. Some concluding thoughts. We identified a number of significant shortcomings in the previous regulatory regime for insurance. Over the past two years or so, and with your help and input, we have considered how best to address these shortcomings and throughout this period, and in addition to regulatory change, there have been some significant commercial challenges. As a result, we have intervened where necessary by introducing new rules and requirements and by setting challenges where rules and requirements are not the best answer. This we believe is the right approach: right for us as regulators, right for you as the industry and, importantly, right for consumers of insurance.
