UK: Insurance Market Update - The Deloitte View For Non-Life Insurers

Welcome to the May edition of the Insurance Market Update in which we review the direction of regulation post-FSA and its impact on the non-life insurance market.

On 14 April 2011, the consultation period closed on the HM Treasury's discussion paper entitled 'A New Approach to Financial Regulation: Building a Stronger System (Cm 8012)', published in February 2011. This paper outlined the Governments plans to transfer prudential supervision of banking and insurance to a subsidiary of the Bank of England (BoE), the Prudential Regulation Authority (PRA), and rename the Financial Services Authority (FSA), the Financial Conduct Authority (FCA), which will focus on consumer protection and market regulation.

The FSA acknowledged that there will be challenges but will continue with 'business as usual', such as the ARROW operating framework, whilst looking at what the changes will mean in practice. In this edition, Ian Jacob and Mark McIlquham review the impact of the new regulatory structure on the insurance industry and consider some of the practical considerations for insurers and intermediaries in the general insurance market.

As always, we look forward to receiving your feedback. Your views, comments and suggestions for future themes or topics are most welcome.


Since the Chancellor's Mansion House speech on 16 June 2010, the Government has worked with the Bank of England (BoE) and the Financial Services Authority (FSA) to develop a revised regulatory structure to address perceived structural weaknesses in micro and macro prudential regulation, and meet the demands of structural changes in European financial regulation.

As part of the development process, two consultation papers have been published which provide insight on the proposed practicalities of the new 'twin peaks' model that would see the introduction of a new Prudential Regulation Authority (PRA) and the evolution and rebranding of the FSA to become the Financial Conduct Authority (FCA).

Discussions are ongoing and the FSA and BoE will continue to engage with the market through seminars and publications over the next few months. Once the consultation process draws to a close, legislation will need to be drafted ahead of the expected changeover at the end of 2012 or early 2013. With this in mind, none of the proposals should be seen as a 'done deal' and firms still have the opportunity to engage with the process and influence the final outcome.

Overview of the new regulatory environment

Overall responsibility for financial regulatory policy in the UK will be retained by the Treasury, with responsibility for financial stability given to the BoE. A new Financial Policy Committee (FPC) will have responsibility over macro-prudential policy and two new regulators will be responsible for regulatory supervision of individual businesses.

The PRA will have responsibility for the stable and prudent operation of the financial system with prudential oversight of approximately 2,000 firms across the financial services industry. In the general insurance (GI) market, this at present appears to be limited to insurers (including Lloyd's), although it is possible that the 'big 3' brokers may also be picked up by the PRA. This is one of the issues currently being debated.

The FCA will have responsibility for conduct issues of approximately 27,000 firms across the financial services industry. It will also be responsible for prudential regulation of firms not subject to PRA regulation, including GI intermediaries.

The FPC will be given powers of recommendation and direction over the PRA and FCA to address systemic risk.

The Prudential Regulation Authority

The PRA's remit will be restricted to prudential oversight and, in the insurance sector, only includes insurers (and possibly the 'big 3' brokers). It is estimated that the PRA will supervise around 1,000 insurance firms (including Lloyd's, GI firms and life firms) making it considerably more focused in scope than the FSA. The strategic objective will be the promotion of stability in the UK financial system with an operational objective of promoting the safety and soundness of PRA authorised persons.

The PRA will be set up as a subsidiary of the BoE and will be governed by a Board chaired by the Governor of the BoE with a majority of non-executives approved by the Treasury and cross representation from the FCA. It will be subject to oversight from the Treasury, the National Audit Office and the Treasury Select Committee.

The inherent differences between the insurance market and the banking sector mean that the PRA's approach will need to be proportionate to the lower systemic economic risk presented by insurers, as recognised by the FSA's Chief Executive, Hector Sants, in a speech on 9 February 2011. The overall regulatory approach will be judgement-led, making use of a new set of regulatory principles. This creates both flexibility and uncertainty for firms, but will need to be applied in the context of more prescriptive European rules. Overall, the PRA's approach is set to be more intrusive, with heightened supervision supported by an increased level of disclosure under Solvency II.

The Financial Conduct Authority

The FCA's strategic objective is to protect and enhance confidence in the UK financial system. This includes facilitating efficiency and choice in the market, a consumer protection role and wider responsibility for protecting the integrity of the UK financial system. It covers both wholesale and retail providers, though stricter controls are likely to continue to apply to consumer markets.

The FSA has started to evolve its internal structure to become a 'shadow' FCA in preparation for a rebranding when the new regime is launched, with many of the broking supervisory teams falling into this structure. The FCA will continue to be a separate legal entity enacted by the Financial Services and Markets Act.

It will be governed by a Board of directors and executive committee, with cross representation on the Board from the PRA and a majority of Treasury appointed non-executives. The FCA will report to the Treasury and to public meetings and will be subject to oversight by the national audit office and Treasury select committee.

The FCA's operational objectives include a new overarching requirement that it discharges its general functions in a way that promotes competition. This marks a significant shift from the existing FSA role. The form of any related powers and means by which Parliament chooses to delegate them may mean that firms are subject to increased scrutiny over competition, or more likely lack of it.

The FCA will need to adhere to the same set of regulatory principles as the PRA. As with the PRA, the intensity of regulation is set to increase further under the FCA. This will include increased proactive scrutiny of products to prevent consumer and taxpayer detriment, albeit in the context of an overriding objective to support increased consumer responsibility. The FCA's approach will be proportionate to each market segment. It will include more issues based supervision, taking action based on thematic reviews and issuing bans and disclosure requirements to address specific industry issues.

Greater public scrutiny

The discussion paper proposed that the FCA's preventative approach will be supported by much wider powers to publish its activities than were given to the FSA. Whilst the FSA is able to direct firms to withdraw misleading financial promotions, under existing proposals, the FCA would also have powers to publicise that it has done so. In addition, the FCA would be able to publish a summary of any warning notice issued to a firm as part of enforcement investigations. This will make it far more important that firms get products right the first time.

The aim of these powers is to encourage better market practices through deterrence, enhancing the existing effect of the FSA's powers of publication. It further increases the reputational risk associated with trading in a regulated market and will place an even greater emphasis on the need to demonstrate full compliance and maintain a good working relationship with supervisors.

Splitting dual regulated requirements

The detail of how the existing handbook areas will be split between the PRA and FCA for firms that will be dual regulated is still unclear. Whilst some areas can be easily assigned, nuances in detailed application are only likely to be clear as the consultation process continues. Effective co-ordination between the two bodies will be required.

An example of this is found in the February 2011 discussion paper which includes two methods for granting Part IV approval under the new regime. The first involves separate 'prudential' and 'conduct' approvals which would be granted by the FCA and, where appropriate, the PRA. The second would see one regulator taking the lead with both regulators able to manage information requests and withhold approvals.

Another area awaiting clarity arises from the need for retail businesses to consider consumer impact in the context of managing the balance sheet under Treating Customers Fairly (TCF). Whilst the consumer protection aspect of TCF easily fits within the FCA's scope, the link between the balance sheet and an ability to meet future customer expectations will also be relevant to the PRA.

Allowing the failure of firms

One of the main criticisms of the old regulatory regime was a reluctance to let firms fail. This has led to the inclusion of specific principles which enable the PRA to pre-empt risks before they materialise and to make failure capable of being resolved without detrimental impact to consumers or the taxpayer. Insurers are already subject to prudential regulation that requires sufficient capital to meet the full costs of run-off, so the impact of the new principles should be minimal.

The picture for intermediaries is less clear. Historically, consumer detriment from the failure of intermediaries was mitigated by trust arrangements for client assets. More recently, the increased scrutiny on stress testing under Threshold Condition 4 (TC4) has led to questions over intermediaries' capital adequacy in the event of a full-failure. Although the principle above (allowing firms to fail) only relates to the PRA, it may be that the FCA introduces 'living will' capital requirements for all intermediaries (which for many intermediaries have already been brought in by the 'back door' by the FSA). Subject to the nature of legislative powers conferred by Government, this could be achieved through the operational objective relating to consumer protection or by further developing the FSA's interpretation of TC4.

An increased influence from Europe

On 1 January 2011, a new European supervisory authority was introduced with responsibility for regulating the European insurance and occupational pensions market. The new authority has responsibilities which include: regulation of financial products, protection of policyholders and oversight of market stability and transparency.

The authority will become the policymaker for the European insurance market, setting the agenda for regulation within member states. This will result in an increased focus on Europe, including increased market participation in European policy discussions and consultation processes. Firms and market bodies will therefore need to keep a steady eye on European policymakers to reduce the risk of surprises when policy is implemented locally in the UK.

The risk of cost and conflict from dual regulation

In a speech on 9 February 2011, the FSA's Chief Executive, Hector Sants, identified four ways in which the new system has sought to address the risk of increased cost and conflict of interest arising from dual regulation:

  • introducing a 'memorandum of understanding' between the PRA and FCA with detailed guidelines on areas of increased risk;
  • cross representation at a Board level to aid consistent policy making;
  • joint working between supervisors at individual firms; and
  • establishing a legal basis for information sharing on specific matters between the PRA and FCA.

Notwithstanding these mechanisms, overlap and inefficiency seems inevitable, particularly in the early stages of the new system. Firms will therefore need to commit additional resources to identify potential risk areas and liaise with each regulator to manage the risk and facilitate open and constructive dialogue.

The costs of regulation will continue to be passed down to the market through levies, though the Government does not expect the overall cost to the industry to materially increase. Efficiencies are anticipated to arise from more use of risk based targeting of market wide issues.


The FSA has worked to smooth the transition to the new regime by adopting as much of the new structure as possible, aligning existing FSA staff with their anticipated new roles in the FCA. This will help to address issues in advance of the changeover, expected at the end of 2012 or early 2013. Initially, the majority of the FSA handbook will continue to apply as revisions will require a full consultation process. This will particularly reduce the initial impact for intermediaries, though it should be noted that client assets regulation has been highlighted as an area of heightened focus under the FCA (although this is already under review by the FSA, with a discussion paper expected shortly).

The practical impact of dual regulation for an insurer is less clear. The planned steps to mitigate the risk of conflict between regulators will take time to fully develop, which will require flexibility from both supervisors in the early stages. The extent to which the prudential rulebook will be rewritten so soon after the introduction of Solvency II is also unclear, though significant change would probably come from Europe.

Whilst the February 2011 discussion paper has revealed much more of the detail, it is important that firms take the opportunity to engage with the ongoing consultation processes ahead of any draft legislation, as many of the details are still being shaped and finalised. Further detail on the operation of the PRA and FCA has been promised by the FSA and BoE through conferences and publications expected over the next few months.

Once the new regime is in place, market leaders will need to invest resources to establish a good working relationship at an early stage by adapting quickly to the new requirements. They will also need to keep an eye on Europe to anticipate and prepare for further developments as EIOPA establishes its new role.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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