FT Future of Insurance 2015 The Impact of Regulation. Hugh Savill ABI

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1 FT Future of Insurance 2015 The Impact of Regulation Hugh Savill ABI

2 Overview Valuable role of insurance for individuals and in society Uncertain environment Pressures on the balance sheet Impact of FCA and conduct regulation Impact of Bank of England and prudential regulation Conclusions

3 Insurance: future opportunities Insurers role to protect their customers against risk A stabilising agent in society Solution to the needs of an ageing society pensions, healthcare, long term care Ever-changing face of risk: e.g. driverless cars and motor insurance Increased need for cover of known risks e.g. natural catastrophe New risks will emerge: e.g. cyber Over-leveraged state balance sheets need for private sector provision of services and sources of funding New technology offers easier access to existing customers New technology also allows coverage of risks previously considered uneconomic, and permits access to customers previously difficult to reach: social inclusion

4 Uncertain environment Macro-political risk - Can Greece stay in the euro-zone? If not, what are the consequences? Can the UK stay in the EU? If not, what are the consequences? Micro-political risk: is partnership with the state possible? Transformational power of big data

5 Pressures on the balance sheet Set to one side ephemeral issues geopolitics, demographics and the power of IT Focus on pressures on the balance sheet: Ultra-low interest rates Unsustainable asset prices Unreliable investments Upheaval in the pensions market Nothing is quite what it seems

6 Interest rates longer term view

7 Ultra-low Interest Rates (1) Quantitative easing. No point blaming the Central Banks imbalance between available savings and opportunities to invest. Lawrence Summers - secular stagnation. Return to pre-crisis levels considered unlikely Bank of England May 2015 Inflation Report: official interest rates remained at historically low levels, and the market path continued to suggest very gradual rises over the next three years Low interest rates hurt savers sometimes over the long term: e.g. low annuity rates Low interest rates benefit borrowers. And asset owners for a while

8 Ultra-low interest rates (2) OECD Business and Finance Outlook June 2015: The current low-growth, low-interest rate environment poses particular problems for pension funds and life insurers. These financial intermediaries, which offer long-term financial promises, rely on investment returns to honour their obligations. Today s Business and Finance Outlook shows shortfalls in many countries, both from rising longevity risk and from lower interest rates. Hard squeeze on providers of savings products where yesterday s guarantees are higher than today s returns Impact varies according to the market: How prevalent are guarantees? How closely are assets matched to liabilities?

9 Do low interest rates discourage savings?

10 Unsustainable asset prices Asset prices move in inverse relation to yields (FT sub-eds manual p.1) Low yields = high asset prices Very low yields = very high asset prices What happens when the interest rate cycle finally turns? Major motive for negotiation of Matching Adjustment in Solvency 2 Timing of pivot will not necessarily be chosen by Central Banks Impact of reduced liquidity on bond prices Bank of England Open Forum: It is entirely possible that dealer inventories will turn out to be structurally lower than their previous unsustainable levels

11 Unreliable investments (1) Myth of the century the search for yield OECD Business and Finance Outlook: Increasingly, therefore, pension funds and life insurers are feeling the pressure to chase yield themselves, and to pursue higher-risk investment strategies that could ultimately undermine their solvency. This not only poses financial sector risks, but potentially jeopardises the secure retirement of our citizens. Zero evidence

12 Unreliable investments (2) picture more complex In 1960 s insurers staple assets bonds, equity and property Withdrawal from equity in 2000s driven by regulators Equities: increased use of tracker funds and ETFs Solvency 2 standard formula drives insurers towards Government bonds and shorter dated assets Solvency 2 discourages bond-like assets such as securitisations and equity release which would offer diversification Regulators ambivalent attitude to infrastructure: such projects can present idiosyncratic risks that are not suitable for traditional portfolio management alone Andrew Bulley, Bank of England Is all this wise? Diversification? Herding effect?illusion of safe assets Bank of England report July 2014: Pro-cyclicality and structural trends in investment allocation by insurance companies and pension funds

13 Upheaval in Pensions Market Freedom and Choice April 2015 onwards Positive change for individuals: pensioners control their own money Radical reallocation of responsibilities between policyholders, pension providers and state But what will be the impact on intermediation of savings? 1 billion pounds cash withdrawn in first six weeks Will this trend continue? Or will we see more choosing drawdown/annuity? Early access regimes can co-exist with long-term products Is this the start of a transfer of funds from long-term to short-term investment?

14 So what are the Regulators Doing to Help?

15 FCA objectives and tone at the top Guiding principles the FCA objectives: Protecting consumers Market integrity Promoting effective competition FCAalive to possibilities of new technology Project Innovate, Smarter Consumer Communications Martin Wheatley Supporting Vibrant Markets: Gone is the existential crisis of survival that dominated in 2007, 2008 and Replacing it, a new growth imperative. So, you now have a domestic focus in areas like employment, productivity, pensions and investment But senior level rhetoric not yet matched by action

16 FCA glue on the web Concern about market-sensitive communication Hemmed in by outdated rules in FCAHandbook, often hardwired at EU level Individual officers dedicated to the maintenance of their section of the Handbook Transactional interpretation of consumer protection objectives Judicious use of the rear view mirror Liability risk a deadweight on insurers behaviour Regulatory impact: increased bureaucracy, high levels of caution

17 Conduct rules in Pensions Market Advice FCA rules on regulatory advice grounded in EU MIFID Advice process triggered by a personal recommendation Extensive fact-finding in suitability test Both reasonable concepts but at least 20 years old, and based in pre-computer thinking And the consumer protection provided by rules comes at a cost FCAreluctant to tailor rules to special circumstances of Freedom and Choice Insurers committed to making Freedom and Choice pension reforms a success; vast majority exercise their choice successfully But some customers unable or unwilling to access advice The FCA srules are not enough to ensure that all can feel the benefits of the reforms

18 B of E faith in capital a guiding principle Objectives of the PRA in the Bank of England: financial stability and consumer protection Higher regulatory capital the preferred regulatory tool Key lesson of the banking crisis But what effect does additional capital have in insurance? Leverage and liquidity have less urgency than in banking Desired impact: more time to address emerging risks (IAIS) Disincentive effect but less toxic deterrents available Higher regulatory capital raises price and restricts choice But is capital really a scarce resource right now? Higher capital may be a much greater burden in the future

19 Solvency 2 High cost of implementation Focus on process: documentation, validation Constant reference back to ICA values and limits Regulatory approvals (internal models, transitionals, Matching Adjustment), now crowded into third quarter 2015 Significant policy issues still unresolved High level of regulatory uncertainty Regulatory impact unclear, but likely to be an even safer industry, and increased cost for policyholders Implementation What will be insurers strategic reaction?

20 Conclusion Insurers still need to protect their customers against risk Highly uncertain environment Nothing is as it seems negative interest rates, safe assets Opportunities for insurance in the future But will this be allowed? Regulators are spiders caught in their own webs Impact of prudential regulation an even safer industry and higher cost for policyholders Impact of conduct regulation increased bureaucracy and strategic caution Heed the wise words of Burt Lancaster

21 Everything must change so everything can stay the same