Issue No.8 September 2006

Transcription

1 Life Insurance Newsletter A regulatory update from the Insurance Sector Team Issue No.8 September 2006 Introduction Welcome to the eighth edition of the Life Insurance Newsletter in which we aim to bring you up to date with regulatory developments over the past four months. One of the most significant developments has been our publication of a suite of documents providing more detail on our Treating Customers Fairly (TCF) initiative. As the sponsoring Director of this important initiative, this is a subject in which I take a keen interest. Many firms have made good progress and the challenge now is to translate this into tangible changes in outcomes for consumers. Meanwhile, I believe the new deadline of March 2007 for firms to reach the implementing stage of their TCF work is not only attainable but essential to ensure TCF makes its way into the core of all firms. If you want more information there s an article about TCF on page 4, but I would also urge you to read the new information on our website, which can be found at This edition of the newsletter also includes: an update on the Quantitative Impact Study 2 (QIS2) process for Solvency 2; changes and developments concerning the ICAS framework; our observations on the influx of new authorisations into the bulk purchase annuities market; and more detail on our thematic work on post-sale communications. I hope you will find this issue useful and thought provoking, and, as ever, the team would be happy to receive any ideas for future issues. Sarah Wilson Insurance Sector Leader The 3rd annual Insurance Sector Conference will be held on 21 March 2007 SUPERVISION AND PRUDENTIAL ISSUES Solvency 2 The Committee of European Insurance and Occupational Pension Supervisors (CEIOPS) recently began a second quantitative impact study (QIS2) to help develop the new EU Solvency 2 framework for insurers. In this latest study, CEIOPS asked a range of firms across Europe for information about provisions calculated on a best-estimate basis, with a market consistent valuation of options and guarantees, and with a risk margin in the provisions for non-hedgeable risks. These risk margins will be assessed on both a 75th percentile approach and a costof-capital approach. In addition, firms were asked to evaluate the potential impact of some possible new capital requirements. Firms will assess the 75th percentile provisions for life insurance liabilities to ensure they cover potential variations in mortality, expenses, and lapses with broadly a 75% level of confidence over the duration of the portfolio. Cost-of-Capital is a relatively new approach being developed by some large insurance firms within Europe. Essentially, it starts from the best estimate provisions and adds a margin to show the cost of servicing the capital that firms need to hold to cover their insurance and other non-hedgeable risks. Including risk margins in insurance provisions is, of course, consistent with our principle that says firms should include prudent margins for adverse experience. However, it is worth noting that it differs from the current practice applied to assess the realistic peak for the socalled realistic basis with-profits reporters. We are pleased that around 35 UK firms agreed to provide valuable information for this study. A summary of their contributions should be available in October.

2 The proposed new capital requirements should provide 99.5% confidence that firms will have enough assets to cover their liabilities in 12 months time. To do this, liabilities need to include the risk margins assessed on one of the two approaches suggested above. This will ensure that the business could either be transferred to a well-diversified third party or recapitalised by the existing owners. The calibration for QIS2 was intentionally quite tentative. CEIOPS will be doing more work in the future to decide the appropriate parameters to match the chosen capital standard. In contrast to the present scenario-based approach that was introduced as part of the realistic reporting regime for UK with-profit offices, the suggested capital requirements in QIS2 are largely factorbased. This is seen as being a more practicable approach for most European firms. The factors should cover both parameter uncertainty and statistical variability in the provisions. Firms should calculate factors separately for each risk component - i.e. financial market risk, credit risk, underwriting risk (including both persistency and expenses for life business), and operational risk. These components are then combined through a set of correlation matrices (based on assumed tail correlations) to allow for some potential diversification benefits between different risks. However, this raises the difficult issue of how to allow for the ability of life firms to reduce bonuses to policyholders in adverse conditions. The Comité Européen des Assurances (CEA), the European industry association, have suggested a so called Kfactor approach to resolve this issue, which essentially reduces the capital requirement by a proportion of the value of future bonuses. However, this approach is likely to need considerable further development to produce a workable and generally acceptable solution. CEIOPS currently envisage that firms will be able to use their own internal models, subject to supervisory approval, in place of the standard approach for capital requirements. In many ways this may resemble the ICAS assessment currently made by firms here. There is likely to be a supervisory review process similar in concept to the Individual Capital Guidance (ICG) regime currently applied for UK firms but the full details of how this would operate have not yet been decided. The design and calibration of the capital requirements will be refined further once the QIS2 results have been analysed. A QIS3 is then expected to be launched next spring. This will test out the refined specification and will include some proposals on how to address group issues. Page 2 There may well be a number of further developments before the Solvency 2 framework is finalised, in time for its implementation, expected to be around Changing Life Insurers Reserving and Capital Requirements and further development of the ICAS framework We have recently published a Consultation Paper (CP) proposing a fuller specification of the ICAS framework through the introduction of FSA highlevel rules and guidance. In the same CP we are consulting on changes to the life insurers reserving and capital requirements under Pillar 1. In order to allow life firms to take advantage of such changes for 2006 year-end reporting purposes, and to avert the need for firms to submit numerous waiver requests, we are shortening the consultation period to 6 weeks, to allow a Policy Statement to be issued before the end of We have set out an overview of our current thinking below. We have also included within this CP four Policy Statements. These are as follows: Chapter 3 of CP05/14 (Quarterly consultation (No. 6)) published in October 2005 where we consulted on disclosures for financial reinsurance; CP06/12 (Implementing the Reinsurance Directive) published in June Chapter 4 of CP06/13, (Quarterly Consultation (No. 9)) published in July Chapter 5 of CP06/10 published in May 2006 which described our plans to revise the structure of the prudential sourcebooks within the Handbook, in relation to insurers. All other aspects of CP06/10 will be covered in a separate FSA Policy Statement, which we aim to publish later in the fourth quarter of This approach means we are collating in one document our recent proposals for the insurance industry, which we hope you find helpful. Summary of Life Insurers Reserving and Capital Requirements Proposals We have examined our current regime for life insurers to identify areas of super-equivalence that may no longer be justified in our existing Pillar 1 requirements. We believe there is good scope for change, provided firms ensure they maintain sufficiently prudent technical provisions overall, to reflect the following:

3 1. to allow non-attributable expenses to be set for each homogenous risk group within mathematical reserves and not at an individual contract level, for all types of non-profit business. Expenses directly attributable to an individual contract would still require consideration within mathematical reserves at that individual contract level; 2. to allow life policies that include no guaranteed surrender value in the policy wording to be valued as assets within mathematical reserves. In order to ensure consistency between direct writers and reinsurers, we propose extending the scope of CP06/12 wider than just protection business; 3. to allow firms to make a prudent lapse rate assumption within mathematical reserves for all classes of long-term business. Again, in order to ensure consistency between direct writers and reinsurers, we propose extending the scope of CP06/12 wider than just protection business; and 4. for with-profits firms within the realistic peak, provisions should allow a deduction for the economic value of future internal transfers made out of that fund from the capital requirement of the with-profit fund. This would reduce the withprofits insurance capital component by the value of these future transfers. 5. To remove the requirement for realistic reporters to calculate the resilience capital requirement. Further development of the ICAS framework We are working with the industry to draft a more developed set of ICAS principles reflecting the progress made by both us and firms in understanding how best to model capital requirements. Our proposals will enable us to articulate a minimum set of supporting principles to underpin the requirement that firms maintain adequate financial resources. This will give firms a clearer understanding of our requirements and expectations regarding Individual Capital Assessments (ICAs). This is especially relevant, given our life Pillar 1 proposals, as we will be placing more reliance on the ICA results as a risk-based measure of the capital a firm must maintain. The CP includes some associated Handbook guidance to support the fuller statement of the principles. We understand that a number of trade associations are jointly looking at the possibility of issuing complementary industry guidance to sit alongside our Handbook provisions. We are, of course, happy to offer comments on this material as it is prepared. The introduction of ICA principles will not require firms that have already had their ICAs assessed to have them re-reviewed. Agreed timetables between firms and their supervisors regarding their future ICA submission reviews will remain unchanged. Insurance Special Purpose Vehicles (ISPVs) The EU Reinsurance Directive (RID) came into force on 10 December 2005 and must be implemented across the EU by 10 December We issued Consultation Paper CP06/12 on 20 June setting out the bulk of our proposals for implementing the RID, and our intention to enable firms to benefit from them as of 31 December 2006 for year-end reporting. One of our proposals which will potentially benefit both insurers and reinsurers is the introduction of a fit-for-purpose framework for ISPVs established in the UK. This will incorporate authorisation and prudential requirements that are proportionate to the risk. Responses received to CP06/12 are supportive of our proposals for ISPVs and we are now preparing to implement them, taking the detailed responses into account. We believe our proposals for authorising ISPVs will enable applications to be processed much more quickly than the current average of four months for insurers and should encourage greater participation in the ISPV market. We are developing a streamlined authorisation process and application pack. This is likely to be available by the end of October, when our Board is expected to make the legal instrument implementing the rule changes and we will publish it. The business supplement part of the application pack will not be available until then. But firms can begin, if they wish, to draft their applications by completing existing authorisation forms available on our website at: Forms/packs/partiv.shtml such as those relating to controllers, approved persons and systems. We anticipate that firms transferring risk to ISPVs will wish to take credit for them on their regulatory balance sheet. A key test will be compliance with the proposed risk-transfer principle and this will require a waiver to be granted. The Waivers form is already available on our website, at: waivers/application_form/w_form.pdf, so again firms can begin to draft this. So we have sufficient time to consider the issues of authorising ISPVs and any associated waiver applications in time for 31 December, we must receive applications by 17 November at the latest. Page 3

4 Firms thinking of establishing ISPVs should make early contact with either their usual supervisor or with Matthew Hazell (Tel: ) of the Authorisation Team, Colin Cairns ( ) or Christopher Cave ( ) of the Waivers Team. Permitted links It has recently come to our attention that some firms have been operating in breach of the rules surrounding permitted links, possibly due to a misunderstanding of the how they operate. Consequently firms writing linked long-term business are reminded that where policyholder benefits are to be linked to property (or to any other class of assets set out in paragraphs 1 to 10 of Part I of Appendix 3.2 to IPRU (INS)) via a collective investment scheme, the scheme must either: (1) be a UCITS; or (2) meet the conditions in paragraph 5(b) of Part I of Appendix 3.2 to IPRU(INS) i.e.: (i) the property of the fund comprises property of any of the descriptions in paragraphs 1-10 of Part I of Appendix 3.2; (ii) the units are readily realisable at a price which represents the net value per unit of the assets and liabilities of the fund; and (iii)the price at which the units may be bought and sold is published regularly), the firm will first need to apply for a modification of IPRU(INS) 3.7R. If such a scheme itself holds units in another collective investment scheme as an investment, the tests have to be applied again to that second scheme. If necessary, the process has to be repeated until the underlying non-collective investment scheme assets are reached. We have committed to a review of the permitted links regime in our 2006/07 Business Plan, and we aim to publish a Consultation Paper in the first quarter of This review is under way, but in the meantime the current permitted links rules still apply. If you would like more information, please see the Applying for a Waiver page on the FSA website. It also includes a streamlined application process for modifications by consent for certain permitted links. CONDUCT OF BUSINESS ISSUES Treating Customers Fairly (TCF) On 19 July we published a series of documents that further explains our Treating Customers Fairly initiative. These are set out on our website at and include: Our latest progress paper: Treating Customers Fairly - Towards fair outcomes for consumers. A number of cluster reports delivering the results of our thematic work. These include reports on: quality of advice; management information; mortgages; and general insurance. Further case studies (in addition to those published in 2005), designed to help firms consider what they need to do in various scenarios. The new case studies are centred around: quality of advice (x2); designing and selling a new product; and marketing and promotion. Many firms in the life sector have made the significant progress and we also encourage these firms to maintain their momentum. Firms should by now be seeking to make TCF an integral part of their business culture. TCF should be seen as a continuous process it is not something that firms can simply implement and then forget about. For those firms that are lagging behind in their implementation, we have set a target to reach at least the implementing stage of their TCF work, as per the FSA definition - in a substantial part of their business by the end of March We will be using this as a benchmark when we next review firms progress. A number of firms have told us they are implementing TCF programmes. But even in these cases, where we have found high levels of senior management commitment to the fair treatment of customers, it is often apparent that this commitment is not yet being translated to the front-line of firms activities. A prime example of an area in need of improvement is the quality of advice being given to retail customers many firms need to improve the way they give financial advice to reduce the risk of mis-selling. Page 4

5 The TCF initiative aims to deliver six improved outcomes for retail consumers that firms should be focused on trying to achieve. The outcomes we have identified for customers will mean they: deal with firms where the fair treatment of customers is a key part of the corporate culture; are marketed and sold retail products that have been designed to meet their needs and are targeted accordingly; receive clear information and are kept suitably informed before, during and after the point of sale; receive suitable advice which takes account of their circumstances; receive the product performance they have been led to expect by firms they deal with - and the service is both of an acceptable standard and as they have been led to expect; and do not face unreasonable post-sale barriers imposed by firms when they want to change product, switch provider, submit a claim or make a complaint. We plan to measure the success of these outcomes through various means: our day-to-day supervision of individual firms; thematic work; the Financial Capability baseline survey; our consumer surveys; and other relevant data provided to us by the Financial Ombudsman Service (FOS) or directly by firms. This will be included as part of the next steps in our work on TCF. Our work plan in the coming period will focus on: embedding TCF in all aspects of our regulatory and supervisory approach; continuing to provide support, for example training and targeted communications to help firms implement TCF; investing in our own internal systems and training to help ensure our supervisors have the tools they need to help firms implement TCF and to form the types of judgement that more principles-based regulation requires; more targeted work on those aspects of the consumer outcomes where we are less wellinformed, notably on product design and the cultural elements of TCF; and analysis of firms own assessments of progress with their TCF initiatives. We will be looking to firms to demonstrate for example, using their own management information how they are building TCF into all they do. There are still some firms that continue to deny TCF has any relevance for them, or fail to take appropriate steps to work out what changes may be required and start implementing them. We reiterate that Principle 6 (a firm must pay due regard to the interests of its customers and treat them fairly) applies to all authorised firms. Consequently, we will be more inclined to instigate enforcement action if a firm s systems or actions leave open the potential for consumer detriment or where actual detriment has occurred. Next year, we expect to start seeing measurable change in the outcomes we have set for consumers both through management information implemented by the industry and in our own firm-specific and thematic supervision work. We welcome the work of many trade associations so far in helping to translate the concept of TCF for their members through good practice guides and case studies and we encourage them to continue to help us embed good practice throughout the industry. Bulk purchase annuities In recent months there has been much speculation in the media over the level of activity in the bulk purchase annuities (BPA) section of the insurance market. Applications for authorisation of new life insurers are typically rare, so the emergence of a number of prospective new entrants has prompted much discussion over the potential for growth in this part of the market. Previously, the BPA section played a supporting role for the market. However, this increased activity seems to suggest this role may grow. With current life insurance market incumbents and entirely new life insurance firms both looking to enter this market, we have been required to assess the credibility of a number of propositions. ICAS has proved to be an excellent tool for assessing this credibility and also provides an illustration of how the BPA market will be subject to the same rules as all other insurance firms we supervise. Any potential new entrants to the BPA market will be subject to the same rules, including both conduct of business and capital requirements, as all insurance firms. This includes, of course, the requirement to treat their customers fairly. As a result, policyholders in schemes transferred to these new entrants will enjoy the same protections granted to all insurance policyholders. Post-sale communications Disclosure is an area of significant importance in the process of product sales. Point-of-sale disclosure is fundamental to customers ongoing understanding of their life insurance products. However, this is just the start of a relationship in many cases a significant Page 5

6 period of the customers life is spent holding a product as a result. Point-of-sale documentation must be clear, fair and not misleading, and so should communications in the post-sale period of the relationship. Customers make a judgement at the point-of-sale stage as to whether the product will meet their needs. But, given the potential for changes in the lifestyle and life circumstances of the customer, firms should give them information that enables them to re-assess this throughout the product s life cycle. There are two distinct types of post-sale disclosures: those mandated by our requirements, and those that are voluntary, driven by trade association initiatives. Too often, post-sale information of both types fails the clear, fair and not misleading test. Mandatory communications The key mandatory post-sale disclosure is the Principles and Practices of Financial Management (PPFM) and its Consumer Friendly counterpart (CFPPFM). In the last edition of this newsletter, we outlined and emphasised our specific areas of concerns over these documents and their disclosures. However, there is a broader point to be made about these documents. The high level of correlation between the details of the PPFM and the CFPPFM is causing issues with the complexity of the consumerfacing document. Often, PPFMs are not of a sufficient quality to engage the adviser population, and so CFPPFMs suffer from the same issues. It is important that the advisers are familiar with PPFMs of not only the business they are currently selling, but also for the funds that their clients have policies with regardless of whether they sold the policy in the first place. Firms should apply more effort in this particular area for two reasons. The first is to increase the quality of information provided to policyholders by increasing the quality of CFPPFMs through improvements in PPFMs. The second is to allow insurers to be confident they have done their bit to ensure advisers have the appropriate tools to understand and be in a position to give good quality advice to their clients. Voluntary communications Our concerns about voluntary communication relate primarily to the distribution of annual policy statements an ABI led initiative. While we very much support the production and distribution of this information, we do have concerns over the complexity of these documents. Often, they are highly complex, and do not take into account the level of financial capability of the average customer. In the current situation where an average consumer may struggle with the use of percentages complex details of terminal and reversionary bonuses clearly are not tailored to the target audience. Page 6 Given the serious nature of the issues outlined above, we feel that a closer look at these issues is necessary. So we have recently begun a targeted thematic review of firms post-sale communications to identify examples of good and bad practice. We will publish our findings later in the year. In similar fashion to last year s work on PPFMs, we will look to name and praise firms providing high quality information to their policyholders mandatory or otherwise that enables them to decide whether the policy continues to meet their needs. Retail Intermediaries - Sector statistics Recognising a demand from the industry for statistical information regarding the numbers of firms operating in different segments of the market, we have decided to publish statistics relating to key areas of the retail sector. These statistics will go live on the FSA website during October. You can find them on the Retail Intermediaries Sector team pages: /Pages/About/Teams/Retail/index.shtml We have provided details on the number of firms in each of the three main sub-sectors (financial advisers, general insurance intermediaries and mortgage intermediaries), together with their legal status, the number of firms holding client money and the number of appointed representative firms. New Authorisation of Life Insurers 27 June Paternoster UK Limited Dates for the Diary On 7 November, we are holding a conference on Treating Customers Fairly. The conference Delivering fairer outcomes for consumers will include speeches by Clive Briault, Managing Director of the FSA Retail Markets Business Unit, Sarah Wilson Director of Retail Firms Division, Insurance Sector Leader and Sponsoring Director of TCF, in addition to a number of representatives from industry. On 21 March 2007 Sarah Wilson will host the 3rd annual Insurance Sector s Conference. Contact details If you have any queries on this issue of the newsletter, please contact: Duncan Scott duncan.scott@fsa.gov.uk Alison Phillip alison.phillip@fsa.gov.uk