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Regulation and the future of the insurance industry

The Deputy Head of the UK’s Prudential Regulatory Authority (PRA) and interim Executive Director of Insurance Supervision Paul Fisher, gave a speech on Regulation and the future of the insurance industry last week in which he explained that the successful implementation of Solvency II is a top priority for the PRA. Solvency II is a maximum-harmonising Directive across Europe with a key objective of promoting cross- border supervisory co-operation. With transposition of the Directive into the UK rulebook underway, the PRA will be open for applications for internal models and matching adjustment from April 1, 2015.

Mr. Fisher reiterated the PRA’s belief that the UK insurance industry is in a good position, having had the risk-based Individual Capital Adequacy Standards (ICAS) regime for ten years. The PRA is “not looking to use Solvency II as an opportunity to raise capital requirements across the board” and will implement the Directive as intended, without “gold plating”. He continued, explaining that the legislation of Solvency II strengthens the connection between capital and risk management allowing flexibility for firms’ management to decide upon their chosen risk appetite and the precise details of their risk models. He reiterated the position that the PRA is not looking to “fix firms’ business models to be identical, nor to restrict the level of innovation across the market. Rather, Solvency II seeks to promote a better understanding of the risks being taken, allowing insurers to take informed decisions.”

The introduction of the Prudent Person Principle says Fisher, is an example of how strategic decision making and risk supervision will be owned by the insurer and its management. The shift from quantitative to qualitative rules means insurers will have more flexibility in their investment choices. The Prudent Person Principle will ensure that firms fully understand and manage their investment risks. Specifically, insurers must be able to demonstrate that they can “properly identify, measure, monitor, manage, control and report on their investment risks and not place reliance upon information provided by third parties”.

The PRA wants to avoid undue influence on the asset allocation behaviour of insurers and will not promote one asset class over another. The PRA recognises that life insurers can be an important source of long-term, stable financing for corporates, infrastructure and mortgages. “Gone are the old investment limits for asset classes. So insurers will have much more freedom in their investment choices” said Fisher.

On the role of management, Fisher mentioned that there has been some industry uncertainty around the PRA’s expectations of non-executive directors for firms that have internal risk models. He expanded that non-executive board members are not expected to be technical experts in risk modelling; however, each board collectively should understand the key strengths, limitations and judgements within their model. The PRA wants non-executives to have “the right tools and sufficient knowledge to be able to challenge model outputs, rather than follow them slavishly”.

The PRA also acknowledges some other challenges facing the insurance industry, in particular the changes to the UK taxation system of the ‘at retirement’ market. This will have a significant impact on some insurers’ business models. The changes to the annuity market for example, will alter business models which will naturally lead to changes in risk exposures which will need to be carefully considered and managed by both insurers and regulators alike. The PRA remains, states Fisher, committed to working openly and transparently with the insurance industry to get the best outcome.

The day after Paul Fishers speech, the PRA published a Consultation Paper | CP3/15 Solvency II: transitional measures and the treatment of participations, which describes the UK’s proposed approach to implementing Solvency II’s transitional measures on risk-free interest rates (article 308c); technical provisions (article 308d); and the phasing in of the Solvency Capital Requirement (SCR) for insurers that will meet their pre-Solvency II Required Solvency Margin on 31 December 2015, but cannot meet their SCR in 2016 (article 308b).

Paul Fishers full speech is available here.

The Consultation Paper Solvency II: transitional measures and the treatment of participations – CP3/15 is available here.

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