The requirements, which will be finalised by the close of 2004, are applicable to life insurers' with-profits funds, non-life insurance companies and reinsurers, and will ensure that the capital held by insurance firms is more closely aligned to the risks of the business that they write. In turn, this will mean that consumers enjoy greater protection as firms make better assessments of the capital they need to meet their liabilities.
David Strachan, the FSA's Sector Leader for Insurance, said:
"The FSA has undertaken a radical programme of reform of insurance regulation. This has sought to deal with weaknesses in the rules that we inherited on both capital adequacy and the way in which companies treat their customers. Today's policy statement marks a step change in the way insurance companies calculate how much capital they are required to hold. This is particularly important for companies which write with-profits business where provisioning and capital requirements will now be more closely linked to the payments and bonuses that policyholders expect.Since publishing the original proposals for consultation, we have worked closely with the industry to refine the new capital requirements, resulting in a balanced approach that will better align the capital that firms hold to the risks they run. This will serve policyholders better.
The industry has come a long way in the last couple of years and I acknowledge the time and resources it has devoted to getting to grips with our reforms. The emphasis now, though, must be to move from consultation to implementation so that these reforms become a reality, the benefit of which can be felt by industry, regulator and consumers alike."
The rules confirm the approaches to be taken on capital requirements for insurance firms. Large firms writing with-profits business will be required to hold capital equivalent to the greater of their statutory requirements (based on EU Directives) and a new realistic calculation of their expected liabilities. This year some firms published a modified realistic calculation as part of the transition to the new regime. Non-life insurers will continue to meet the statutory solvency requirements (based on EU Directives), but in addition will provide a risk-based enhanced capital calculation to the FSA on a private basis.
All firms will be required to make their own assessments of their capital needs (Individual Capital Assessments). These, in turn, will be used by the FSA when we give firms individual capital guidance (ICG) reflecting our own view of the capital required to support their individual business profiles.
Background
- The rules contained in the policy statement will be made by the FSA Board in November this year and will take effect on 31 December 2004. Firms with financial years ending on 31 December 2004 or later will be required to complete their annual returns on the basis of the rules in the policy statement.
- CP190 was published in July 2003, and CP195 was published in August 2003.
- The rules will form part of the FSA's Integrated Prudential Sourcebook. This takes effect for insurance firms from 31 December 2004, and for banks and relevant investment firms at the end of 2006.
- Responses to the consultation paper along with the calibration work carried out by consulting actuaries Watson Wyatt have helped the FSA refine a number of the more technical aspects of the requirements for with-profits business. The report by Watson Wyatt is available on our website.
- Compared with the consultation proposals, the main changes to the realistic solvency calculation that large with-profits firms will be required to undertake are:
- revising certain requirements applicable to the realistic balance sheet, for example, increasing the range of admissible assets by including a wider range of derivatives and the embedded value of a subsidiary;
- changes to the instruments that can be used in calculating capital, e.g. confirmation that subordinated debt is eligible as capital to cover realistic as well as statutory (EU) capital requirements;
- recalibration of the stress tests used to calculate the risk capital margin (RCM). The research carried out by Watson Wyatt has enabled the FSA to reduce some of the risk margin factors used to calculate the RCM; and
- changes to the credit risk test.
- revising certain requirements applicable to the realistic balance sheet, for example, increasing the range of admissible assets by including a wider range of derivatives and the embedded value of a subsidiary;
- For non-life insurance business there are two key changes in the policy statement, in response to the comments that we received in the consultation:
- confirmation that the enhanced capital requirement (ECR) will, for the moment, be privately reported to the FSA and not a "hard" capital requirement. The ECR will be used both as a benchmark and as a basis for considering a non-life insurer's ICA; and
- the exclusion from the ECR calculation of insurers' investments in collective investment schemes that hold only money market instruments.
- For both non-life and life insurers, we are asking that ICAs provided to us show results based on a confidence level equivalent to 99.5% over a one-year period. This will ensure consistency between firms, even if insurers also wish to adopt a higher standard for their own management purposes.
- Further details about the policy statement can be found in a briefing note that is available from the Press Office.
- The FSA regulates the financial services industry and has four objectives under the Financial Services and Markets Act 2000: maintaining market confidence; promoting public understanding of the financial system; securing the appropriate degree of protection of consumers; and fighting financial crime.
- The FSA aims to maintain efficient, orderly and clean financial markets and help retail consumers obtain a fair deal.
