Through gritted teeth, everyone agrees that regulation is a good thing. But, as Adrian Leonard points out, making the change will be expensive

EVERYTHING HAS its price. Regulatory regime change for general insurance in the UK is no different: from the GISC rulebook to N2 to John Tiner's new vision for statutory regulation of the market, insurance companies and intermediaries will have to foot the bill.

But how much does regulation cost? Figures quoted by various experts range as high as an unlikely 10% of expenses. Several rather unscientific rules of thumb have been proposed, including a simple estimate of 3% on the cost base, and the slightly more complex calculation of four times the actual fees charged by the relevant regulatory authorities.

In practice, finding the precise cost isn't simple, and probably isn't even possible. Since N2 changed the fundamental methodology of insurance regulation one year ago, those regulated have had to increase their compliance activities, and thus face an accompanying increased expense. But none is able to say by exactly how much.

"The cost is spread out across our different business units, and is not calculated centrally," says a Norwich Union spokesperson. "However, as an indication, the cost is significantly more than under the old regime."

Costs of compliance
Royal & SunAlliance will go only as far as saying the cost of compliance with the new N2 regulatory regime is "probably" significantly more than under the old regime. Direct Line also reports increased costs. A Direct Line spokesman says: "To become FSA compliant, we have had to increase headcount and alter certain processes to ensure that we meet the full requirements."

Churchill, which says the cost of specific regulatory initiatives on their own are "impossible to quantify", has coped with the additional workload brought by N2 without increasing existing resources. However, it says: "The real cost to Churchill is the cost of our staff spending time on N2, when they could have been doing something else."

Behind the comments lies a recognition, albeit a grudging one, that regulation is inherently good. Implicitly, insurers indicate that the cash they spend on compliance is money well spent, provided it leads to a marketplace that consumers trust, where catastrophic failures are prevented, and that regulation costs do not spiral out of control.

Consumer benefit
The Direct Line spokesman says: "FSA regulation is for the benefit of the consumer, which can only be a good thing, and something which we believe is worth investing money in." And health insurer Bupa has a similar line. A spokesman says: "Regulation is, in the main, good business practice. Where N2 compliance has improved our processes, it represents fair value."

But Allianz Cornhill commercial lines executive Bob Eveleigh warns against a regulatory panacea.

"In the long run, the cost of regulation will be good for the industry or the customer only if it is effective and gives protection in the areas where it is most needed.

"It would be a brave man to guarantee that no other insurers will ever go out of business, but the increased requirements for risk-based solvency will offer more security to the public. The key issue in all of this will be the efficacy of FSA's monitoring."

Eveleigh thinks the direction of the current regime could have a dire cost for some smaller insurers: forcing them to change their business profile.

"Companies will need to meet solvency requirements that are based on the exposures that they write. We will have to wait and see what affect this has on small insurers, but it is likely that some will not be able to write the same book of business that they did in the past."

A Zurich spokeswoman takes a slightly more defensive view. She says: "What we need is not more regulation, but more effective regulation.

"Regulation is only strictly necessary if competition cannot be made to work well enough to protect the public interest without it. When sufficient competitive pressure emerges in a market, regulators can and should reduce regulatory intervention accordingly."

Groupama service quality manager Colin Darnell says the way management approaches regulation is as important as its cost.

"We treated the GISC rulebook as fundamental business best practice, notwithstanding the requirement to comply with it," he says. "We have taken the same approach with the FSA rule book. It is a very detailed best practice guideline, and we try to treat it that way."

Norwich Union's spokesman took a similarly optimistic approach. "We are also looking at ways to improve best practice and so welcome new initiatives," he says. Pricewaterhouse Coopers regulation partner David Taylor says the approach is the correct one. "For some, the debate gets concentrated on the burden arising from a particular compliance regime. More practically, the issue is for firms to assess how efficiently they implement whatever regime is there."

Risk management
Since regulation is about managing risks, he says, companies should use regulation to assist in assessing whether they manage risks effectively.

Taylor adds: "There is a link to governance concepts here. We are spending a lot of time talking to boards of directors about being aware of risks and managing them, and putting in place an efficient and effective control framework. The interaction of the group risk, group audit, group compliance, and equivalent functions can impact on the cost of compliance."

On a more down-to-earth level, Darnell describes the implementation process at his company as a simple gap analysis of current practice and best practice as suggested by legislation. "We see what the rulebook requires, what we do at the moment, and where the gaps lie," he says.

He reveals that Groupama discovered a 'best practice' gap during implementation of the GISC regime. He says: "We didn't have a requirement for a CDP [Continuing Professional Development] regime, but we have now devised and implemented one.

It is both a cost of regulation and of doing business; it depends how you look at it."

He says that although Groupama has not costed regulatory compliance per se, he believes the cost will ultimately reach "two to three per cent." However, he notes that each new regulatory requirement does not bring a whole new set of costs.

Darnell adds: "We have a lot of stuff already in place - recruitment procedures, appraisals, and record-keeping regimes are already there."

However, he points out that the burden may fall much more heavily on smaller companies - particularly small intermediaries faced with GISC and N2 regulation, wrapped up in the EU's new Intermediary Directive.

"For example, the requirements for approved persons are not too difficult for us," Mr Darnell explains. "When you already have a regime in place that includes competency-based appraisals and job descriptions, it is simple to explain the additional responsibilities that an approved person acquires, and where appropriate, include them in the individuals' job descriptions. However, for a small intermediary, it might be a big step to get that up and running."

The point is pertinent. While philosophical questions about the attitudes toward the cost of regulation continue, the reality for insurers is that very measurable costs are about to increase. In its 1 October publication The Future of Insurance Regulation: A progress report, the FSA outlined increased fees for supervision.

When the so-called Tiner Project was announced in 2001, the FSA increased the total fees it levies on insurers by £1m to cover the new costs, over and above the previous levy of about £20m. Now that the project has been outlined in more detail, the costs have crystallised, too.

The document states"One effect of the actions we are taking to be a smarter regulator of insurance will be higher regulatory fees for insurance firms.

"As foreshadowed in our November 2001 report, the FSA's expenditure for 2001/02 was increased during the year by £1m, to allow for the costs of more intensive regulation of the insurance sector. Our budget for 2002-03 made provision for an increase of £2.8m to enable this work to continue, for example through increasing the number of staff employed in insurance regulation."

Incumbent staff transferred from the old DTI regulatory regime have been extensively retrained, as their job is evolving from the simple assessment of insurers' statutory returns to one of proactive risk assessment of insurance companies. To help, the FSA has already increased its insurance supervisory headcount by 25, most of whom joined from insurance companies. There are currently 35 former industry insiders on the FSA payroll.

Indirectly, all of these supervisors are still on the insurance sector's payroll. Fees to fund the insurance supervisory department of the FSA are paid in blocks calculated according to a formula based on the regulated company's assets. Broadly speaking, the bigger a company is, the more it is required to pay.

The formula means, ironically, that if a given company has a higher-than-average ratio of assets to premium, it must pay a greater share of the cost of regulation than a company which is more highly geared, despite being inherently 'safer' due to its higher solvency.