UK insurance regulation – the big picture and what will change

Since January 2005 the entire insurance industry has been regulated by the FSA, the UK financial services regulator. In June 2010, the UK government announced the abolition of the FSA.

History of regulation

The industry originally set its own standards of governance. In 2001, the FSA took over the roles of the former Department of Trade and Industry and the General Insurance Standards Council, placing regulation of the industry under one body.

In January 2005, regulation of general insurance intermediaries also became the FSA’s responsibility. This followed the EU insurance mediation directive, which set minimum standards for the sale and administration of both general insurance and life insurance.

Regulatory philosophies

In 2007, the FSA introduced 10 guiding principles. These required a company to:

• conduct business with integrity;

• conduct business with due skill, care and attention;

• take reasonable care to organise and control its affairs responsibly and effectively, with adequate risk management systems;

• maintain adequate financial resources;

• observe proper standards of market conduct;

• treat customers fairly;

• manage conflicts of interest fairly, both between itself and its customers and between a customer and another client;

• pay dues regard to the information needs of clients and communicate to them information that is clear and fair;

• take reasonable care to ensure suitability of advise and discretionary decision for customers who are entitled to rely on the financial institution’s judgment; and

• provide adequate protection where it is responsible for clients’ assets.

This principle-based regulation makes companies and individuals responsible for aligning business objectives with FSA-required outcomes. It replaces rules-based regulation that required companies to follow a set of rules.

Following the financial market dislocations of 2008, the focus of the FSA changed to outcomes-based regulation. Previously, the authority had seen its role as assessing if companies had the mechanism to achieve the desired outcomes; individual managements had been left to make the right judgments to achieve these outcomes.

From 2009, however, the FSA stance changed from regulation based on judgments on observable facts, to regulation based on judgments about company management. This is a more intrusive style of intervention.

In May 2010, the Conservative-Liberal Democrat coalition announced the abolition of the FSA. Its proposed new system includes three new bodies and a new committee to manage different aspects of regulation. These are:

• The Prudential Regulation Authority: this will be a subsidiary of the Bank of England. Together with the new Bank of England Financial Policy Committee, the PRA will be responsible for protecting the economy against a financial crisis, taking preventative action when necessary. The committee will also watch for systemic risk – actions taken inside the financial sector (including banks) that could threaten stability.

• The Consumer Protection and Markets Authority: this will regulate the conduct of every financial services business. This will include all banks, insurance companies and regulated firms. It will also oversee the Financial Ombudsman Service, the Financial Services Compensation Scheme and the new Consumer Financial Education Body (CFEB).

• A new economic crimes unit: this will take over the role of fighting white-collar crime.

As of July 2010, it is not known how regulation will be split between these new bodies. It is believed the current set-up of the FSA in relation to insurance regulation may provide some clues.

What does being regulated by the FSA currently mean for the insurance sector?

The FSA has wide ranging powers to make rules, investigate regulated firms and enforce compliance through sanctions. It directs its activities around four major objectives, two of which, maintaining market confidence and securing the appropriate degree of protection for consumers, create a significant amount of compliance work for regulated insurance firms.

• Maintaining market confidence. Regulating the financial position of large players whose failure could cause market dislocations is an important activity for the FSA. It currently achieves this objective for (re)insurers by ascertaining that firms meet individual capital adequacy standards (ICAS) to support the level of risk that they carry. But the ongoing EU-initiated Solvency II project will replace ICAS in 2012 creating even more onerous compliance issues for regulated firms in the sector. Solvency II aims to ensure that firms meet an EU-wide standard for capital requirements and employ valuation techniques and risk management standards.

• Securing the appropriate degree of protection for consumers. This has a particular impact for insurance intermediaries. Since December 2008 under the FSA’s ‘Treating Customers Fairly’ initiative, firms must be able to demonstrate that they have instilled a culture that delivers fair outcomes for customers. To reinforce their regulatory clout in this area, in January 2010, the FSA appointed a new consumer champion to drive the agenda for better consumer outcomes thereby helping to rebuild consumer trust in financial services including insurance.

• Fighting financial crime. The FSA’s role is to reduce the extent to which it is possible for financial business to be used for a purpose connected with financial crime and includes any offence that involves money laundering, fraud, dishonesty or market abuse. To achieve this, the FSA uses sanctions at its disposal as deterrents such as fines or removing authorisation to trade. As the regulator, it ensures that firms comply with the requirements of any anti-crime legislation such as the third EU anti-money laundering directive that came into force in December 2007.

• Promoting public understanding of the financial system. The FSA-owned website, MoneyMadeClear is an important asset in achieving this objective. The website, aimed at consumers, provides impartial help and information about insurance products. For example, the FSA uses the website to promote better understanding of payment protection insurance (PPI) as one means of countering perceived sharp practice within the financial services industry and can force PPI providers to submit the relevant data that it needs for its product price comparison tools. The Moneymadeclear website is already carrying the logo of the new CFEB.

• In recent years, the many directives originating from the EU in Brussels and transposed into UK law under the auspices of the Treasury, has caused the FSA to direct significant efforts to consultation and advisory activities with the industry. Solvency II consultations are ongoing.

How does the FSA currently supervise the insurance sector?

Direct regulatory supervision is undertaken by the FSA’s supervision business unit, one of the FSA’s three divisions. (The other two divisions cover operations and risk.) Within this business unit, the wholesale insurance department is responsible for the supervision of commercial insurers and the London insurance and reinsurance market, including Lloyd’s. Larger general insurance intermediaries with a largely commercial customer base and any general insurance intermediaries that are in run-off are also supervised by this department.

Other general insurance intermediaries are regulated by another part of the supervision business unit, the small companies division, where many regulated entities’ interactions with the FSA can be conducted online. Definition of a large or small firm is based on the degree of risk the entity poses rather than the actual size of the business.

The identification and mitigation of insurance sector risk is undertaken by the risk business unit. This unit formulates policies for risk mitigation and conduct of business in insurance that are implemented by the supervisory division.

The FSA Handbook is the reference manual that lays down the ‘rules of the road’ for all sectors including insurance.

From where can more information about UK insurance rgulation be obtained?

The FSA: http://www.fsa.gov.uk/Pages/about/index.shtml

Moneymadeclear: http://www.moneymadeclear.org.uk/products/insurance/insurance.html

Bank of England: http://www.bankofengland.co.uk/financialstability/index.htm