19 April 2012

FSA/Adams: The new approach to insurance regulation and the implementation of Solvency II

The proposal is to make the Bank of England responsible for so-called macro-prudential supervision. Alongside this responsibility, the Bank – through a new subsidiary called the Prudential Regulation Authority (the PRA) – will also have responsibility for the micro-prudential supervision of individual firms which undertake deposit-taking and insurance activities. There will be clear linkages between the two so that, for instance, the outputs of macro-prudential analysis will influence the agenda in relation to the supervision of individual firms.

There will also be a separate body – the Financial Conduct Authority. This will be responsible for supervision of the conduct activities of firms which are prudentially regulated by the PRA, and it will be responsible for all aspects of supervision of all of the other firms currently supervised by the FSA. This will include responsibility for markets oversight and acting as the Listing Authority, as well as issues relating to the fair treatment of retail and commercial customers. 

The PRA will have two statutory objectives: first, there will be the PRA’s general objective of safety and soundness of firms, minimising the potential impact of a firm’s activities on the stability of the UK financial system; and, second, there will be the more specific insurance objective of contributing to the securing of an appropriate degree of protection for policyholders.  These complementary objectives recognise the differences between different parts of the financial sector, and the different ways in which firm failure can affect counterparties and other stakeholders, as well as the real economy.

So, what will be the main features of the new regime? What the PRA will seek to do is two things – first, to minimise the probability of firm failure, and second to bring about a situation where the impact of such a failure, both on policyholders and on the financial system, is also minimised. 

The way we will go about this involves a number of stages:

• The first stage in the new framework will be an assessment of the vulnerability of the firm’s business model.
• The second stage will be for us to consider whether there is a reasonable resolution approach which could be adopted in the event of firm failure.
• The third stage will be for us to undertake a detailed analysis of firms’ financial strength, and this is one of the areas where the preparatory work we are doing with the industry on Solvency II will achieve broader progress towards the PRA’s objectives, particularly in the case of those firms who are in our internal model approval process.
• The fourth and final stage will be to consider the quality of the firm’s risk management and governance arrangements. 

The need for a framework for intervention is another aspect which is recognised both by the Solvency II Directive and by the PRA’s design. Last summer, FSA set out its intention to create a proactive intervention framework for the PRA, which will be an extension of the ‘ladder of intervention’ which is a feature of Solvency II, and which FSA already has in place for dealing with firms which have breached their individual capital guidance. This will set out a series of trigger points at which regulatory action will be presumed. This is not to say that the ability of supervisors to exercise judgement will be fettered by this, as the precise measures which will be taken in any set of circumstances will differ in accordance with the risk posed and the extent to which matters have the potential to deteriorate further.

The proactive intervention framework will set out the actions which will be expected of firms’ management and the PRA’s supervisors. These actions will clearly become more intensive as the firm’s position deteriorates, and will start to involve greater degrees of contingency planning, including not only the PRA but also the FCA and other bodies such as the FSCS.

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