Phase 6: 2000 – 2001

The Insurance Companies (Amendment)Regulations 2000

969 ICR 1994 was amended on a number of occasions⁵⁹⁹before they were revoked on 1 December 2001⁶⁰⁰. Of the changes made in the intervening years, those under the Insurance Companies (Amendment) Regulations 2000⁶⁰¹ (the ICA Regulations 2000) were of particular significance.The ICA Regulations 2000 came into force on 29May 2000.

970 The ICA Regulations 2000 amended various regulations relating to the determination of liabilities under Part IX of ICR 1994:

• Regulation 64 regarding the general basis for determination of long term liabilities;
• Regulation 67 regarding valuation of future premiums;
• Regulation 69 regarding rates of interest; and
• Regulation 72 regarding options.

971 In addition, the ICA Regulations 2000 made a consequential amendment to Schedule 4 of the ICAS Regulations 1996 in relation to the required contents of the abstract of the appointed actuary’s valuation report.

972 As noted above, these revisions largely flowed from the recommendations of the SVWP which had undertaken a review of statutory valuation of long-term business and reported in 1998.

Amendment to Regulation 64 of ICR 1994 –determination of long term liabilities

973 A new item was added to the list of matters under Regulation 64(3)⁶⁰² which, without prejudice to the general requirements of Regulation 64(1)⁶⁰³, the appointed actuary was required to take into account in determining the amount of the long term liabilities.

974 The additional item was discretionary charges and deductions, in so far as they did not exceed the‘reasonable expectations of policyholders’(Regulation 2(a) of the ICA Regulations 2000). This was described as a ‘clarificatory amendment’ in the explanatory notes to the 2000 Regulations.

Amendments to Regulation 67 of ICR 1994 – valuation of future premiums

975 Regulation 67 of ICR 1994, which described the methods by which future premiums were to be valued (and required, in general, that a net premium valuation method should be used⁶⁰⁴), was amended so as to limit its application to contracts under which the policyholder was entitled to participate in any surplus.

976 The aim of this amendment was to allow a gross premium method to be used for non-profitcontracts⁶⁰⁵. Amendments were also made to paragraph (2) of Regulation 67 to provide alternative methods of valuation where the terms of an insurance contract were changed (regulation2(b) of the ICA Regulations 2000).

Amendment to Regulation 69 of ICR 1994 – rates of interest

977 Paragraph (9)(a) of Regulation 69 of ICR 1994, which set upper limits on the assumptions made about yields on investments to be made more than three years after the valuation date, was revised to take account of changes to the indices referred to in that paragraph, following a fall in interest rates(Regulation 2(c) of the ICA Regulations 2000).

Amendments to Regulation 72 of ICR 1994 – options

978 Paragraph (1) of Regulation 72 of ICR 1994 (and its predecessor provision, Regulation 62(1) of ICR 1981)imposed a general requirement that provision should be made to cover any increase in liabilities caused by policyholders exercising options under their contracts.

979 From 1994, the Regulation had stated that such provision was to be made on ‘prudent assumptions’. Paragraph (2) of Regulation 72 made more detailed provision regarding the calculation of the amount of the required provision for certain kinds of options, namely those where the policyholder had an option to secure a guaranteed cash payment within twelve months of the valuation date. However, as originally drafted,Regulation 72 did not provide any detail of how the calculation was to be undertaken in other cases (beyond the stipulation, from 1994 onwards,that it should be made ‘on prudent assumptions’).

980 Regulation 2(d) of the ICA Regulations 2000 added new paragraphs (3)-(5) to Regulation 72 to make detailed provision regarding the calculation of provisions for other kinds of option, which were not catered for by paragraph (2). The new paragraphs (3) and (4) of Regulation 72 provided:

3.   
4.  Where a contract includes an option whereby the policy holder could secure a cash payment,but paragraph (2) above does not apply, the provision for that option shall at all times be such as to ensure that, if the assumptions adopted for the valuation of the contract are fulfilled in practice –    
   1.       
   2. the resulting value (and therefore the provision) is not less than the amount required to provide for the payment which would have to be made if the option were exercised; and      
   3. the payment when it falls due is covered from resources arising solely from the contract and from the assets covering the amount of the liability determined at the current valuation.
     
5. For the purposes of paragraph (3) above, the amount of a cash payment secured by the exercise of an option shall be assumed to be     
   1.  in the case of an accumulating with-profitspolicy⁶⁰⁶, the lower of –
      1.           
      2. the amount which would reasonably be expected to be paid if the option were exercised, having regard to the representations of the company; and          
      3. that amount, disregarding all discretionary adjustments; and
          
   2. in the case of any other policy to which this regulation applies, the amount which would reasonably be expected to be paid if the option were exercised, having regard to the representations of the company, without taking into account any expectations regarding future distributions of profits or the granting of discretionary additions in respect of an established surplus⁶⁰⁷ or in anticipation thereof.

981 Whilst this amendment specified, for the first time,particular ways in which the provision for certain contracts containing options was to be made, it did not alter the basic requirement (which had existed since 1981) that provision should be made for ‘any increase in liabilities’ caused by policyholders exercising options under their contracts.

Amendments to Schedule 4 of the ICAS Regulations1996 – revised instructions for prescribed forms where the net premium method was not used

982 Consequential amendments were made to Schedule 4 of the ICAS Regulations 1996 (regarding the abstract of the valuation report prepared by the appointed actuary) to revise the instructions for the completion of Forms 51-54⁶⁰⁸ to allow for cases in which the net premium method of valuation had not been used.

Further guidance for appointed actuaries on resilience testing from GAD (and the FSA) in 2000 and 2001 and the Resilience Reserves Working Party report

DAA14

983 On 15 May 2000, shortly before the ICA Regulations 2000 came into force, the Government Actuary wrote to appointed actuaries again on the topic of resilience testing (DAA14). The letter noted that the revisions to ICR 1994 were to include a revised formula for determining the yield on investments which were to be made more than three years in the future, with consequent effects on shorter term assumptions.

984 The letter went on to state that the effect of two of the scenarios promulgated in the Government actuary’s letter of 30 September 1993⁶⁰⁹ as amended by his letter of 30 September 1999⁶¹⁰appeared to be unnecessarily severe, given that ICR1994 as amended allowed for the effect of a sustained reduction in interest rates.

985 DAA14 stated that from the date of the ICA Regulations 2000 coming into force (29 May 2000),for with-profit offices, the second of the three scenarios to be used as a benchmark by GAD would comprise a combination of:

1.  a fall in the value of equities of the greater of:
   1.       
   2. 25%, subject to the fall being restricted to such as would not produce a price/earnings ratio on the FTSE Actuaries All Share Index lower than 75% of the inverse of the long term gilt yield (as defined in regulation69(9)) before the assumed fall in paragraph(b), and
   3. 10%;
2.  for fixed interest securities:
   1.           
   2. a fall in the yields on risk-free securities of less than five years outstanding term to redemption and on short-term deposits to the level which is calculated under Regulation 69(9) for future investments (or remain constant if already at or below this level),          
   3. the yields on risk-free securities of at least fifteen years’ duration remaining constant,and          
   4. a fall in the yields on risk-free securities of more than five but less than fifteen years’outstanding term to redemption to levels obtained by interpolating between the figures given by (i) above and the 15 year gilt index yield (or remain constant if already at or below this level);
3. a fall in property values of 20%; and
4. a  rise in the real yields on indexed gilts of 10%(e.g. from 2% to 2.2%).

986 DAA14 noted that in arriving at these benchmarks,GAD had been mindful of the existence of the professional working party⁶¹¹ and had endeavoured not to anticipate its recommendations; for this reason, core features of the previous tests had been retained.

987 The Baird Report (paragraph 3.24.10) noted that where assets and liabilities were well matched,then the changes in investment conditions described in the above resilience tests might require little reserves. However, if assets and liabilities were not well matched or the liabilities included onerous options or guarantees, the tests could require significant reserves⁶¹².

DAA15, DAA15A and the FSA letter of 4 December 2001

988 The guidance from the Government Actuary on resilience testing was replaced on a temporary basis (intended to be until 31 May 2002) by a further DAA letter issued on 10 September 2001 by the Head of Actuarial Department of the FSA⁶¹³(DAA15).

989 The contents of DAA15 were said to constitute guidance for the purpose of section 157 of the FSMA 2000, which had come into force on 18 June2001, empowering the FSA to give guidance consisting of such information and advice as it considered appropriate with respect to such matters as the operation of rules made under the Act.

990 DAA15 stated that the FSA had decided that the guidance on resilience testing should be modified and simplified. In place of the set of scenarios previously recommended by the Government actuary as revised over the years, the letter advised that the actuary should, as a minimum,consider the scenario of a fall in the value of equities of the greater of:

1.   
2. 25%, subject to the fall being restricted to such as would not produce a price/earnings ratio on the FTSE Actuaries All Share Index lower than75% of the inverse of the long term gilt yield (as defined in Regulation 69 of ICR 1994 and rule5.11 of the Interim Prudential Sourcebook for Insurers), and
3. 10%.

At the same time, the actuary was to make the‘prudent assumption’ that company earnings might fall by 10% (shortly after the above fall in equity values), but that dividends would remain unaltered when assessing the corresponding rate of interest at which the liabilities should be valued.

991 A further letter was issued by the Head of Actuarial Department of the FSA to appointed actuaries on 24 September 2001 (DAA15A),indicating that the suggested minimum figure of10% in subparagraph (b) of the 10 September 2001letter should not be regarded as an absolute figure which was to be applied in all circumstances.

992 Instead, appointed actuaries were to apply their professional judgment which could well lead, in some circumstances, to a lower figure being assumed.

993 DAA15A was described in a further letter from the FSA to appointed actuaries of 4 December 2001 as‘emergency guidance’, issued against a background of unusual market conditions of extreme volatility following the attack on the World Trade Centre on11 September 2001, aimed at avoiding the risk that insurance companies might sell equities for short term technical reasons in a way which could be damaging to the interests of policyholders.

994 The FSA letter of 4 December 2001 restored the guidance as set out in the letter of 10 September2001 on a temporary basis until 31 May 2002.

The Resilience Reserves Working Party report

995 A further working party established by the F&IA,the Resilience Reserves Working Party (RRWP),examined resilience reserve requirements under the UK regulatory framework. The RRWP produced an interim report in May 1998 and presented its final report at the Life Convention in November2000.

996 The RRWP’s report noted that the requirement to make an allowance for the resilience of an office to changes in financial circumstances had been implicit for many years⁶¹⁴, and that an approach outlined in 1985⁶¹⁵ had formed the cornerstone of what had been required by the regulators since then, albeit amended to remove the effects of particular unintentional features.

997 The aim of the RRWP was to use actuarial techniques which had become commonplace since1985 to find a more robust framework for identifying what needed to be tested and to try to make recommendations regarding a way forward.Its terms of reference were ‘[t]o consider whether the Government Actuary should be asked to revise the standard of the resilience test as set out in his letter to Appointed Actuaries dated 30September 1993 and amplified in his letter to Appointed Actuaries dated 29 October 1996, and if so for what reasons’. The Government Actuary’s letters of 24 November 1998, 30 September 1999and 15 May 2000 were also taken into account

998 One of the issues considered by the RRWP was the purpose of the resilience test. The view was expressed that this was an issue over which the profession might not display a ‘common understanding’.

999 As a ‘working hypothesis’ it was assumed that the purpose of resilience testing was to provide comfort to regulators that no life assurance company meeting the test scenarios was likely to require statutory intervention within the period from the date on which the returns were calculated until the date on which the next returns were due.

1000 The RRWP decided to look at the probability of events occurring within 12 months of the valuation date, and described the test as effectively ‘a short term stress test of solvency’.

1001 The RRWP noted that ‘as currently constructed the impact of a resilience test is merely to make the statutory test [of solvency] more harsh. It does not provide an advance warning of statutory insolvency’ (although it was noted that it was unlikely that a company would fail the statutory insolvency test without first having failed the statutory solvency test with the resilience test applied).

1002 The RRWP also noted that most of the ‘numerous’working parties which had looked at the fundamental valuation regime had found that their results were, in practice, heavily dependent upon the nature of the resilience regime which was applied to them.

1003 Much of the RRWP report was concerned with methodology for resilience testing and an examination of the efficacy of alternative models for solvency investigations. Ultimately the RRWP selected an approach which looked only at short term investment fluctuations and identified four specific risks which it considered to be worthy of investigation:

1. a fall in equity values, accompanied by a fall infixed interest yields for terms of less than 15 years;
2. a fall in gilt yields;
3. a fall in equity values and a rise in gilt yields; and
4. a rise in equity values coupled with a fall in gilt yields.

Illustrations were given of the application of the proposed tests and proposals were made for the treatment of other investments such as property.

1004 The RRWP concluded that the tests it had proposed, although complex, were ‘somewhat simpler to use than to write down’. It was acknowledged that the tests would not eliminate the need for the actuary to apply professional judgment if ‘post balance sheet events were to expose imprudence in any assumption’.

1005 However, the RRWP was of the view that the tests it proposed would meet the needs of the profession, the regulators and the industry. It was recommended that the outcome of all the tests should be reported in the briefest summary form‘in Schedule 4’ (i.e. in the abstract of the actuary’s valuation report forming part of the statutory returns under the ICAS Regulations 1996). No change was recommended to the then existing requirement that only the most onerous resilience test should be the subject of ‘the full rigours of Form 57’ (i.e. the matching rectangle⁶¹⁶).

Revisions to GN8 in 2001

1006A revised version of GN8 (6.0) came into effect on 12March 2001. The covering letter from the F&IA⁶¹⁷described the revised guidance as being required to take account of changes introduced by the ICA Regulations 2000 and of other issues ‘arising from the conclusions of the statutory valuation working party … [including] … new requirements for provisions for surrender values or other options available to policyholders, as well as a number of other technical amendments’. The changes made to GN8 largely followed the proposals outlined in Appendix F to the1998 SVWP report referred to above⁶¹⁸.

1007 The covering letter suggested that version 6.0 ofGN8 incorporated, among other changes,amendments regarding the valuation of with-profit business which was not subject to a net premium method of valuation. However, such guidance as appeared on that topic was brief.

1008The amendments made in version 6.0 included guidance on certain of the determination of liability regulations of Part IX of ICR 1994 which had not been addressed in the earlier versions ofGN8, such as Regulation 66 (avoidance of future valuation strain); Regulation 67 (valuation of future premiums, as revised by the ICA Regulations 2000)and Regulation 72 (on options, which had also been revised by the 2000 Regulations).

Additional guidance on Regulation 65

1009 Additional guidance was given on Regulation 65 of ICR 1994 (which, in general, required a prospective calculation of long term liabilities). Paragraph 3.2.2of GN8 version 6.0 provided specific guidance in respect of with-profit business not subject to a net premium valuation.

1010 That paragraph repeated general requirements for with-profits policies (that the appointed actuary should ensure that the reserve was sufficient to provide for future reversionary bonus, including the cost of any shareholders’ share of the surplus associated with the declaration of such a bonus(including tax where appropriate)), and, in addition,required that the rates for future bonus to be assumed for this purpose were to be selected‘having regard to current rates of bonus and to changes in the rates of future bonus which would be consistent with the reasonable expectations of policyholders in the event that experience were to follow the valuation basis’.

1011 This appears to be the extent of the specific advice on ‘with-profits business not subject to a net premium valuation’ (but see paragraphs 1017 to1020 regarding the guidance on Regulations 72 and75, which were of particular relevance to such business).

1012 The guidance does not specify the circumstances in which a net premium method would not be used for with-profits business, as to which see the comments on Regulation 67 in paragraph 975 and footnote 604⁶¹⁹.

1013 Additional guidance was also given in connection with Regulation 65 on assessing the adequacy of the reserve in relation to permanent health insurance business, generally requiring the use of a method which made specific allowance for claim inception rates and the duration of sickness.

Guidance on Regulation 66

1014 For the first time, GN8 included guidance on Regulation 66 of ICR 1994 regarding avoidance of future valuation strain, which was said to be of particular importance in the assessment of the non-unit reserves for linked contracts.

Guidance on Regulation 67

1015 Reference was also made to Regulation 67, but without any detailed commentary. The guidance simply stated that:

Regulation 67(1) requires the use of a net premium method for certain categories of with-profits business. It does not apply to non-profit business, which may be valued on a gross premium or a net premium method.

1016 The second sentence reflected the amendment which had been made to Regulation 67 by the ICA regulations 2000 (see paragraph 975).

Guidance on Regulation 72

1017 The guidance noted that Regulation 64(3)(c)required that all options available to the policyholder be taken into account in determining the amount of the long term liabilities and that Regulation 72(1) required that provision should be made on prudent assumptions to cover any increase in liabilities caused by policyholders exercising options under their contracts. The guidance went on to state (in paragraph 3.8.2):

Where an optional benefit is of greater value than the basic benefit under the valuation assumptions then a prudent allowance should be made in the valuation for the proportion of policyholders likely to exercise the option. Where the optional benefit is likely to be the most attractive alternative to the policyholder and the most costly option to the company, then it will normally be appropriate to assume that all policyholders exercise the option. However, where there are advantages to policyholders in not exercising the option,for example tax treatment, or a preference for a cash sum alternative to an annuity, then it may be appropriate to make allowance for a proportion failing to exercise the option. In making such an allowance past experience may only be taken into account to the extent that it is deemed likely to remain relevant under the other valuation assumptions. In addition, any such allowance must be sufficiently prudent to allow for possible future changes in circumstances.

1018 The guidance went on to state (in paragraphs 3.8.5and 3.8.6):

Regulation 72(4) refers to an amount which would reasonably be expected to be paid if the option were exercised, having regard to the representations of the company. This maybe interpreted as referring to the level of that amount in the event of a significant level of policy discontinuances. Regulation 72(4)(a)(ii)refers to an amount obtained by disregarding all discretionary adjustments. This means disregarding all such adjustments, both positive (such as terminal bonus) and negative(such as market value adjustment factors), but does not mean that it is necessary to disregard automatic adjustments (such as surrender penalties) that are applied to discontinuance values in any financial conditions.

When considering reasonable expectations with regard to discontinuance values, the Appointed Actuary must take account of representations made by the company to policyholders, including those in marketing literature and the company’s With-Profits Guide, and also the practice of the company in determining discontinuance values, with particular regard to:

(a) the relationship between the discontinuance values and the value of the underlying assets, and

(b) any circumstances of which the policyholder can reasonably be expected to be aware in which discontinuance values might be reduced due to losses not directly related to the investment return earned by the company on those assets non-profit

Additional guidance on Regulation 75

1019 Additional guidance was given on Regulation 75,which required that the nature and term of the assets representing the long term liabilities betaken into account when determining the amount of the long term liabilities and that prudent provision be made for possible future changes in the value of those assets.

1020 A new paragraph 3.9.6 of GN8 stated that the appointed actuary should ensure that the‘liability’⁶²⁰ in the changed investment conditions would adequately cover ‘policyholders’ (revised)reasonable expectations …’.

1021 Version 6.0 of GN8 was replaced by version 6.1 with effect from 1 December 2001.

Background to the introduction of the Financial Services and Markets Act 2000

General background

1022 As noted above⁶²¹, the proposals which eventually led to the enactment of the FSMA 2000 were outlined in broad terms by the then Chancellor of the Exchequer in a statement made to the House of Commons on 20 May 1997 in relation to the Bank of England, in which he announced the government’s wider intentions to reorganise the financial sector and establish a single financial regulator for a considerable part of the UK financial services sector.

1023 The Chancellor stated that ‘[the] financial services industry needs a regulator which can deliver the most effective supervision in the world’, and that‘[o]ne cannot ensure the success of British financial services in the 21st century without modernising arrangements for the protection of investors’.

1024 The Chancellor noted that the distinction between different types of financial institution, ‘banks,security firms and insurance companies – are becoming increasingly blurred’, and that many were regulated by a plethora of different supervisors, increasing the costs and reducing the effectiveness of supervision⁶²². He considered that regulators needed to look at the businesses of financial institutions in a consistent way, to bring the regulatory structure more closely into line with‘today’s increasingly integrated financial markets’.

1025 The Chancellor proposed that the SIB (which changed its name to the FSA five months later)should become the single financial regulator underpinned by statute, with the then current regime of self-regulation being replaced by a new and fully statutory system ‘which will put the public first, and increase public confidence in the system’. He requested that the SIB ‘project manage’the process of implementation of the proposals,working with the SROs and the financial industry.

1026 In July 1998, the Treasury published ‘Financial Services and Markets Bill: A Consultation Document’ which included an incomplete draft of the Bill, a document containing an overview of the proposed regulatory reform and draft Explanatory Notes.

1027 The consultation exercise was reported to have attracted responses from over 220 firms and bodies with an interest in the regulation of financial services. A number of further consultation documents and drafts of proposed subordinate legislation were published by the Treasury in relation to particular aspects of the proposals.

1028 The draft Bill was subject to ‘pre-legislative scrutiny’. In February 1999 the Treasury Select Committee of the House of Commons published a report on the draft Bill⁶²³. Aspects of the Bill were considered by a Joint Committee of both Houses of Parliament before being introduced into the House of Commons on 17 June 1999. Following a fairly difficult passage through Parliament, the Bill received Royal Assent on 14 June 2000.

1029 The main cause of contention over the Bill does not appear to have been the basic principle of the establishment of a single regulator, but rather the proposed extent of the FSA’s powers and the need for controls over those powers to ensure fairness and public accountability. These issues were the subject of considerable debate and resulted in extensive amendments to the Bill⁶²⁴.

1030 The Act gave power to the FSA to undertake authorisation and regulation of those engaged in investment business, including stocks and shares,unit trusts, life assurance and personal pensions.

1031 The FSA assumed responsibility for the work of nine separate regulatory bodies⁶²⁵ and the SROs were dissolved. The categories of business subject to regulation was not greatly varied. Despite the shift towards regulation through detailed rules made mainly by the FSA, rather than by primary or secondary legislation, the FSMA 2000 is underpinned by an extensive network of secondary legislation which contains much of the detailed provision⁶²⁶.

1032 Only five provisions of the Act came into force on the date of Royal Assent, the remainder were brought into force on various dates appointed by the Treasury⁶²⁷. As outlined above, implementation of the regime under the FSMA 2000 was undertaken in stages, with the main implementation date of 1 December 2001.

1033 Neither the FSA, nor the new bodies created under the FSMA 2000 (some of which are mentioned below), are subject to my powers of investigation under the 1967 Act⁶²⁸.

Regulatory objectives and functions of the FSA

1034 Under section 2(2) of the FSMA 2000, the FSA is given four regulatory objectives:

1. market confidence;
2. public awareness;
3. the protection of consumers; and
4. the reduction of financial crime.

In discharging its general functions under the FSMA2000, the FSA is required to act in a way which, so far as is reasonably possible, is compatible with its regulatory objectives and which it considers most appropriate for the purpose of meeting those objectives.

1035 Under section 2(4) of the FSMA 2000, the general functions of the FSA are:

1. the making of rules under the Act;
2. preparing and issuing codes under the Act;
3. the giving of general guidance; and
4. determining the general policy and principles by reference to which it performs particular functions.

1036 Under section 2(3) of the FSMA 2000, in discharging its general functions the FSA is required to have regard to:

1.   
2. the need to use its resources in the most efficient and economic way;  
3. the responsibilities of those who manage the affairs of authorised persons;  
4. the principle that the burden or restriction which is imposed on a person, or on the carrying on of an activity, should be proportionate to the benefits,considered in general terms, which are expected to result from the imposition of that burden or restriction;  
5. the desirability of facilitating innovation in connection with regulated activities;  
6. the international character of financial services and markets and the desirability of maintaining the competitive position of the UK;  
7. the need to minimise the adverse effects on competition that may arise from anything done in the discharge of those functions; and  
8. the desirability of facilitating competition between those who are subject to any form of regulation by the FSA.

1037 In addition to its functions under the FSMA 2000,the FSA was given regulatory powers under other legislation including enactments relating to building societies, friendly societies and industrial and provident societies, the Enterprise Act 2002,the Unfair Terms in Consumer Contracts Regulations 1999⁶²⁹ and the Financial Services(Distance Marketing) Regulations 2004⁶³⁰.

The role of the Treasury

1038 The FSMA 2000 confers a number of functions on the Treasury, including powers to make orders and regulations and to arrange independent inquiries.The Treasury’s order-making powers include powers to specify the activities which are to be subject to regulation under the Act and those to exempt persons from the general prohibition on carrying on a regulated activity without being authorised under the Act⁶³¹.

1039 The FSA is required to report annually to the Treasury on the discharge of its functions and regarding its opinion on the extent to which its regulatory objectives have been met. That report must be laid before Parliament (and the FSA must hold an annual public meeting to enable the report to be considered)⁶³². The Chairman and other members of the governing body of the FSA are appointed and liable to removal from office by the treasury (paragraph 2(3) of Schedule 1 to the FSMA2000).

1040 The FSA describes its relationship with the Treasury as being one under which it is accountable to Treasury Ministers and through them, to Parliament, but that it is ‘operationally independent of the Treasury’. The relationship between the Treasury and the FSA was set out in a published exchange of letters between the Chancellor of the Exchequer and the Chairman of the FSA dated 13 December 2001.

1041 In his letter, the Chancellor described his proposals for the use of his powers, ‘without in any way compromising the FSA’s statutory independence’,as covering such matters as:

•   
• directing the FSA to cover particular issues in its public annual report, including how the FSA had dealt with major regulatory cases or issues which had arisen during the year (subject to statutory restrictions on disclosure and any market sensitivities);
•   
• establishing whether the FSA was providing value for money, through periodic independent review under section 12 of the FSMA 2000 as necessary;
•   
• periodically reviewing the ‘panoply of statutory instruments which sit under the[FSMA 2000]’; and
•   
• the power to launch a statutory inquiry into possible serious regulatory failure (but emphasising that the failures of individual firms were not, in themselves, evidence of regulatory failure by the FSA⁶³³).

The Financial Services and Markets Tribunal, the Ombudsman Scheme and the compensation scheme

1042 Part IX of the FSMA 2000 (and Schedule 13 to the Act) established an independent tribunal, known as the Financial Services and Markets Tribunal, to determine issues referred to it by an aggrieved party under various provisions of the FSMA 2000 in respect of decisions of, or action taken by, the FSA,including decision notices and supervisory notices and in relation to applications for permissions to undertake regulated activities under Part IV.

1043 Appeals on a point of law arising from a decision of the Tribunal may be made, with the permission of the Tribunal, to the Court of Appeal (or to the Court of Session in Scotland). The Lord Chancellor is responsible for appointing a panel of people to act as chairmen of the Tribunal (paragraph 3(1) of Schedule 13 to the FSMA).

1044 Part XVI of the FSMA 2000 established a single Ombudsman Scheme, bringing together at least five former dispute resolution schemes. The Scheme is administered by a body corporate (the Financial Ombudsman Service Limited) and deals with complaints made against authorised persons(or against those who had been authorised persons at the time of the act or omission to which the complaint relates) in relation to activities regulated by the FSMA 2000.

1045 The stated aim of the Scheme is to provide a means by which certain disputes can be resolved‘quickly and with minimum formality by an independent person’. The Chairman and other members of the Board of the Ombudsman Scheme are appointed and liable to removal by the FSA acting, in the case of the Chairman, with the approval of the Treasury (paragraph 3(2) of schedule 17 to the FSMA 2000).

1046 Part XV of the FSMA 2000 created a single compensation scheme to replace the Investor’s Compensation Scheme, the Policyholders Protection Board Scheme and three other compensation schemes.

1047 The compensation scheme is administered by a body corporate (the Financial Service Compensation Scheme Limited – the ‘scheme manager’ for the purpose of section 212 of the Act)and financed by a levy on authorised persons.

1048 The FSA is responsible for the appointment and removal of the Chairman and other members of the board of the compensation scheme management company acting, in the case of the Chairman, with the approval of the Treasury(section 212(4) of the FSMA 2000).

Some implications of the FSMA 2000 for prudential regulation of long term insurance business

1049 Effecting and carrying out contracts of insurance is an activity of a ‘specified kind’ which is a ‘regulated activity’ for the purpose of the FSMA 2000⁶³⁴.

1050 The effects of the FSMA 2000 for the prudential regulation of long term insurance include:

•   
• the repeal of the ICA 1982, the FS Act 1986, the PPA 1975, the Policyholders Protection Act 1997,the Insurance Companies (Reserves) Act 1995and related subordinate legislation, mainly with effect from 1 December 2001⁶³⁵;
•   
• the vesting of responsibility for prudential regulation and conduct of business regulation in a single regulator and the gradual harmonisation of rules for regulation of insurance business with those applied to other parts of the financial sector;
•   
• (for most purposes) the replacement of the relevant legislation with rules made by theFSA⁶³⁶ set out as ‘rule making instruments’⁶³⁷,consolidated in the FSA Handbook, a lengthy(and constantly evolving) document which contains ‘business standards’ for, inter alia,insurance business in ‘prudential sourcebooks’(initially in ‘interim prudential sourcebooks’specific to individual financial sectors, but now being combined into an ‘integrated prudential sourcebook’ of general application);
•   
• the designation of the Institute of Actuaries(but not the Faculty of Actuaries) as a‘designated professional body’ for the purpose of section 326 of the FSMA 2000⁶³⁸ (actuaries supervised by the Institute are thereby entitled to undertake certain regulated activities without breaching the general prohibition on carrying on a regulated activity unless authorised or exempt under the Act); and
• specific provision in the legislation:
  •       
  • to the effect that an actuary (or auditor)appointed for the purpose of rules made under the FSMA 2000 does not contravene any duty merely through providing the FSA with information or his or her opinion on any matter, provided that the actuary (or auditor) acts in good faith and reasonably believes that the information or opinion is relevant to the functions of the FSA⁶³⁹; and
  •       
  • to impose a duty on the actuary who is acting or has acted for an authorised person to communicate information or his or her opinion to the FSA in specifiedcircumstances⁶⁴⁰.

1051 Guidance for appointed actuaries such as that inGN1, GN2, GN7 and GN8 continues to be issued by the F&IA. In versions of the guidance issued at the end of December 2004, references to legislation have largely been replaced by references to the FSA Handbook and Interim Prudential Sourcebook for Insurers.

1052 Since the issue of that guidance, the Integrated Prudential Sourcebook for Insurers has been produced.

Footnotes

599 See paragraph 683 and the footnotes thereto.

600 By SI 2001 No. 3649 (referred to in paragraph 683).

601 SI 2000 No. 1231, see paragraph 613.

602 See paragraph 644 in which paragraph (3) of regulation 64 as originally enacted is quoted.

603 Namely, that the amount of the long term liabilities should be determined on actuarial principles which had due regard to PRE and made proper provision for all liabilities on prudent assumptions that included appropriate margins for adverse deviation of relevant factors.

604 Regulation 67(1) required that a net premium valuation method should be used where further premiums were payable under the contract and benefits were determined at the outset in relation to the total premiums payable. For contracts under which each premium increased the benefits or those where the amount of premium payable in the future could not be determined until it was paid (such as certain of the contracts entered into by Equitable), Regulation 67(3) permitted future premiums and the corresponding liability to be left out of account so long as adequate provision was made against any risk that the increase in liabilities resulting from the payment of future premiums might exceed the amount of those premiums. Paragraph (4) of Regulation 67 allowed an alternative method of valuation to be used to that described in paragraphs (1)-(3) of that regulation provided that it could be demonstrated that the alternative method would result in reserves no less, in aggregate, than those which would result from the use of the methods described in paragraphs (1)-(3).

605 According to the explanatory notes to the ICA Regulations 2000.

606 The definitions in the new paragraph (5) of regulation 72 provided that an ‘accumulating with-profits policy’ meant ‘a with-profits policy which has a readily identifiable current benefit, whether or not this benefit is currently realisable, which is adjusted by an amount explicitly related to the amount of any premium payment and to which additional benefits are added in respect of participation in profits by additions directly related to the current benefit, or a policy which has similar characteristics’. A ‘with-profits policy’ was given the same meaning as in the ICAS Regulations 1996, namely a contract falling within a class of long term business as specified in Schedule 1 to the Act which was eligible to participate in any part of any established surplus.

607 Paragraph (5) provided that ‘established surplus’ had the same meaning as in section 30(4) of the ICA 1982, namely ‘an excess of assets representing the whole or a particular part of the fund or funds maintained by the company in respect of its long term business over the liabilities, or a particular part of the liabilities, of the company attributable to that business as shown by an investigation to which section 18 above applies or which is made in pursuance of a requirement imposed under section 42 below’.

608 Forms 51-54 were the prescribed forms for the valuation summaries of non-linked contracts (other than accumulating with-profit policies), accumulating with-profit policies, property linked contracts and index linked contracts.

609 DAA6, see paragraph 524.

610 DAA12, see paragraph 706.

611 Apparently a reference to the Resilience Reserves Working Party mentioned below.

612 Paragraph 3.24.11 of the Baird Report notes that in the case of Equitable, the tests described in DAA14 had a significant effect on the reserves required to be made. On 11 August 2000, the company’s appointed actuary estimated the effect would be to reduce net explicit assets by some £600 million.

613 To which the GAD staff involved in prudential regulation of insurance companies had transferred (on 26 April 2001), in order to provide the FSA with ‘in house’ actuarial advice (paragraph 2.8.9 of the Baird Report).

614 An express requirement for insurance companies to make ‘appropriate provision against the effects of possible future changes in the value of the assets on their adequacy to meet the liabilities’ had existed since the coming into force of Regulation 55 of ICR 1981 in October 1982, see paragraphs 267 and 268.

615 Apparently a reference to the ‘working rule’ first outlined by the Government Actuary in DAA1 (referred to in paragraph 397).

616 See paragraphs 797 et seq and Appendix C.

617 Dated February 2001.

618 Paragraph 963.

619 The amendments to GN8 proposed in Appendix F to the 1998 report of the SVWP indicated that the additional guidance on Regulation65 was intended to apply to business which was subject to Regulation 67(3) which allowed for the use of a specified alternative method for certain contracts under which each premium increased the benefits or where the amount of the premium payable in the future could not be ascertained in advance, provided certain conditions were met.

620 See paragraphs 674 to 676 regarding the question of whether the cost of meeting PRE was to be treated as a liability of an insurance company for the purpose of ICR 1994.

621 At paragraph 902 and 903.

622 Hansard Debates, House of Commons, 20 May 1997, column 510.

623 Financial Services Regulation, Third Report from the Treasury Committee, Session 1998-99, HC 73.

624 It has been reported that the Bill was subject to some 2,500 amendments prior to enactment.

625 In addition to the former functions of the SIB, the FSA assumed responsibility for work formerly undertaken by the Supervision and Surveillance Division of the Bank of England; the Treasury; the Building Societies Commission; the Friendly Societies Commission; the Registry of Friendly Societies; and the three SROs: the Securities and Futures Authority, the PIA and IMRO. Lloyd’s of London is also subject to external supervision by the FSA. More recently, the FSA has assumed responsibility for regulation of mortgage lending and for general insurance regulation (formerly the responsibility of the General Insurance Council). The FSA has been described as a ‘superregulator’.

626More than 80 statutory instruments were identified as being required even before the main implementation date on 1 December 2001and some 136 statutory instruments have been made under the FSMA 2000 to date.

627 Section 431 of the FSMA 2000.

628 As noted at the outset of this Part of the report, the actions of the FSA in respect of the prudential regulation of insurance companies are relevant to this investigation only in so far as they relate to functions ‘contracted out’ to the FSA by the Treasury during the period from 1 January 1999 until immediately before the FSMA 2000 came into force on 1 December 2001.

629 SI No. 2083 as amended by the Unfair Terms in Consumer Contracts (Amendment) Regulations 2001 SI No.1186.

630 SI 2004 No. 2095.

631 Sections 22 and 38 of the FSMA 2000.

632 Paragraphs 10 and 11 of Schedule 1 to the FSMA 2000.

633 The Chancellor added that ‘[the] Government believes that it is right for the FSA to set the maintenance of confidence in the financial system as a target, rather than the avoidance of failure of firms per se’.

634 Contracts of insurance are described in general terms in Schedule 2 to the FSMA 2000 as being within the scope of regulated activities for the purpose of the Act. Effecting a contract of insurance as a principal and carrying out a contract of insurance as a principal are‘specified kinds of activity’ which are ‘regulated activities’ for the purpose of the FSMA 2000 by virtue of article 10 of the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 SI No. 544 (made by the Treasury in exercise of powers under, inter alia, section 22 of the FSMA 2000).

635 By SI 2001 No. 3649 (referred to in paragraph 683).

636 Generally, made by the FSA under section 138 of the FSMA 2000.

637 Under section 153 of the FSMA 2000, any power of the FSA to make rules is to be exercisable in writing and must specify the provision under which the rule is made. The instrument by which rules are made by the FSA is described as ‘a rule-making instrument’. The treasury has limited power to make supplementary rules in relation to insurance business for the purpose of preventing certain persons who are not authorised under the Act from doing anything which would lessen the effectiveness of certain ‘asset identification rules’(section 142).

638 By virtue of the Financial Services and Markets Act 2000 (Designated Professional Bodies) Order 2001 SI No. 1226.

639 Section 342(3) of the FSMA 2000 (see paragraph 383 regarding the former provisions in relation to auditors under section 21A of the ICA1982).

640 By virtue of the Financial Services and Markets Act 2000 (Communications by Actuaries) Regulations 2003 SI No. 1294. Comparable provision was made in relation to communication of information by auditors to the FSA, by the Financial Services and Markets Act 2000 (Communications by Auditors) Regulations 2001 SI No. 2587, to replace the provisions of SI 1994 No. 449 (referred to in paragraphs 697 et seq) which was revoked when the relevant provisions of the FSMA 2000 came into force.