Appendix B: Summary of FSA's responses to the recommendations of the Baird Report
Jump to
Summary of FSA's responses to the recommendations made in the Baird Report
Following the closure of Equitable to new business on 8 December 2000 FSA commissioned their then Head of Internal Audit, Mr Ronnie Baird, to lead an internal review of their regulation of Equitable between 1 January 1999 and 8 December 2000 with a view to identifying lessons for the future. The team’s subsequent report (the Baird report) was published by order of the House of Commons on 16 October 2001. Chapter 7 of the Baird report included a number of recommendations with commentary. This appendix lists those recommendations and summarises the actions FSA say they have taken since then. The summary responses to the Baird recommendations are drawn primarily from FSA’s progress report of October 2002 “The future regulation of insurance”, reporting work led by FSA’s John Tiner (the Tiner report) and include other recent material provided by FSA. The paragraph numbers refer to the Baird Report.
The Baird report recommended that:
7.2 Solvency standards
The current framework needs to be restructured so that the required minimum capital reflects all the risks in the business.
FSA say they will introduce, in 2004, a new risk-based approach to the calculation of capital for life insurers writing with-profits business. They say that consultation on this will take place in the summer.
7.2.1 Guarantees and options within policies
Financial guarantees and onerous options in life insurance policies should be valued stochastically and consistently with traded option prices in the market.
FSA say this will be part of the new risk-based approach to capital planned for 2004. In the meantime, FSA say they are prepared to anticipate some elements of the new approach such as stochastic modelling in the valuation of guarantees, provided firms can demonstrate that this does not create undue risks for their policyholders. They say that a number of firms have done so.
7.2.2 Future profits implicit items
The exercise of discretion over the use of implicit items should be reviewed.
FSA say that they have now given guidance clarifying their criteria for granting waivers to life insurers and friendly societies seeking to include implicit items in their solvency margin calculations. Future profits implicit items will no longer be able to be used in solvency margin calculations from 2009. In the meantime, the amount of any implicit item waivers may be limited by reference to the realistic solvency position.
7.2.3 Financial reinsurance
A review [should] be undertaken of the extent to which the financial strength of the industry is eroded by the amount of such financial reinsurance in place.
FSA have reviewed and consulted upon a new regulatory approach to insurance firms’ use of financial engineering and say they will introduce guidance on how firms should conduct such business.
Full disclosure of [financial reinsurance] arrangements, including the material contingencies to which they are subject, should be made in the regulatory returns.
FSA say that their consultation paper (CP144) proposed clearer, and more directly comparable, presentation of information on such financial engineering to be included in the regulatory returns. FSA say that following the conclusion of this consultation, regulatory reporting for life insurers has been enhanced. There is additional disclosure of financial reinsurance and other financial engineering.
7.2.4 Control levels
The regulator [should] review the possibility of introducing multiple control levels as a basis for triggering proportionate regulatory action.
FSA have consulted on how individual capital adequacy standards for firms might be set and say they will consult on how this approach might be applied to insurance firms (including where there are special concerns about a particular firm or firms). FSA say there will be further consultation this summer.
7.3 The role of the Appointed Actuary
Appointed actuaries should be subject to independent external review. This may be carried out by FSA or by independent firms, but must be conducted to a level which would provide comfort equivalent to that of an external audit.
FSA say that they have consulted on detailed proposals for the future role of actuaries in life insurers. These include widening the scope of the audit review to cover the aspects of the regulatory return that are currently the responsibility of the appointed actuary. As part of their audit work, the auditors would be required to obtain an opinion from an actuary (who must be independent of the firm), which they would then publish as an annex to their audit opinion. The actuarial work on the valuation of policyholder liabilities would thus be subject to the professional challenge of audit and review by an independent actuary.
7.4 Disclosure
The purpose, content and frequency of the regulatory returns [should] be reviewed. The information provided by all firms must be both timely and sufficient to assess the risk of customer detriment which might arise from issues relating to solvency or PRE [policyholders’ reasonable expectations] issues.
FSA say that they have committed to a fundamental review of regulatory reporting and that there will be two consultation papers in 2003. Part of this will be more regular and timely reporting to the FSA, covering all aspects of prudential and conduct of business information. This review will also consult on electronic submission of data to the FSA to improve timeliness and efficiency.
FSA say they have consulted on proposals that would require firms carrying on with-profits business to establish and make publicly available the principles and practices of financial management they apply in managing with-profits funds, and to inform policyholders of changes in these. The with-profits review also recommended a number of improvements to the information given to with-profits policyholders in annual statements, the detail of which will be covered in a forthcoming consultation. FSA say they are also seeking views (in DP20) on issues arising from the Sandler Review's recommendations on compulsory disclosure to policyholders of unsmoothed asset shares.
The assessed financial risk must be an integral part of an overall risk assessment which is consistent, and consistently applied, across the FSA.
FSA say they have introduced a new risk assessment framework which they have already applied to all insurance firms except a number of Lloyd’s managing agents and low impact firms. This framework includes an assessment of the financial position of the firm and of the potential risks to its soundness from its existing and proposed business. For an insurance firm this will cover its overall regulatory solvency as well as, for example, more detailed analysis of its capital position, reserving, reinsurance arrangements and underwriting results. FSA say they use their specialist actuarial resources or independent skilled persons to provide more expert analysis where appropriate.
The regulator must also have the ability to obtain further relevant information when appropriate, and perhaps routinely for higher risk firms, and may want to conduct its own review in appropriate circumstances.
Since 1 December 2001, FSA have had substantial powers under the Financial Services and Markets Act (FSMA) to require further information from insurance firms. FSA say they are exercising these powers and in particular have commissioned reports from skilled persons on specific aspects of individual firms’ operations. In addition, FSA say they have recently recruited insurance risk specialists to form a central team which is now being actively used as part of the risk review process.
7.5 Industry review
FSA [should] consider the feasibility of producing on a regular basis a review of issues and trends that may pose a regulatory risk to the industry.
FSA published their Financial Risk Outlook in January 2003 and say that this includes a full review of risks affecting the insurance industry. FSA’s Insurance Risks Group, chaired by John Tiner, draws together supervisors, actuaries, economists and other specialists to assess emerging consumer and market risks to decide how to deal with them.
7.7 Culture
FSA, in its regulation of the long term insurance industry:
- where appropriate to do so, [should] be prepared to act more proactively in pursuance of its statutory objectives to ensure that the interests of customers are properly protected;
- forms and articulates a clear view of what are the permissible boundaries of proactive regulation;
- reviews its approach to the use of its powers of investigation, influence and intervention so that it acts in a way proportionate to the perceived risks; and
- adopts a more proactive, risk-based approach so that the frequency, depth and breadth of contact with firms is related to the risk category of that firm.
FSA say that they are using their new statutory powers and risk assessment framework to achieve these aims. Particular improvements include: the identification of insurance risks; the assessment and prioritisation of them; and the use of a regulatory ‘toolkit’ of measures designed to mitigate risks.
FSA devotes more resources to developing internal awareness between teams both as to what functions each team performs and the information each team requires to assist it to do its job. We welcome FSA’s creation of one division, comprising prudential and conduct of business regulators, to deliver integrated supervision of the insurance industry.
FSA say that more effective internal liaison has been achieved, including through the full integration of actuaries and supervisors. This has been further enhanced by the establishment of two groups to co-ordinate insurance issues across the FSA: John Tiner chairs a high level group to ensure that the necessary cultural changes are embedded firmly across all FSA divisions and there is a separate group to identify and discuss emerging risks in the insurance industry.
7.8 Process
Wholly integrated supervision of the insurance industry is being introduced. FSA should remain alert to the difficulties of implementing change and, in particular, be alive to the risk that such structural change may facilitate better communication and co-ordination within FSA, but it will not necessarily achieve it.
FSA say they have established a high level group (chaired by John Tiner and which meets monthly) to ensure that the necessary cultural changes are embedded firmly across all FSA divisions.
[When any matter emerges which is of a certain size and scale and/or has potentially significant reputational issues], FSA management [should] take steps to ensure that:
- the existing team structure includes all those with a relevant interest in and the necessary expertise concerning the matter; or
- a special team is formed to handle the matter; and
- in both cases, the team is properly constituted with persons with the necessary expertise and knowledge and thereafter works comprehensively exchanging all relevant information and managing issues in a consistent and comprehensive way.
FSA-wide processes for dealing with major event management have now been introduced and steps taken to improve communication and co-ordination between the various divisions with an interest in insurance regulation.
This message [that the market confidence objective does not imply aiming to prevent all collapses or lapses in conduct in the financial system] be reinforced by making it clear to customers that non-intervention or no comment by FSA, where a company’s difficulties are attracting press coverage, should not be taken as an endorsement of the company’s financial well-being.
FSA say that they take every appropriate opportunity to make this clear and are considering more broadly how consumers might obtain more information about potential problems in firms.
FSA considers what standards of disclosure should apply [when customers are potentially exposed to significant operational risks] and the extent to which these can be codified.
FSA say that this recommendation is being addressed in several strands of work including initiatives to improve: firms’ marketing material; firms’ understanding of their disclosure obligations; information given to customers at the point of sale; disclosure of how discretion is exercised in with-profits funds; and information given after point of sale.
Steps [should] be taken to rectify the [lack of effective interaction between the regulator and Enforcement] and, in particular, to ensure that information in the hands of the Enforcement team is made available to the regulator and vice versa in a timely way in order to improve management of the matter and thereby overall consumer protection.
FSA say they have put formal procedures in place to promote timely and effective liaison, and co-ordination, between the insurance supervisors and the Enforcement Division.
As part of the integration of [prudential and conduct of business regulation], FSA takes steps to ensure that responsibilities [relating to customers’ interests and communications with customers] are comprehensive and properly co-ordinated and managed.
The supervisors responsible for managing relationships with individual firms now have responsibility for issues relating to both customers’ interests and communications with them.
7.9 Tools
FSA give consideration as to how to apply a more rigorous risk assessment process to specific situations where certain risks have escalated or crystallised, and where it is particularly important to plan for all reasonably considered outcomes. We welcome FSA’s stated intention to adopt a more proactive risk-based approach so that the frequency, depth and breadth of contact within firms is related to the risk category of that firm.
FSA say they have introduced a comprehensive new risk assessment and mitigation framework. In addition FSA say that they have improved their internal processes including developing an internal ‘watchlist’ of higher risk firms and implementation of FSA-wide processes for dealing with major event management.
In situations where regulators have to have regard for concepts such as PRE [policyholders’ reasonable expectations], which are undefined or capable of more than one interpretation, FSA should develop policy templates so as to ensure consistency of interpretation and application across the regulatory process.
FSA say their internal policy and procedural guidelines have been updated to promote consistent interpretation and application of the current regulatory regime and the risk-based approach to regulation.
In particular, [the Baird review team] encourage FSA to carry through to completion its current work on clarifying the meaning of customer interests and PRE.
The concept of policyholders’ reasonable expectations has now been replaced by the principle that due regard must be paid to the interest of customers and they must be treated fairly. FSA say their work in this area includes a number of strands relating to firms’ responsibility to treat customers fairly before, during and after the point of sale. FSA say they are consulting on proposals to improve the effectiveness of product disclosure at the point of sale for packaged products, including with-profits funds (CP170). FSA have already consulted on a requirement for firms to publish the principles and practices of financial management, which they apply to the management of with-profits funds. FSA say they will also consult on guidance designed to give firms greater clarity on what the obligation to treat customers fairly means as regards with-profits business.
The new approach as set out in the “New Regulator for the New Millennium”* will require consideration to be given by FSA to the level of resources committed to [life insurance regulation] and to the mix of competencies and skills required in order to give effect to the more proactive and interactive approach which is planned.
FSA say they have recruited 35 new insurance supervisors, most from the insurance industry and, in addition, have recruited two senior insurance advisers, both with extensive expertise.
7.10 General
The Baird report concluded that the Equitable case had industry-wide implications but that their terms of reference had only allowed limited insight into FSA’s consideration of those. They said that they: would expect FSA to have progressed such exercises.
FSA say that following the House of Lords’ judgment in the Equitable case, they asked firms with GARs to consider whether they were compliant with the judgment and, if not, what they would do or were doing to bring themselves into compliance. For those firms which have been identified as not being compliant, FSA say that they have sought proposals for rectification to compensate those who may have suffered loss. Following the publication of the Warren and Glick Opinions (for the Equitable and the FSA respectively) in 2001, FSA say they issued guidance in early 2002 to all with-profits firms that sold guaranteed annuity business about how firms should assess whether there had been
mis-selling and, if so, the financial impact of the cost of the guarantees on non-guaranteed policyholders. Work is continuing to identify any incidences of mis-selling and to resolve with firms how such mis-selling should be rectified.
Further information on the Tiner Report and other matters is available from FSA or their website at www.fsa.gov.uk.
--------------------------------
* “A New Regulator for the New Millennium” was published by FSA in January 2000.
