Lloyd’s of London has welcomed comments made in a speech by the UK financial watchdog, the Financial Services Authority (FSA). The regulator’s chief executive, Hector Sants, told market participants attending an Insurance Institute of London talk at Lloyd’s that the FSA recognises industry concerns over Solvency II and is pushing to have the views of UK insurers heard in Europe.

On the proposed changes to the UK regulatory framework, he said that as the degree of systemic importance is less for insurers than banks, the purpose of prudential regulation for insurers needs to be viewed in a different way to that of banks.

“The approach to the supervision of insurance set out by Hector Sants in his presentation is encouraging,” said James Walmsley, senior manager, government policy and affairs at Lloyd’s. “We are pleased to hear that the FSA understands the need to ensure that Solvency II gives the right result for UK insurers and in particular that he is pushing the European Commission to deal with the issue of non-life catastrophe risk.”

Sants also pressed home his view that banks and insurers require different regulatory treatment. He moved to allay industry fears that the benefits of the new Solvency II regime may be outweighed by its cost and that the standard model used to set solvency would be wrongly calibrated.

Sants acknowledged that the correct calibration of the standard model will be key for insurers, even if they intend to use their own models to calculate solvency, as is allowed under Solvency II. The regulator is committed to dealing with areas of both over-calibration and under-calibration, he says.

The FSA chief executive also addressed the specific issue of the capital charge for non-life catastrophe risk under Solvency II. “We continue to press the Commission for appropriate capital requirements,” said Sants, “and we have already highlighted non-life catastrophe risk as a particular area for further work.”

The FSA is due to be replaced in 2013 by two new regulatory bodies, a Prudential Regulatory Authority (PRA) under the Bank of England and the Consumer Protection and Markets Authority (CPMA). The form the CPMA will take is still under discussion but the PRA will be a more intrusive and judgement based supervisor than the FSA. However, it will not aim for zero tolerance of failure, recognising that removing risk taking completely would damage industry innovation and consumer choice, said Sants.

The FSA chief also addressed one of the insurance industry’s main worries with the direction of regulatory change, the risk that insurers will be tarred with the same brush as banks. “At this point, it is crucially important that we remind ourselves that insurance is different to banking,” he said.

Insurers have a very different business model to banks and do not represent the same level and type of systemic risk. The PRA’s regulatory approach should take into account the different nature of insurance, he added.

In his address, Sants also noted the EU’s new regulatory framework, effective 1 January, including the creation of the European Insurance and Occupational Pensions Authority (EIOPA). The authority will be the rule making body in Europe, leaving the FSA and its successor to become a national supervisory arm of an EU policy setting body, he said. “It is thus vitally important that the UK organises itself to effectively influence decision-making, not just in EIOPA, but also in the wider European framework.

“The FSA is represented on the inaugural Management Board of EIOPA and I can assure you we will invest significant effort, including my own personal time, into fully engaging with the issues facing the insurance sector at a European level.”

Sants stressed the recognition that UK insurers – which have a far greater international business than many other European countries – could be disadvantaged by regulatory changes in Europe. “It is fair to say that in the European regulatory debate, many supervisors are domestically focused, but in London there are far more international elements to the insurance industry. This will be a cultural challenge and we recognise that EIOPA must recognise the different needs of insurers in Europe,” he said.

In recognition of difficulties encountered by insurers with developing Solvency II, the FSA will push to get improvements in the consultation process on to the agenda in Europe, said Sants. There is room for significant improvements in the consultation process and cost benefit analysis for European legislation, he says. However, he also called on the insurance industry to push for action on this issue.

Lloyd’s is active in lobbying in Europe, through the European trade association CEA, and also directly with the Commission, said Walmsley.
Hector Sants’ presentation formed part of the Insurance Institute of London lecture programme. A podcast of the speech is available on the IIL website and a full transcript on the FSA website at http://www.fsa.gov.uk/pages/Library/Communication/Speeches/2011/0209_hs.shtml

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