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Published 29 January 2010
Contents
FSA expresses concerns over client money in letter to brokers
TCF and today’s market
FSA fines director £75,000 for lying to the regulator
FSA bans insurance broker for failing in his duties as a director
FSA fines Standard Life £2.45 million
Changes to FSA returns
No exemption from VAT for reinsurance transfers
FSA policy statement on stress and scenario testing
Solvency II – Level 2 guidance papers: respondent’s comments
Solvency II – CEIOPS finalisation of Level 2 advice
Solvency II – 2010 timeline
FSA expresses concerns over client money in letter to brokers
The FSA has sent a letter and report to the chief executive officers of all insurance brokers and investment firms which are supervised on a ‘relationship managed’ basis and which are able to hold clients’ money or assets. The letter expresses the FSA’s concerns over the handling of clients’ money and assets.
This follows a letter sent to such firms in March 2009, explaining the obligations of firms to protect clients’ money and assets. It also set out the FSA’s intentions to carry out further visits during 2009. The present letter and accompanying report follows visits to a range of firms, where the FSA found a number of failings. The report contains details of the findings and highlights some of the weaknesses discovered, including:
• poor management oversight and control,
• lack of establishment of trust status for segregated accounts,
• unclear arrangements for the segregation and diversification of clients’ money, and
• incomplete or inaccurate records, accounts and reconciliations.
Measures have already been taken against a number of firms visited, including referring two firms to enforcement, freezing a firm’s assets and commissioning of skilled persons reports.
In addition to highlighting failings, the report also includes examples of how firms should meet the expectations of the FSA in relation to compliance with its requirements. The FSA will be increasing its visits to firms during 2010, in order to assess how well these expectations are being met.
carole.skinner@moorestephens.co.uk
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TCF and today’s market
The FSA has updated the TCF area of its website in response to the current business environment. This environment is described as “challenging for firms as they look to stabilise and rebuild their capital base. This, combined with a low interest rate environment where returns on investments are not at the level of previous years, generates risks for consumers.”
Whilst the FSA acknowledges the difficult economic and financial conditions, where in its view, firms will be seeking to grow revenues by attracting profitable customers, it also emphasises that firms must retain their focus on the fair treatment of customers.
carole.skinner@moorestephens.co.uk
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FSA fines director £75,000 for lying to the regulator
The FSA has recently fined the director of a financial adviser firm £75,000 for lying repeatedly to the regulator and in addition, banned him from the industry.
The tribunal identified failings with respect to the Statements of Principles for Approved Persons. A lack of honesty and integrity had been demonstrated, contrary to Principle 1, in addition to failures to be open, cooperative and truthful contrary to the requirements of Principle 4.
The director first came to the FSA’s attention during a supervisory visit, when previous failings were incorrectly asserted as having been rectified. This underlines the importance, both of being fully prepared for FSA ARROW visits and of ensuring that all statements are carefully considered.
carole.skinner@moorestephens.co.uk
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FSA bans insurance broker for failing in his duties as a director
The FSA has recently banned Stephen Allen, a director of insurance broker, Fabien Risk Services Ltd, which was placed in creditors’ voluntary liquidation in late 2005.
Whilst concluding that Allen did not lack honesty or integrity the FSA concluded that he lacked the competency required to look after client money. This follows other directors being banned for lacking integrity when they withdrew client funds to keep the business trading. Allen’s ban arises as he was unaware of these activities, and in his role as director this represented a neglect of his duties.
The clear implication is that directors of regulated entities must be fully conversant with the on-goings of their business in order to fulfil their duties.
carole.skinner@moorestephens.co.uk
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FSA fines Standard Life £2.45 million
The FSA has recently fined Standard Life Assurance Limited £2.45 million for systems and controls failures relating to misleading marketing material for its Pension Sterling Fund. Included within the FSA’s findings:
• marketing material regarding the fund was not clear, fair and not misleading;
• there were no adequate systems or controls in place to ensure the marketing material accurately reflected the investment strategy for the fund.
The FSA has confirmed that it “will continue to take strong action when a firm’s financial promotions fall short of the requirement to be clear, fair and not misleading and customers have not been treated fairly”.
The Final Notice refers to breaches of Principle 3, management and control and 7, communications with clients.
carole.skinner@moorestephens.co.uk
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Changes to FSA returns
The FSA has recently confirmed inflationary increases to apply in the preparation of FSA Returns for insurance companies in respect of year ends 31 December 2009 onwards. This is the first such increase since 31 December 2006.
There are increases to the base capital resource requirement (expressed in euros) to be used in Form 1, which may affect smaller firms or those in run off. Full details of these increases can be found in the FSA Handbook at GENPRU 2.1.30.
There are also increases to the euro amounts used in the calculations of the general insurance capital requirement, forming part of Forms 11 and 12. These changes are reflected in the forms which can be accessed within IPRU(INS) at Appendix 9.1.
For those firms which use a software package to assist in the preparation of the returns, these changes should have been made, but firms should check that this is the case.
In addition, an updated euro rate is to be applied for returns covering year ends from 31 December 2009 to 30 December 2010. The exchange rates will be 1 euro equivalent to 0.89375 pound sterling (previous year 0.7869). For those returns prepared in US dollars, the relevant rate is 1.4800 (previous year 1.2757).
carole.skinner@moorestephens.co.uk
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No exemption from VAT for reinsurance transfers
The procedure on reinsurance portfolio transfers has been changed by the UK tax authority with the result that companies may no longer avoid VAT payments on such transfers. UK insurers and reinsurers were previously able to obtain exemption from VAT by stating that the forthcoming transfer qualified as a “transfer-of-a-going-concern”. However, the UK tax authority has now stopped this type of pre-clearance.
This subject will be considered in more detail in the next edition of Insured Interest.
carole.skinner@moorestephens.co.uk
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FSA policy statement on stress and scenario testing
The FSA has released a policy statement outlining their final rules for a firm’s own stress and scenario testing (PS09/20), which forms part of the FSA’s integrated approach to stress testing.
PS09/20 has been issued in relation to the Firms’ own stress testing element of the framework.
The key change that firms will find is the introduction of reverse stress-testing requirements. Reverse stress testing is designed for firms to identify scenarios which would make their business plan unviable, a ‘hand back the keys’ scenario.
The FSA has clarified that the reverse stress test should be used by the firm to devise appropriate risk management strategies, and is not the FSA’s intention for this to form part of the capital and liquidity assessments. Senior management should be using this to put in place recovery plans, which would outline strategies, risk mitigants and contingencies, in line with the firms’ risk appetite.
The FSA will expect to review reverse stress tests during their ARROW visits, and will expect this analysis in the ICAs produced by firms. They will also expect this testing to be carried out at regulated entity level, and not at group level for regulated groups, as scenarios leading failure of a singular entity are likely to differ from those scenarios which would lead to failure of a group.
The various responsibilities were clarified:
• Establishing an effective programme - Directors and senior management
• Implementing the programme - Senior management
• Integrate outputs into decision making - Senior management
The FSA are allowing a period of 12 months (December 2010) before the reverse stress-testing requirements come fully into force.
sandip.johal@moorestephens.co.uk
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Solvency II – Level 2 guidance papers: respondent’s comments
The third and final phase of CEIOPS’ Level 2 guidance was released in November 2009, with the consultation period closing on 11 December 2009 (this excludes CP78, discussed below with a consultation period open until 5th February 2010). CEIOPs has made available respondent’s comments on the sixteen closed consultation papers, which are summarised below. One overarching comment concerned the length of the consultation period, which at six weeks, was felt to be too short (this compared to nine and ten weeks for phases one and two, respectively).
SCR standard formula
Own funds – treatment of participations (CP 67)
Some respondents have expressed the view that the proposed approach to the treatment of participations within this CP does not meet the terms of the level 1 text and is not in line with the philosophy of Solvency II. It is seen as a more prudent approach than that anticipated in the directive. Specific comments have been raised regarding double gearing and the fact that this is addressed at group level, so does not need also to be addressed at solo level and also that the elimination of goodwill gives no recognition to the fact that goodwill has an economic value.
Own funds – treatment of ring fenced funds (CP 68)
There is widespread concern by respondents that neither of the definitions proposed by CEIOPS, with respect to such funds, is appropriate. There is also concern that the CP is unclear as to how to identify a ring fenced fund and that the proposed definitions therefore have the potential to include as ring fenced, funds which would not normally be considered as such. UK respondents are of the view that, for the UK market, ring fenced funds should only apply in respect of with profit funds.
Design of the equity risk sub-module (CP 69)
Respondents expressed concern that the capital requirement as proposed are some way above the QIS4 levels, and may be over prudent taking insurers some way over the 99.5% VaR. It has also been suggested that the ‘other equities’ bracket is too wide, and needs to be divided up such that appropriate capital charges can be applied to differing equity types.
Calibration of market risk (CP 70)
Continuing with the above theme respondents felt the capital charges were too onerous, with the Association of British Insurers (ABI) estimating the capital charge will be 3.5 times the QIS 4 level for a typical A-AAA rated bond portfolio. There was also a concern that the current structure of the spread risk module would give insurers an incentive to invest in shorter term assets, which may go against best practice of matching asset durations to liability duration estimates. Additionally the split of investment property between ‘city’ and ‘non-city’ was considered an over complication, and a measure which could lead to inconsistencies in the definition of what a city is.
Calibration of non-life underwriting risk (CP 71)
The ABI again estimated that the requirements as currently drafted were overly onerous, with an indicative study suggesting an average increase over QIS4 numbers of around 65% in SCR. Many respondents commented that CEIOPS had not done enough to justify the recommendations and the increases over QIS4 levels.
This was due in part to the current approach double counting the impact of catastrophes, a situation excessively onerous for catastrophe re/insurers. There was also not enough explicit consideration given to geographical diversification of portfolios, a key risk mitigation used by many firms.
Calibration of health underwriting risk (CP 72)
The theme continued in this consultation paper, with the over prudence of CEIOPS causing concern for most respondents. It was also felt that not enough consideration has been given to the variations within the health insurance markets across Europe, and as such one size may not fit all.
Correlation parameters (CP 74)
Respondents commented that they felt CEIOPS had not had a sufficiently detailed nor lengthy analysis process, with many respondents arguing that until such analysis can take place the factors should be left unchanged. Again no geographical diversification is allowed for, which does not correspond with how insurers are managing their concentration risk.
Undertaking specific parameters (CP 75)
Respondents welcomed the ability to apply industry sector specific parameters to their calculation, given that many industries, such as the mutual insurance market, is unique from other insurers. There remains however a concern amongst respondents regarding the autonomy given to local supervisors when approving such parameters and thus could lead to divergent interpretations. Respondents also felt that recalculating the USP more frequently than the SCR would be overly onerous, particularly in a situation where a firm may find themselves being monitored quarterly.
Simplifications (CP 77)
There was a concern that CEIOPS suggest they would require firms to calculate the model error of the simplifications in use, as this negates all benefits of a simplified calculation.
Others
Repackaged loans investment (CP63)
Respondents expressed concern around the requirements which state that the Insurer must ensure they review the suitability of the originator of such investments, which would result in insurers having to make up for failures in banks and the banking regulators, and effectively acting themselves as regulators to the banks. It was felt that this would come at a disproportionate cost.
Extension of the recovery period - Pillar II dampener (CP64)
The paper advised on when supervisors may consider extending the period granted to undertakings to restore their SCR following an exceptional fall in the financial markets, with the majority of respondents agreeing to the 30 month period. Respondents were concerned that the definition of ‘an exceptional fall’ would be so onerous that the extension period would not be available, or worse still that the definition of ‘exceptional fall’ would not be harmonised across member states.
Partial internal models (CP 65)
Respondents have generally welcomed CEIOPS’ advice and approach with respect to partial modelling, in particular the recognition that maintenance of such a model may be a permanent rather than a temporary solution. Some concerns have been expressed, however, regarding the necessity to provide strong evidence that the Standard Formula correlation matrix is not appropriate, rather than demonstrating why an alternative correlation matrix would be more appropriate.
With respect to integration of the partial internal model, where the standard formula correlation matrix is not appropriate, the advice put forward three options. Those respondents who expressed a preference, felt that Option 3, which uses dependency structures and parameters provided by the undertaking (or techniques provided by the supervisory authority) was the most appropriate.
Group solvency for groups with centralised risk management (CP 66)
The general feeling of respondents is that the requirements for groups with centralised risk management are extremely onerous, would be impractical for the majority of groups and go beyond what is required for effective risk management. Where a group has consistent group-wide management, respondents are of the opinion that some of the advantages of centralised risk management should be permitted, such as the requirement for preparation of the ORSA at group level.
Some respondents also considered that guidance should be provided in respect of how centralised risk management should be applied where the group includes non EEA undertakings.
Advice on MCR – calibration (CP 73)
This paper received little comment, other than to say that as the MCR is derived on the same basis as the SCR then the changes CEIOPS have made to the SCR will have the same impact on MCR as it does on SCR (i.e. increase it). Most respondents have thus referred CEIOPS to their responses on the SCR consultations.
Technical provisions – simplifications (CP 76)
As with CP77 (above) respondents felt that the requirements on firms to be able to use simplified calculations may be onerous and defeat the objective of simplification. It was considered over zealous of CEIOPS to stipulate simplified methods within level 2 text. Whilst some respondents thought such specifications should wait until level 3 text, others thought it should be left to the judgement of the expert involved, as the requirement stipulates the individual should have the appropriate skills and experience.
Simplifications for captives (CP 79)
Respondents felt that CEIOPS had narrowed the definition of what a captive is more than the original directive. This could have a significant impact on this sector according to many respondents. Respondents felt that insufficient consideration was given to the fact that captive re(insurers) are non profit organisations, put in place to offer their parent groups flexibility and cost effective access to insurance.
Open consultation
CP 78 – Technical criteria for assessing 3rd country equivalence
The one remaining open level 2 consultation paper relates to third country equivalence for non EU, regulators. The consultation period for this paper closes on 5th February 2010. The paper outlines the process for third country regulators to seek equivalence, such that entities may apply the same capital charge to reinsurance with group entities within such third countries as they would if the entity were within the EU.
sandip.johal@moorestephens.co.uk
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Solvency II – CEIOPS finalisation of Level 2 advice
CEIOPS met on January 26th – 27th to finalise their Level 2 advice on Solvency II practical implementation (excluding CP78, see above). This follows consultation on three phases of consultation in March, July and November 2009.
For detailed analysis on how the comments on the final phase of consultation papers impacted CEIOPS’ final advice please keep an eye out for our February 2010 regulatory alert.
sandip.johal@moorestephens.co.uk
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Solvency II – 2010 timeline
Below we have outlined the key dates relating to Solvency II for 2010. Developments will come thick and fast, with finalisation of Level 2 advice followed swiftly by CEIOPS moving onto QIS5, possibly the last of these quantitative impact studies before Solvency II comes into effect towards the end of 2012.
Solvency II timeline (PDF)
sandip.johal@moorestephens.co.uk
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We believe the information in this Insurance Regulatory Alert to be correct at the time it was sent, but cannot accept any responsibility for any loss occasioned to any person as a result of action or refraining from action of any item herein.