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All Solvency II firms should apply remuneration requirements in the same way, says UK regulator


All senior staff with "significant levels of responsibility" within large UK-regulated insurers should be subject to the same remuneration requirements, the Prudential Regulation Authority (PRA) has confirmed.

The regulator has issued a draft supervisory statement setting out its expectations of firms subject to the EU-wide Solvency II regulatory regime (22-page / 869KB PDF), after its own review of industry remuneration practices found that firms were confused about which staff were subject to the new rules and "significant discrepancies" in the ways in which they dealt with deferral of a certain proportion of variable pay.

In its statement, the PRA said that it was important that all firms applied the rules the same way in order to prevent a "race to the bottom", in which firms were "able to compete for staff resources by adopting lower than the industry standard". It has confirmed that, in its view, a 'substantial proportion' of variable remuneration means no less than 40%; and set out a non-exhaustive list of staff that should be subject to the new rules.

Insurance law expert Rabbani Choudhury of Pinsent Masons, the law firm behind Out-Law.com, said that although it was "inevitable" that the PRA would publish guidance along these lines following its insurance remuneration review, the document raised further questions for Solvency II firms.

"The key issue now is whether this proposed guidance contains an appropriate set of provisions to support insurers to comply with the requirements," he said. "For instance, will the provisions relating to the new 'material risk takers' concept easily enable insurers to identify who these employees are? Has the PRA got it right with its proposed 40% minimum deferral threshold of the 'variable remuneration component'? It has also set out some expectations on bonus and award criteria which appear challenging, however, it has avoided stipulating any bonus cap."

"It is helpful for smaller firms that the PRA has said that the main target group for this proposed supervisory statement is cat 1 and cat 2 firms, which will mean firms outside of these categories will not necessarily have to bear the disproportionate cost impact which will have to be borne to meet the expectations in the proposed supervisory statement," he said.

The Solvency II regime came into force across the EU on 1 January 2016, setting out tougher risk management and capital requirements for those insurers which are regulated by its provisions. In the UK, the new rules apply to more than 400 retail and wholesale firms, including the Lloyds of London syndicate and managing agents.

Remuneration policy requirements are set out in Article 275 of the EU's Solvency II delegated regulation. Although the rules are not as rigid or as detailed as those applicable to bankers under the revised Capital Requirements Directive (CRD IV), they do require firms to appoint independent remuneration committees and establish remuneration policies which "[promote] sound and effective risk management". Such policies should incorporate an "appropriate balance" of fixed and performance-related variable pay elements, which a "substantial proportion" of any variable pay entitlement must be deferred for at least three years.

The PRA said that it expected all Solvency II firms to apply the remuneration requirements consistently across the corporate group, "so there should not be significant deviations between what applies to the Solvency II entities and other entities in the group". The exception would be if those other entities were banking or asset management firms subject to their own remuneration requirements; but there should still be "a high degree of consistency" across those policies with ultimate control resting at the group level.

For the purposes of the directive, 'Solvency II' staff subject to the remuneration requirements should include members of the board and executive committee, Senior Insurance Manager Function (SIMF) holders with PRA supervisory pre-approval and Significant Influence Function (SIF) holders pre-approved by the Financial Conduct Authority (FCA); as well as 'key function' holders under the Senior Insurance Managers Regime (SIMR) and other material risk-takers. As a minimum, this should include those with "significant levels of responsibility" for risk management, compliance, actuarial and internal functions, and not just the heads of those areas at the group level, according to the draft.

The PRA has advised firms to take those staff subject to the SIMR as a "natural starting point" when identifying Solvency II staff, given that this UK individual accountability regime applies to "senior decision makers and those who manage the firm or who are responsible for key functions". Firms should also consider whether there are "any additional key functions of specific importance to the sound and prudent management of their business" within which staff should be subject to the regime, such as the investment or IT functions, or a claims management function.

The 40% threshold which the PRA intends to use as its definition of a "substantial proportion" of variable remuneration has been selected to align with that used in the banking and asset management industries, where the relevant legislation uses the same wording but specifies a 40% threshold. The regulator noted that this threshold "might be perceived as relatively high" given that insurance variable pay levels are often lower than at banking and asset management firms, but said that a "harmonised approach across the sectors" was needed to discourage staff movement between those financial sectors.

The PRA is consulting on its draft until 2 June 2016, although its expectations of firms may be subject to change once proposals to extend the Senior Managers and Certification Regime (SM&CR) to insurers receive royal assent. However, this would be covered in a separate consultation later in the year, it said.

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