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Insurers not adequately preparing for new European regulatory regime, FSA head warns

Insurers are falling behind in their implementation of new risk management and solvency processes that are due to come into force for European insurers from the start of next year, the UK's financial regulator has warned.20 Apr 2012

In a speech to the industry Julian Adams, director of insurance supervision at the Financial Services Authority (FSA), said that that some of the firms who would be seeking approval to use an internal mechanism for meeting their responsibilities under the new Solvency II regime were at risk of missing their submission slots.

He warned that the regulator would "cease to work with" firms if it took the view that they would not "reach the required standard by a date which makes model approval viable" before the changes begin to take effect from January 2013.

The European Parliament's Economic and Monetary Affairs Committee (ECON) approved further compromise measures in the Omnibus II Directive, which will implement the Solvency II standards for insurers, last month. However the regime, which has proved controversial, will be subject to further discussions as the Parliament, Council and European Commission produce a new draft of the text. A plenary vote on this draft is due to take place at the European Parliament in July.

Omnibus II (155-page / 3.7MB PDF) is a draft EU Directive which sets out stronger risk management requirements for insurers and dictates how much capital firms must hold in relation to their liabilities. Once it is finalised, implementation of the Directive is expected to happen on a phased basis from 2013 to 2014.

Adams said that insurers were likely to receive a higher degree of feedback from the regulator over the coming weeks and months as it finished its review work and began to draw "meaningful conclusions" from firms' pre-application materials.

In many cases, supporting documentation was "weak or underdeveloped", while some firms were relying too heavily on "expert judgements" that were not sufficiently supported by documentary evidence.

"Whilst poor documentation is bad in and of itself, we are also concerned in some cases that it is an indicator of poor underlying thinking, or a lack of senior management engagement with a particular issue," he said. "We would caution against a perception which seems to exist among some firms that expert judgement is a magic bullet which can be used to explain away any aspects of a model which are not properly documented or justified."

Adams also moved to reassure firms that the focus of the new regulator the Prudential Regulation Authority (PRA) would be "the overall effectiveness of the system of governance and how it works in practice" rather than considering the form and structure of the industry in unnecessary detail.

"What the PRA will seek to do is two things - first, to minimise the probability of firm failure, and second to bring about a situation where the impact of such a failure, both on policyholders and on the financial system, is also minimised," he said.

The FSA recently began an internal reorganisation process intended to reflect the new 'twin peaks' structure of financial services regulation due to come into force from 2013. Under the new regime all banks, building societies and credit unions, investment banks and insurers will be prudentially regulated by the PRA while conduct regulation will be the preserve of the Financial Conduct Authority (FCA). The PRA will be based within the Bank of England while a new Financial Policy Committee (FPC), also within the Bank, will address wider 'macro-prudential' issues that may threaten economic and financial stability.

Adams said that having two sets of regulators dealing with prudential and compliance issues was a "significant development" for the industry, but added that combining prudential oversight with wider macro-prudential responsibilities within the Bank of England would ensure consistent treatment for financial transactions – whether they were being conducted by insurers or other financial bodies, such as banks.

"The clear combination of macro- and micro-prudential responsibilities will put us in a much better position to understand and deal with the nature and extent of cross-sectoral risk transfer, and the potential effects this may have on the overall system," he said.