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Newsroom & speeches
12 November 2009
Thank you Peter (Vipond) for the introduction and thanks to the ABI for the invitation to speak this morning.
I would not normally discuss substantive matters of policy so soon after breakfast, it is not good for the digestion, but I’m afraid I am forced to make an exception today as there is a pressing issue that affect us all, Solvency II, that we must collectively address.
However before I do, and hopefully to give you a chance to at least recharge your coffees, I want to make a broader point on the importance of the insurance industry to the UK, not just economically, but socially.
The transfer of risk is an important social function. It allows people to get on with their lives without having to worry about risks they are unwilling or unable to bear. The insurance industry provides for such transfer.
The industry makes a huge contribution to the wealth of the country, to the Government’s tax receipts and is a significant provider of capital for investment across the economy.
It employs around a third of all the people who work in financial services here in the UK.
The industry has fared well relative to other financial sectors in the face of the global financial crisis, but we must not be complacent. As the Chancellor noted recently – the UK industry faces an increasingly competitive global market. As an industry you have recognised this challenge and demonstrated your commitment to building for the future.
In July, the Chancellor and nine insurance industry leaders jointly published the Insurance Industry Working Group (IIWG) report ‘Vision for the insurance industry in 2020’ - a vision for the UK to be recognised as the world’s leading global insurance centre.
Key to the report was recognition of the mutual benefits to insurers and government of working together.
Working together in areas such as promoting financial capability and responsibility; seeking innovative solutions to social challenges like increasing life expectancy and long term care needs; and sharing data and research efforts enabling better decision making.
In the future there will be increased public focus on the effectiveness with which the financial services industry serves the real economy, consumers and society – and insurance will not be exempt from this scrutiny.
The global financial crisis and well-publicised issues with products, such as payment protection insurance, have fairly or otherwise, undermined consumer trust in the financial services industry.
The IIWG report recognises that rebuilding trust is critical to the health and sustainability of the sector. This is a key issue and one where industry, government and the regulator all have a role to play.
Firms need to ensure that they treat their customers fairly, government must provide legal certainty for the industry and regulators must preside over a framework that renders consumer trust well founded.
This last issue is also recognised by the report and brings me to my main topic today; Solvency II.
I wish to reaffirm upfront something I have said many times in the past - European reforms are of great importance to the UK financial system and present clear opportunities that should be welcomed.
The Solvency II directive is an ambitious and crucial step forward for the insurance sector.
There are many positives in Solvency 2. It is a sea change that promotes risk based, market consistent capital requirements and regulatory approaches. It then seeks to spread these throughout Europe helping to create a level playing field. But to be credible it must be proportionate and economically sustainable
I have been a vocal advocate of better quality capital. A consistent, workable definition of capital across insurance, banking and investment will provide market certainty and promote market confidence.
But Solvency II was conceived under benign economic circumstances. It is now being negotiated in a starkly different climate. It is important for legislators to resist calls for sweeping reform to the Directive in the absence of robust data and analysis demonstrating a need for this.
Insurance companies differ from banks principally in the much lower significance of liquidity risks, which played such a central role in the banking crisis.
The regulation of insurance companies should not automatically follow the blueprint of that for banks. There are areas where consitency is desirable. But we should not have consistency for consistency’s sake.
Like with AIFM, we need to lead the debate. We have to explain why Solvency II matters for the economy, for the industry and for society. We must demonstrate leadership.
The UK industry and the FSA have already been through a significant reform of our domestic legislation through ICAS and are well placed to respond to, and inform the debate on these issues.
I met this week with Peter Skinner, a British Member of the European Parliament who did sterling work steering this difficult dossier through negotiations in his guise as the Parliamentary ‘Rapporteur’. He agrees that we have achieved good results to date; but that there is still some way to go.
Level 1 was a success; but we cannot allow this strong start to be undone by well intentioned, but ill-conceived implementation at Level 2. In Solvency II, as with so much legislation, the devil is most certainly in the detail.
I wish to discuss some of these details with you this morning that affect both life and general insurance.
For life insurers the focus has been on the need to recognise a liquidity premium in the interest rate term structure used to discount certain liabilities, principally annuity liabilities, and the risk that failure to do so will artificially inflate technical provisions.
This is a point the FSA’s Jon Paine raised recently in his speech at Gleneagles.
We need to make sure that we do not overvalue the risks associated with annuity liabilities, thus requiring overly prudent levels of capital.
Capital must be sufficient to provide security and assurance, but setting capital at an excessively conservative level will have very real consequences in terms of dis-incentivising retirement provision and adversely impacting pensioner income.
For all the talk of discount rates and technical provisions we must be crystal clear that the risk here is increased costs for pension businesses, and ultimately pensioners.
We absolutely cannot allow this to happen. Government is committed to ensuring that these regulatory reforms do not unintentionally impact the lives and well being of pensioners in the UK and elsewhere in Europe.
We also run the risk of creating unwanted structural imbalances if we construct a regime that implicitly favors one asset class, such as equities, over others such as Gilts and corporate bonds, through the capital charges associated with them. Capital requirements must remain true to the Directive’s original ideal of market consistency and be grounded in the fundamentals of risk.
The UK’s developed annuities market means that the burden of proof lies with us to drive the technical debate. We need industry and insurance regulators to agree a methodology for the practical quantification of the liquidity premium that contributes to confidence in the product.
These arguments should find a home elsewhere in Europe with a number of countries moving towards annuities for pension provision. It would also make little sense to discourage the insurance industry from providing finance to other actors in the economy. To do so would impede growth and job creation across the EU precisely when we should be seeking to nurture and facilitate economic recovery.
We have secured progress through our efforts to date. The liquidity premium will be explicitly discussed in a European Commission Working Group. The Commission has signaled its support for drawing on a broad church of experience, including the industry, in analyzing this technical area.
I was delighted to see that CEIOPS, the committee of European insurance regulators, recognised the need for a liquidity premium for certain types of liabilities in their formal advice to the Commission published on Tuesday. This is a fundamental step forward, but I reiterate that more needs to be done.
In this instance technical arguments are required to achieve social aims. The government has a social duty to the pensioners and future pensioners of the UK, and the industry has a robust technical basis for its concerns. I am committed to furthering the technical argument here and in Europe, building on the CEIOPS advice, to ensure that our social obligations are met.
Other areas of the Directive require attention as well. It is important we ensure that the standards set for the Solvency Capital Requirement are evidence-based and appropriately reflect the economic risks of businesses.
Risk factors such as operational risk must not be given an unwarranted uplift without a solid base of empirical evidence justifying this. The CEIOPS advice on this is another positive step forward that should be welcomed across the sector.
Similarly, we need to ensure that the rules dictating technical provisions are appropriately calibrated, and interact sensibly with other capital requirements.
We share an over-arching concern with industry about the need to carefully assess the aggregate impact of all of the proposed measures, before we come to any final conclusions on each of the issues involved. Again Peter Skinner is alive to this issue and is working to ensure it is properly considered within the Parliament.
We need to be careful to ensure the right structure of regulatory responsibilities and deliver a framework that supports the business of our international groups, and groups with subsidiaries based here.
Fundamentally underpinning all of these challenges is the need to ensure that the eventual regulatory obligations Solvency II do not go beyond the original intentions of the framework directive.
We must deliver on multiple fronts, not just on annuity concerns, if Solvency II is to realise its potential for positive reform.
The European Commission will now consider CEIOPS’s advice and propose formal draft implementing measures to the Council and Parliament. The final implementing measures will not be agreed by the Council and Parliament until mid 2011, so there is a long road ahead of us and plenty of opportunity to shape debate along the way.
Getting the detail right is not the responsibility of government, or the FSA, in isolation – you have an important role to play.
So to conclude the directive is hugely progressive and is a welcome and timely update of the prudential framework for insurers.
I commend the work of Treasury officials, the FSA and the industry in bringing us to this point. But there is more to be done.
We need to draw on our experiences with the AIFM Directive. Good regulation requires solid evidence and analysis and visible engagement.
The UK can and must lead the debate on all fronts to ensure that Solvency II delivers on its promise of significant regulatory reform of an industry that is crucial to not only European economies, but European claimants, savers and pensioners.
Thank you and I look forward to your questions.
