The 2020 European financial services outlook
For all financial services practitioners, 2020 will be a year of dynamic developments.
The impact on the insurance sector of a ‘yes’ vote in the referendum on Scottish independence is considered in our latest updater. How insurers deal with their capital resources is the subject of two recent PRA consultations. Our summary sets out what the regulator expects from firms and the proposed timetable. At its conference on general insurance, the FCA highlighted wholesale markets and Lloyd’s as key areas of focus. Finally, we include an update on proposed changes to the direct compensation procedure in Italy.
On September 18, 2014 Scotland will hold a referendum on whether Scotland should be independent. British, qualifying Commonwealth and EU citizens who are resident in Scotland and aged 16 or over on September 18 will be entitled to vote in the referendum. The vote will also extend to service personnel serving in the UK or overseas in the Armed Forces and entitled to vote.
Although a ‘yes’ vote would not legally require the UK government to recognise Scottish independence, it would clearly be a very difficult position politically, if the UK government were not to then work with the Scottish government towards a negotiated independence.
How might independence influence insurance business in Scotland?
Currently, the UK has a successful domestic market for financial services including banking, insurance, asset management and other financial services. Scotland shares a significant proportion of this UK domestic market and has an international reputation for its skills in banking and finance. Indeed, some of the UK’s most well-known financial services brands began their life in Scotland and over £300 billion of funds are managed in Scotland. In 2010 financial services and insurance contributed £8.8 billion towards Scotland’s economy, accounting for more than 8 per cent of Scotland’s onshore activity. Furthermore, 24 per cent of employment in the UK life and pensions sector is based in Scotland.
Should Scotland vote ‘yes’ on September 18, what might we expect to happen to the insurance sector in the UK? Read our Insurance Q&A on Scottish independence
The Prudential Regulation Authority (PRA) has published the following consultation papers:
CP9/14 seeks views on a draft supervisory statement which sets out the PRA’s expectations of insurers in relation to:
The statement relates only to structures where guarantees are being used to facilitate obtaining finance, however, for guarantees outside of scope firms should still consider whether those guarantees serve to undermine the quality of their capital.
According to the statement, subordinated guarantees should not serve to undermine the capital requirements. Any subordinated guarantee arrangement will be assessed by the PRA to ascertain whether it is consistent with one of the following situations deemed acceptable by the regulator:
In either case, any capital instrument that is guaranteed should still fulfil its regulatory purpose. The subordinated guarantee should not override the loss-absorbing features of a capital instrument and investors in a capital instrument should not avoid bearing losses when it is appropriate for them to do so.
Assessing quality of capital
Firms are expected to provide evidence so that the PRA can make informed judgements about the quality of firms’ capital resources. Within one calendar month of the publication of the final supervisory statement, firms must inform their usual PRA supervisory contact if their capital structures involve the use of subordinated guarantees and whether the existence of such guarantees has led to any adjustment to the tiering of their capital resources. Category 1 to 3 firms that do not have these capital structures in place are expected to confirm this to the PRA, also within one month of publication of the final statement.
By December 31, firms that have made, or will make, an adjustment to capital resources in their regulatory returns for year-end 2014, should provide to the PRA the contractual terms governing the subordinated guarantee, and information as to where in the firm’s regulatory returns the adjustment has been, or will be, made.
Also by December 31, firms that have made no adjustment to their capital resources, and do not intend to, must provide to the PRA the contractual terms governing the subordinated guarantee and an independent legal opinion to support their position. The legal opinion should address the economic substance and legal form of the structure and assess whether the capital instrument that is guaranteed is fulfilling its regulatory purpose.
Firms that have made no adjustment to their capital resources but are proposing a restructuring or changes to contractual terms to address the issue should submit the terms governing the subordinated guarantee and a detailed plan of the proposed restructuring or term changes to the PRA by December 31, 2014. Firms should also include the expected implementation date of the plan, which should be no later than December 31, 2015.
The draft supervisory statement includes two situations where the quality of capital is undermined by a subordinated guarantee designed to illustrate the issue addressed by the statement.
CP10/14 sets out the PRA’s expectations of firms in relation to existing rules on the valuation of financial assets. The draft supervisory statement applies to all PRA-authorised insurers and may also be relevant to insurance holding companies and other entities in the same group. The statement seeks to clarify existing rules on the valuation of financial assets in the General Prudential sourcebook (GENPRU). The PRA expects firms to have governance and processes in place to meet the requirements on valuation uncertainty and prudent valuation.
The draft statement explains that valuation uncertainty is the term used to refer to the existence, at the reporting date and time, of a range of plausible values for a financial instrument or portfolio of positions. Insurers should ensure that the assessment and quantification of valuation uncertainty is sufficiently robust and complete, particularly with portfolios of structured products and illiquid securities where valuation risk is most material. Quantification of valuation uncertainty should be underpinned by: sufficient independence in valuing assets; adequate documentation of policies and procedures; adequate control over valuation models; adequate management information; and consistent governance between internally and externally managed funds. Where firms consider valuation uncertainty to be immaterial, the PRA expects them to provide analysis as evidence.
Finally, the PRA expects firms to monitor and limit their use of client-supplied pricing (by external valuation providers) and have clear visibility of the price sources used, in particular to identify where client-supplied prices are used in their valuations. Where there are no practical alternatives to client-supplied pricing, the PRA expects firms to operate robust controls, including independent price verification and reporting of the materiality of client-supplied prices to senior management.
The closing date for both consultations is July 11, 2014.
For further information:
The Financial Conduct Authority (FCA) held its first general insurance conference on June 2, 2014 in which the regulator outlined its strategy for the sector and the key conduct issues that will be addressed over the coming year. Martin Wheatley, FCA Chief Executive Officer, acknowledged the industry’s positive engagement with the regulator over a year of significant change.
Wheatley argues that the industry has an opportunity to create a significantly better post-crisis business environment, with an emphasis on conduct, ethics and prevention. The overall theme of the conference points to a shift in regulatory focus from retail to wholesale markets. Over the next year the FCA will seek to move conduct forward to create greater market integrity in the long run. The main priorities are:
Clive Adamson, FCA Director of Supervision, in his speech focused on the industry’s response to the conduct agenda and how it plays into the regulator’s supervisory approach. For the general insurance sector, the FCA wants to see an industry that operates to the highest standards of integrity from top to bottom and is genuinely built around the interests of its customers. Adamson reiterates previous comments on the FCA’s outcomes-focused philosophy and how this translates into better business models and good conduct, culture and governance. Firms have addressed these issues in various ways including strengthening compliance, setting risk appetite, building in cultural and behavioural change programmes, changing incentive structures, and reviewing business models.
In response to comments from firms that the FCA is doing too much, Adamson argues that the industry has had less regulatory oversight from a conduct perspective than others so there is some catching up to do. The FCA acknowledges, however, that it needs to ensure its work is properly focused, coordinated and carried out as efficiently as possible. From the regulator’s work so far, Adamson notes that broadly firms do work in the interests of their customers but retail consumer outcomes vary markedly, largely due to culture and business model. Conflicts of interest, however, are a problem and further work will be done to ensure effective conflict management.
Adamson concludes that more can be done to embrace the conduct agenda and the FCA will continue to work towards raising conduct standards. While the retail sector should focus on maintaining the progress made over the past year, wholesale markets should prepare for increased regulatory focus on board engagement in consumer outcomes, distribution chains including coverholders, and the connectivity between commercial and retail markets. Upcoming thematic work will focus on more complex distribution structures, specifically the key risks and mixed responsibilities in the chain including cultural risks in relation to product design, sales and post-sales handling. Building on its retail claims and conflict of interest thematic reviews, the FCA will look at whether commercial customers’ expectations are met in the claims process and whether poor behaviour has an impact on consumer outcomes and market trust. As noted by Wheatley, a significant part of FCA supervision will be dedicated to Lloyd’s and London market firms over the next year.
Finally, Christopher Woolard, Director of Policy, Risk and Research, discussed how the FCA sees its role in promoting competitive markets. The FCA’s main tool in achieving its competition objective is its programme of market studies, the first of which focused on general insurance add-ons. Work is ongoing in this area but Woolard raises the following key ‘take-aways’ of this study that will inform the regulator’s thinking about competition:
The FCA acknowledges that it has more to do to promote competition and, later this year, will look at barriers to entry created by its authorisation procedure and how competition is dealt with in the wider Handbook.
For further information:
Direct compensation proceedings were introduced in 2007 in relation to certain damages arising out of, or in connection with, accidents involving insured motor vehicles allowing non-fault parties to be compensated directly by their own insurer, rather than from the insurer of the at-fault party for certain damages suffered. The current system provides that insurers of non-fault parties, having compensated the insured, can claim a certain amount from the insurer of the at-fault party. The amount that can be claimed is fixed annually by a technical committee of the Ministry of Economic Development, therefore, may be higher or lower than the sum paid by the non-fault insurer. The respective credit and debt positions amongst the various insurers which adhere to this procedure is then settled through a clearing house.
Although the direct compensation procedure has generally proved to have a positive effect on insurance services, mainly by decreasing the costs of indemnification, some inefficiencies were found in the subsequent economic settlements among insurers, currently based on a lump-sum system. To address this, IVASS recently issued a new draft measure for consultations which sets out new criteria for calculating costs and deductibles that will serve as a basis to settlement procedures for insurers in connection with motor third party liability direct compensation procedures (the Proposed Measure).
The Proposed Measure has introduced new operational models of claims management, depending on whether these claims have been raised by an injured party or by passengers:
Public consultation ended on May 31 and, when adopted in final form, the Proposed Measure should enter into force on January 1, 2015.
The new models, as described above, should offer insurers more incentive to adopt better claims management practices and discourage opportunistic and fraudulent actions, therefore enabling insured parties to benefit from lower compensation costs and quicker liquidation procedures.
For further information please contact Nicolò Juvara
For all financial services practitioners, 2020 will be a year of dynamic developments.
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