Reforming Insurance Regulation Solvency 2

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Reforming Insurance Regulation - Solvency 2

• Paul Sharma
• Financial Services Authority

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Why change(1)?

• Insurance markets are becoming
• more open
• more sophisticated and
• more competitive.

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Why change(2)?

• Policyholders are demanding
• more choice
• better products and
• fairer treatment.

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Why change(3)?

• Insurers are becoming
• more willing to accept and manage risk
• more willing to take on new types of risk but
  also
• more innovative in the ways they diversify and
  transfer risk.

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Why change(4)?

• The management of insurers are becoming
• more risk conscience
• more scientific in their approach to risk and
• more comprehensive in their approach to risk
  management.

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Why change(5)?

• In summary
• We can not rely upon the future being much like
  the past.
• Just doing the same today as we did yesterday
  means giving less protection to policyholders.
• Old style regulation risks standing in the way of
  innovation, competition and market efficiency.

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So what does change need to achieve?

• We need to
• enhance safety and soundness in the insurance
  markets
• improve competitive equality and
• be more comprehensive in our approach to
  addressing risk.

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So how do we achieve this?

• First, we need to learn from others.
• Second, we need to change our laws and
  regulations.
• Third, we need change ourselves.

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Learning from others (1)

• We need to
• learn from regulators in other sectors,
  especially banking
• learn from management and other risk
  professionals and
• learn from one another.

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Learning from others (2)

• Learning from others (e.g. banking regulators)
• is not the same as copying them
• includes learning from their successes
• but also from their mistakes.

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Lessons from one another

• We need to
• work together more closely
• exchange information and ideas and
• learn to trust and respect each other.

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How we are learning from one another

• We now work together more closely in the
  co-ordination groups set up under the Insurance
  Groups Directive.
• We are exchange information and ideas in
  developing the Solvency 2 directive, especially
  in the Commission and Conference Working groups.

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The Conference Working Group(1)

• This working group is
• drawing up a list of key risks faced by insurers
  and mapping those risks in a cause-effect
  diagram and
• identifying and distinguishing between the
  originating, intermediate and ultimate causes of
  financial failure and between causes and symptoms.

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The Conference Working Group(2)

• This working group is drawing information from
• the detailed knowledge and experience of its
  participants
• surveys of all recent financial failures and
  near misses and
• detailed discussion of a selection of important
  case studies.

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The Conference Working Group(3)

• The working groups will also
• survey diagnostic, remedial and preventative
  regulatory tools
• review whether those tools are adequate to
  address not merely the symptoms of financial
  failure but also their underlying, intermediate
  and ultimate causes.

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Lessons from management

• Investors are demanding greater transparency and
  efficiency in capital use.
• This is leading to new techniques for assessing
  risk and allocating capital.
• These techniques go beyond traditional actuarial
  methods.

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Lessons from banking

• Banking is also changing rapidly (and in many of
  the same ways as insurance)
• but so is the regulatory regime (in Basle 2)
• and so is the accounting regime.

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Key points from Basle 2

• Minimum capital requirements need
• a sound and transparent accounting system
• a calculation method that is risk-sensitive and
  well calibrated to actual market data and
• to be supplemented by supervisory review and
  measures to enhance market discipline.

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The three pillars of Basle 2

• Minimum capital requirements (pillar 1)
• Supervisory review (pillar 2) and
• Enhanced market discipline (pillar 3).

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Minimum capital requirements

• The regulatory minimum capital requirements
  should
• take account of all risks not just the dominant
  risk
• be calibrated at similar levels to economic
  capital and
• allow for the use of well-tested internal models.

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Supervisory review - first principle

• Management should
• have a process for assessing their overall
  capital in relation to their risk profile and
• and a strategy for maintaining their capital
  levels.

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Supervisory review - second principle

• Supervisors should review and evaluate
• managements internal capital assessments and
  strategies
• its ability to monitor and ensure compliance with
  regulatory capital requirements and
• take appropriate action if not satisfied with the
  results of this review.

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Supervisory review - third principle

• Supervisors should
• expect firms to operate above minimum regulatory
  capital requirements and
• have the ability to require them to hold capital
  in excess of the minimum.

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Supervisory review - fourth principle

• Supervisors should
• seek to intervene at an early stage to prevent
  capital from falling below the minimum levels
  required to support the firms risk
  characteristics and
• require rapid remedial action if capital is not
  maintained or restored.

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Enhancing market forces

• Accounting reform and enhanced disclosure are the
  key to enhancing market forces.
• Better disclosure not just more disclosure.
• Disclosure which helps stakeholders make economic
  decisions.

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Good disclosure

• Firms should have
• a formal disclosure policy approved by the board
  of directors
• a process for assessing the appropriateness, and
  frequency, of their disclosure and
• should base their disclosures on their internal
  risk assessments.

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Accounting reform

• Accounting reform is needed
• to close the gap between accounting conventions
  and economic reality
• to expose and measure hidden prudence and
• to remove incentives for dysfunctional decision
  making.

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Drawing these lessons together

• The challenge we face is to achieve a Solvency 2
  directive which
• responds to the lesson we need to learn
• facilitates radical reform of insurance
  regulation and
• makes our regulation more relevant, more potent
  and better focused.

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Conclusion

• The world is changing.
• We need to learn ...
• and change too!