UK To Introduce Stiffer Capitalisation For Life Insurers

by Robin Pilgrim, LawAndTax-News.com, London

03 September 2003

The UK's Financial Services Authority (FSA) has proposed new rules to determine how much capital should be held by life insurers. These rules, which would be compulsory for any company with aggregate with-profits liabilities of £500 million or more, covering 95% of the UK market, will link the capital requirements for with-profits insurers more directly to how they smooth the payments they make to their policyholders. Thus, the more smoothing takes place the more capital with-profits life insurers will have to hold. This will reduce the pressure on with-profits funds to sell equities when the stock markets fall as the capital requirements will also reduce as a reflection of their ability to adjust discretionary payments downwards.

The new rules would also give the regulator more scope to set higher capital requirements than the minimum levels to reflect any additional risks in the business. In addition the new regime would require all life insurers to undertake their own self-assessments of how much capital they need to hold, including through undertaking stress and scenario tests. The FSA has already proposed similar rules for non-life insurers in July.

Clive Briault, Director of the Prudential Standards Division at the FSA said:

“These proposed rules are a major step forward in the modernisation of insurance regulation. They will provide a more appropriate and sensitive calculation of regulatory capital requirements for life insurers, especially those with large with-profits funds. They will link closely with the introduction of our new requirements for these funds to issue statements of how they will determine payments to their policyholders as well as reducing the pressure on with-profits funds to sell shares when the stock markets fall. The proposed rules are a refinement of an approach that was outlined in earlier consultation papers and the Tiner report, and which formed the basis of waivers from our current requirements that were granted to some life insurers earlier this year."

The proposed rules on the calculation of minimum regulatory capital would require life insurers with large with-profits funds to undertake two calculations to determine their minimum regulatory capital requirement- a modified version of the current calculation and a new, more realistic one which takes into account discretionary payments more explicitly. Life insurers would then have to hold enough capital to cover whichever calculation gave the higher result. Under the proposals companies would publish both the statutory and realistic figures once a year. They would also submit a further update on their realistic figures to the FSA every 6 months.

The new rules on capital propose that all life insurance firms would in future be given individually tailored guidance on how much capital they should hold, similar to the system already in place for banks in the UK. This individual capital guidance would be set with reference to the specific business and control risks incurred by each life insurer. The onus would be on life insurers to make their own assessment of their capital requirements and then discuss it with the FSA. Following these discussions the FSA would then be able to vary each insurer’s regulatory capital requirement.

All with-profits insurers will continue to have to meet the EU minimum requirements. These are broadly that with-profits insurers have to have at least 4% of assets over and above their liabilities to meet the guaranteed payments to policyholders.

The timetable for implementing the proposals envisages that the new way of calculating capital requirements would come into force during the second half of 2004. The consultation period is until 30 November 2003.

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