Life insurance newsletter: Issue 14 - FINRA - Rules and Regulations

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The changes: • enhance the analysis of assets held by insurers by improving the analysis of derivatives in response to the current financial crisis; • add guidance on assets that embed derivatives; and • make several amendments of a technical or clarifying nature in response to queries from firms and their advisers. Further information can be obtained from our online Handbook, Handbook Notice 83 (http://www.fsa.gov.uk/pubs/handbook/ hb_notice83.pdf) paragraphs 2.7 to 2.11 and 4.14 to 4.105 and Chapter 4 of Quarterly Consultation (No 17) published in July 2008 (http://www.fsa.gov.uk/pages/Library/Policy/CP/ 2008/08_12.shtml). Consultation Paper (CP) on stress and scenario testing In September 2008, our Insurance Sector Briefing highlighted the need for insurers to continue to make advances in the integration of risk and capital management. A key aspect of these advances was updating stress and scenario practices. The briefing provided some feedback on how – within the existing rules and guidance – we expect insurers to develop their approach to stress and scenario testing in light of recent market events. In December 2008 we published a CP on stress and scenario testing for banks, investment firms and insurers (http://www.fsa.gov.uk/pubs/cp/cp08_24.pdf). A key aim of the CP is to ensure that firms have stress and scenario testing practices in place that allow for better informed and more timely decision-making by their senior management. We have proposed several changes to our Handbook rules and guidance to achieve that outcome. The following are relevant to insurers. • Reverse-stress testing: We have proposed the introduction of a reverse-stress test requirement, whereby a firm must identify and assess the scenarios most likely to cause its current business plan to become unviable. • Capital planning: We have proposed clarifications of our general prudential sourcebook rules and guidance on stress and scenario testing in the context of capital planning, typically over a three to five-year time horizon. These set out the requirement for a firm to project the capital necessary to cover all its material risk exposures and to support any new business plans, taking account of the effects of potential adverse economic and business cycles. • Further proposed guidance on pension obligation risk and group risk. A guide to the key messages for insurers can be found in Annex 3 of the CP. The closing date for responses is 31 March 2009. Passporting and reinsurance The Reinsurance Directive (RID) extended a system of authorisation and financial supervision to all pure reinsurers with their head offices in EEA member states. Our Handbook was amended on 31 December 2006 to incorporate the prudential provisions of the RID. HM Treasury completed the implementation of the RID on 10 December 2007 by making changes to the Financial Services and Markets Act (the Act) and regulations made under it. We have recently made some further updates within the Supervision Manual with effect from 6 March 2009 as follows: • Updated guidance on passporting changes to the Act. • Introduction of a basic notification requirement on UK pure reinsurers, which is not a requirement under the Act and not a precondition of carrying on business through a branch in another EEA state. The requirement enables us to monitor the activities of UK pure reinsurers and to carry out our obligations under the CEIOPS general protocol. UK pure reinsurance firms had already voluntarily complied with the notification prior to consultation. • Clarification of our guidance on the exercise of Treaty Rights by EEA direct insurers in respect of their reinsurance business. Further details may be found in FSA 2009/9 Supervision Manual (Passporting And Reinsurance) (Amendment) Instrument 2009 (http://fsahandbook.info/FSA/handbook/LI/2009/ 2009_9.pdf), Handbook Notice 85 paragraphs 2.10 to 2.14 and 4.7 to 4.10 (http://www.fsa.gov.uk/pubs/handbook/ hb_notice85.pdf) and CP08/16 Quarterly Consultation (No 18) Chapter 4 (http://www.fsa.gov.uk/pubs/cp/cp08_16.pdf). Page ◆ 4 This is not FSA guidance.
Professional indemnity insurance (PII) – new limits From 1 March 2009, there are new PII minimum indemnity limits for intermediaries who give advice on or sell insurance-based products (both investment and non-investment types). The limits have been changed, as required by the Insurance Mediation Directive (IMD), in line with the increase in the European Index of Consumer Prices over the five-year period since the IMD came into effect. The minimum limits for firms have been raised to €1,120,200 for a single claim (currently €1 million) and €1,680,300 in aggregate (currently €1.5 million). PII indemnity limits for firms not subject to the IMD remain unaffected. More information is available on our website at: http://www.fsa.gov.uk/smallfirms/good_practice/ protecting_your_business/PII_limits.shtml. Reminders of existing requirements Valuation of bonds Some insurers may have experienced difficulty with the valuation of their assets and in particular corporate bonds because of the considerable reduction in market activity in many asset classes. We would expect firms to have regard to guidance of the IASB’s Expert Advisory Panel (published in October 2008) in this regard. Mark-to-market valuations are still likely to be the norm, but if this guidance were to steer some firms towards adopting a mark-to-model approach for valuing some of their assets, then they may need to develop their modelling capability and enhance the relevant internal controls on this activity, including appropriate involvement of senior management. Impact of foreign exchange rates Given the scale and speed in the decline of the value of the Sterling and the changes in the relative strengths and weaknesses of various currencies, it is important that firms with material currency exposures recognise fully, and reflect in their ICAs, current and potential future risks that could arise from future foreign exchange movements. Consideration should apply not only to the reported figures, but also to underlying currency exposures and risks that may not be fully reflected under various reporting methodologies. COBS 21 requirements: unregulated collective investment schemes (CIS) The Permitted Links rules (COBS 21) allow up to 20% of assets used to back unit-linked retail policyholder benefits to be held in unregulated CISs, provided that: • all the assets held within the unregulated CIS are themselves permitted links; and • all the other requirements of COBS 21 are met. The purpose of the 20% limit is to prevent the risk of marketing restrictions on the sale of unregulated CIS to retail consumers being circumvented by placing it in a unit-linked life or pension fund, which is then marketed to retail policyholders. The limit applies to all funds except those available only to institutional-linked policyholders. Recently, some firms have notified us that their holdings in unregulated CIS have risen above the 20% limit. While the new Permitted Links rules are designed to operate more flexibly, exceeding the 20% is still regarded as a breach and we expect firms to notify us and then submit a plan to take reasonable and timely steps to restore compliance. We would not expect firms to act in a way likely to aggravate the breach. Gearing Gearing on linked property funds must not exceed 10% of the gross asset value of a linked fund. Unregulated CIS that invest in property are often highly geared. Firms must ensure that the gearing in unregulated CIS contained within unit-linked funds does not put them in breach of the overall 10% gearing limit. If a breach does occur, firms must notify us in writing as soon as they become aware of the breach and submit timely and coherent plans for bringing their funds back into compliance. Solvency II update The negotiations between the Council of Ministers and the European Parliament (EP) on the final wording of the legislation needed to underpin the new regime are still ongoing in Brussels. The aim is to find an agreement before the EP elections in June. In the meantime, work has started on the development of technical rules and guidance needed to implement Solvency II (the Level 2 implementing measures). The CEIOPS consultation schedule for 2009 will cover a number of the major areas of the This is not FSA guidance. Page ◆ 5
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Life insurance newsletter: Issue 14 - FINRA - Rules and Regulations

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