Speech by the Financial Secretary to the Treasury.
[Check against delivery]
It’s great to be here today, in what’s my second visit to the ABI as Financial Secretary.
I’d also like to take this opportunity to congratulate the ABI on the appointment of Otto Thoresen as your new Director General.
I’ve had the pleasure of working with Otto over the last few years on policy relating to savings and financial advice, and I have found him to be a very effective advocate for the sector.
I look forward to working with him, and many of you here, in the months and years ahead.
Some of you may recall that I had the privilege of speaking at your annual dinner last year.
On that night, back in June, I focussed on the Government’s plans for a new regulatory framework:
- How we intend to rebalance our economy towards a model that encourages more savings, investment and growth.
- Break up the tripartite system that had so badly failed us in the run up to the crisis.
- And work with our partners across the Channel to shape Europe’s own regulatory architecture.
Well this morning, unsurprisingly, the themes are generally the same but we have made significant progress in the last nine months.
So I want to discuss where we are now, how far we’ve come, but also what we should be looking to achieve as we look ahead to the future.
And how the insurance industry has a vital role to play in delivering this Government’s plans.
Britain’s insurance sector
It’s well known that Britain has a world class insurance sector and world class insurance firms to match.
You’re at the very heart of our financial system.
And a strong and successful insurance sector is important for the direct wealth and employment benefits it brings, and for the way it can meet the needs of businesses and households.
Because it’s your industry that enables households, businesses and every other part of the economy to function… as it’s you who you manage the risks that we each face on a daily basis.
It’s vital for your long term success, as well as the rest of the economy’s, that this remains the case.
That households and businesses have the confidence to buy your policies… safe in the knowledge that they’ll be getting a good deal and the appropriate level of protection from an insurer able to meet their end of the bargain.
The Government is committed to working with you, the insurers, to help you achieve the long term success that is good for your businesses, good for your customers, and good for the economy as a whole
Insurance and savings
When we came to office in May of last year, one of the first things we made clear was our desire to create an economy that was built on the back of savings and investment.
As a Government we’re looking to create the right conditions to support higher savings across the board… especially for retirement.
To create a savings and pensions framework that reflects a culture of greater responsibility, and is therefore responsible but also more sustainable over the longer term.
And we’ve taken significant steps towards this.
Take pensions for instance.
The removal of the outdated requirement to annuitise by age 75 will give people more freedom to take responsibility for their financial future…
…To make decisions about retirement that are right for them.
At the same time, we’ve had to make sure that pension tax relief is both fair and sustainable.
That’s why we reduced the annual and lifetime allowances.
With the input of the ABI - we came to a solution that was simpler than our predecessors’ approach; will ensure that pension relief remains generous; but is also affordable to the Exchequer.
We recognise that our policies have to work with the grain of saving habits and not inadvertently undermine the market.
Which is why I feel that auto-enrolment strikes the right balance between working in the interests of the electorate, and being mindful of the effects on the industry.
And I know this is something that the ABI has broadly welcomed.
There are over a quarter of households with no liquid savings whatsoever in the UK- this needs to change.
So I’d encourage you to engage in our further work on savings, pensions and protection, including our current consultation on simplified products.
To help inform the debate.
And provide the analysis that will shape Britain and Europe’s savings - and of course, regulatory- agenda.
Regulatory architecture at home and abroad
As a Government, we firmly believe that businesses and consumers get the best outcomes from financial services if markets are competitive and properly regulated.
However, we also recognise that disproportionate or overbearing regulation imposes costs on firms that are passed on to users… either through higher charges; lower returns; or reduced choice and competition.
We’re committed to getting this delicate balance right both at home and abroad.
On the domestic front, you will already know that we’re putting in place a new regulatory architecture - one that will ensure all regulation of the financial system is effectively targeted.
Whilst these reforms have been triggered by the banking crisis we believe a stronger, proportionate regulatory framework with better focus on systemic risk, prudential supervision and better consumer outcomes will benefit the whole industry.
As a first step, we’re creating a single, dedicated, macro-prudential supervisor.
This new body is the Financial Policy Committee - who, as part of the Bank of England, will have chief responsibility for maintaining financial stability and addressing systemic risk.
It will ensure that any risks developing across the financial system are identified and dealt with.
On a micro-prudential level, the Prudential Regulation Authority and the Financial Conduct Authority will be responsible for the day-to-day regulation of firms.
Both the PRA and the FCA will have a strong role in the regulation of insurers, as directed by their objectives.
However, as indicated in last month’s consultation document ‘Building a stronger system’, we are clear that the risks carried by insurers, and those which they pose to the financial system, differ to other types of institution.
It will be important for the supervisory approach of the new authorities to reflect the particular characteristics of the sector.
For example, authorities must reconcile policyholder protection and expectation of future return with balance sheet soundness and stability of institutions.
This is a particular issue for those insurers offering with profits policies.
I encourage you to respond to the consultation, to help us ensure that the regulatory framework is fully effective.
And I’m sure I don’t need to tell this audience that Europe too is taking forward its own major reform of financial regulation.
The new European supervisory structure, for instance, is now up and running.
If we look first at EIOPA, I certainly welcome their approach to improving the regulation of insurance and pensions.
But also, their efforts to introduce consistent regulation across the EU will be of great benefit to Britain’s insurance industry.
As the world’s leading insurance market, Britain has much to gain from this harmonisation of supervision.
We are keen to work with these authorities as they develop, and ensure that they deliver their objectives:
- To deliver higher and consistent standards of supervision across the EU.
- To implement common rules that every institution must adhere to.
- And most importantly of all, help create a level playing field across Europe.
EIOPA should help deliver a major advance in completing a single market in insurance creating new opportunities for our sector overseas.
The Government will continue to help shape the European regulatory architecture.
And I encourage you to stay focussed, and also engage in the European debate.
Which brings me, of course, to Solvency II.
Solvency II will introduce a harmonised and modern approach to prudential regulation of insurers, which is an approach that we are all signed up to.
It will replace the tired patchwork of regulations that existed under Solvency I.
In the wake of the financial crisis, consumers need to be confident that insurers can meet claims regardless of what’s going on with the wider economy.
This means that solvency regulation should be robust enough to withstand any market conditions; enhance policyholder protection; and foster confidence in the financial services industries.
Yet any changes to the current rules need to be proportionate and not place undue burdens on the sector as a whole.
These are the messages the UK took to the Level I discussions… where we secured some valuable wins:
- Agreeing a market-consistent approach that will provide strong policyholder protection…
- Alongside a supervisory and disclosure framework that will encourage risk management and improve competition.
However, now is not the time to reflect on previous negotiations.
We still have a long way to go if we’re to get Level 2 to where it needs to be.
In this game at least, there’s still a lot to play for.
And I’d like to emphasise that I remain fully committed to working closely with you and with our European partners to ensure we get this right.
For example, I recently exchanged letters with Commissioner Barnier on annuities business.
And in my trip to Brussels earlier this week to meet MEPs and Commission officials, Solvency II was one of the main topics of discussion.
It’s crucial to keep these lines of communication open because, as you well know there remain some outstanding issues. Let me highlight just three for the purposes of my remarks this morning.
On the capital side, let’s be clear: we need a sensible definition of liabilities and contract boundaries reflected in the Directive.
The terminology in the definition should ensure that all known insurance obligations are captured.
Because as insurers you need to be able to look ahead, forecast, and manage all your risks effectively….
And accounting for future liabilities and future premiums in determining the quantity of available capital is at the very core of Solvency II.
Which is why profits from future premiums should count in the calculation of capital (or Own Funds).
To do anything else would go against the economic approach of the Directive.
Calibration of the standard formula
Secondly - when it comes to the often contentious ‘Standard Formula’ - anything other than a 1/200 risk profile would be inappropriate…
…yet calibrations must still be consistent with the risks of the ‘average firm’.
This is a difficult balance to strike, but one we have to get right.
In considering the Standard Formula calibrations, it is also appropriate to discuss the internal model - which is used to derive more firm-specific capital requirements.
AsI know that, for many of you, the issue of how the internal model will be used, and the approval process for the internal model is a real concern.
So, I welcome the FSA’s commitment that the internal model will not be benchmarked against the Standard Formula. And it’s important to stress that firms using an internal model will not be obliged to disclose standard formula results.
However, there are outstanding issues regarding when internal models can and will be approved- and we’ll continue to work with the Commission to ensure that this doesn’t create any headaches for the insurance sector.
Illiquity premium and long-term guarantee products
And last, but by no means least, the illiquidity premium remains a key priority.
We’re pressing for a predictable, automatic and objective method of discounting annuities.
The inclusion of a formula would achieve this, and furthermore, will ensure that the illiquidity premium functions as an effective counter-cyclical measure in stressed conditions. I hope that you will continue to work with us to develop the proposals on this.
Equally important is securing adequate transitional protection for existing businesses, to give the industry time to adapt to these new proposals. I understand your concerns about the current proposal of 7 years with a taper, but I believe that there is a drive to make progress on this.
A Commission working group is looking at the issue of the illiquidity premium more closely, in line with treatment of long term products under Solvency II.
And we’re strongly represented on this important working group, as I know some of you are. I’m confident that through constructive engagement, we’ll achieve the right outcome.
Last week’s QIS5 results reaffirmed the importance of securing these priorities.
However, when considering the results, we should be mindful of three things:
First of all: QIS5 was a field test not a stress test.
It was designed to give a basic overview of the Commission’s draft Solvency II legislation in its current state… and not a definitive judgement on the final design of the Directive.
Secondly, the picture it gives is just a snapshot taken at the end of 2009.
So when deciding what the results tell us, we need to be conscious that they don’t tell the whole story…
…they don’t take account for the whole range of circumstances that firms can encounter from one year to the next.
And finally, it’s clear there are some limitations to the results.
For example, the effects a transitional measure could have on groups with non-EEA holdings are simply not captured.
And it’s worth remembering that QIS5 results are based largely on the use of the Standard Formula… but a significant number of firms - in the UK at least - will use an Internal Model.
It is for these reasons that the aggregate results are useful but not definitive- and why the results from QIS5 for individual firms should not be disclosed.
That said, it’s clear that QIS5 will be useful in shaping further Solvency II discussion.
It’s certainly highlighted some of the issues surrounding the Standard Formula, most notably in the areas of internal reinsurance calibrations, and non-life catastrophe risk charges.
But from my perspective we need even more evidenced-based assessment to help inform the Solvency II debate.
Which is where you come in.
When it comes to finding the best solutions - both domestically, and in Europe - we’re at our most effective when we work together - with industry - and engage openly on our priorities.
In this respect, I can’t overstate your importance.
Equally, when it comes to gathering evidence to back up our position, Government cannot do this alone.
It’s you who are the experts.
Who know where the problems lie.
Who recognise when things need to change.
And are in a position to make sure that this happens.
When it comes to European regulation, it’s detailed analysis that sways opinion.
It’s your evidence.
Your sense of priorities as to what really matters for the industry.
And your impact assessments that can help deliver the right outcomes for Europe.
So I’d encourage you to support the Government in defending your interests.
To help us win the argument.
To deliver on the issues that really matter
And secure a prosperous future for Britain’s insurance industry.
That is the message I’d like to leave you with.
And I look forward to taking your questions.