The Association of British Insurers- Written evidence- (CIR0021)

 

ABI response to House of Lords Industry and Regulators Committee on Commercial Insurance and Reinsurance

About the Association of British Insurers

The Association of British Insurers is the voice of the UK’s world-leading insurance and long-term savings industry. A productive and inclusive sector, our industry supports towns and cities across Britain in building back a balanced and innovative economy, employing over 310,000 individuals in high-skilled, lifelong careers, two-thirds of which are outside of London.  

 

Our members manage investments of nearly £1.7 trillion, collect and pay over £16 billion in taxes to the Government and support communities across the UK by enabling trade, risk-taking, investment and innovation.

 

We are also a global success story, the largest insurance sector in Europe and the fourth largest in the world.  

 

The ABI represents over 200 member companies, including most household names and     specialist providers, giving peace of mind to customers across the UK. 

 

Consultation response

  1. The ABI welcome the opportunity to submit evidence to the committee’s inquiry on Commercial Insurance and Reinsurance, with a specific focus on the London Market and how regulation can be adapted and improved. The committee’s inquiry is timely, taking place alongside HM Treasury’s latest consultation on the Future Regulatory Framework for Financial Services and the ongoing review of the Solvency II regulatory framework.

 

  1. The ABI’s response does not attempt to answer every question from the committee in detail, but provides information on the key issues for the commercial insurance and reinsurance sector as part of the wider post-Brexit regulatory environment. We hope the committee finds this helpful and we would welcome the opportunity to contribute to the inquiry further, and the wider work of the Select Committee in the future. The Government have committed to significant legislative change to undo EU rules and establish a robust, competitive, flexible and new regulatory framework that will embed the UK as a world leader in financial services.  The committee will have a key role to play in scrutinising this legislation and we look forward to continuing to work with you.

 

Is the UK regulatory framework appropriate for the commercial insurance and reinsurance sectors?

  1. The long standing, traditional regulatory framework has served the UK well however, the changing nature of the risks (and opportunities) our country faces, as well as the moving away from the EU rules-based model of regulation, means this traditional approach needs to adapt if it is able to meet the reality of modern times. In post Brexit Britain the Government has a chance to grasp the nettle of reform and create a complementary tax and regulatory framework that drives competitiveness, attracts overseas capital and promotes the UK as a place to invest, innovate and inspire and recognises the unique requirements of our world leading London Market. Now that we have left the EU, the Government can set the UK apart from its continental competitors if it embraces reforms that enable institutional investors to support the Government’s ambitions, both to ‘level up’ across the country and take a leading role in transforming our economy and society to reach ‘net zero’.

To what extent do the Bank of England and Financial Conduct Authority apply and interpret regulatory policy in these areas in a proportionate manner and strike the right balance between regulation and competitiveness?

  1. Unlike other financial services sectors, the legislation of the insurance and long-term savings industry is not set by an international standard setter, such as the Basel Committee on Banking Standards. This means that there are no detailed regulatory perimeters within which the PRA must operate, and potentially an extremely vital level of oversight is lost.

 

  1. We strongly believe that where there are no international standards, such as in insurance, HM Treasury must have a greater role in setting out in detail some core assumptions in legislation that directs the PRA in its own rulemaking power.

 

  1. HM Treasury’s FRF consultation considers the use of “have regards” and “obligations” in legislation to give some future direction of approach for the regulators. We broadly agree with this, however, these should not act as a replacement for HM Treasury in setting out in more detail certain regulatory perimeters in insurance legislation when it is required. What is required will need to be considered sector by sector.

 

  1. The second consultation on the Financial Services Future Regulatory Framework Review has the right intentions towards creating a regime that is fit for purpose, but it could have gone further. If the Government wants the UK to compete on the global financial stage, then we need a regulatory framework that matches the same vision. It’s disappointing to see the consultation recommends a new growth and international competitiveness objective as only  a secondary objective for the PRA and FCA. This does not go far enough as regulators will always put primary objectives above secondary ones. We have a unique opportunity to boost competitiveness, attract overseas capital and promote the UK as a world leading financial services hub, but unless regulators have economic growth and international competitiveness as a primary objective, we are not convinced anything major will change.

 

  1. Insurance is one of the first financial services sectors to see a review of its cornerstone prudential regulation (Solvency II) in the post-Brexit environment. Under this live experience, what we have witnessed so far only serves to increase our concern at the regulator’s ability to consider HMG’s overarching policy objectives and amplified our belief that a primary objective is necessary. While the Government has not indicated a hierarchy for their Solvency II objectives, the PRA has assigned primacy to objective 2 (policyholder protection), which is also a primary statutory objective of the PRA, suggesting that this objective “supersedes” the other two.

 

  1. As HM Treasury foresees a greater transfer of responsibilities and discretion to the regulators, we maintain that in parallel there needs to be an enhanced mechanism to support Parliament in scrutinising their activities both at a level of greater detail and in greater quantities.

 

  1.         We continue to believe that a Joint Committee of both Houses of Parliament to scrutinise financial services legislation and rules and look in depth at areas to improve regulatory effectiveness, would be most effective. The Joint Committee would be supported by a panel of experts who have experience in financial services law, policy and consumer advocacy, and are fully independent, including dealing with any potential conflicts of interest. Ultimately, this proposal would be aiming at ensuring that (i) regulator policy meets intended policy objectives); (ii) performance is measured against the statutory objectives / principles; and (iii) supervisory effectiveness.

 

What improvements could be made to the regulation of commercial insurance and reinsurance in a post-Brexit context?

  1.         The current Solvency II framework is one of the world's most prudent and cautious prudential regimes – now is the time to make sure we have a regime that is fit for the UK’s needs. The EU is also carrying out a review of the framework to ensure it offers greater flexibility and investment opportunity. 

 

  1.         Independent KPMG modelling, commissioned by the ABI, demonstrates that, with no additional cost to the taxpayer, two specific reforms to Solvency II can unlock £95 billion to help level-up our communities, help tackle climate change and invest in the businesses of the future, while still upholding high levels of policyholder protection to international standards.

 

  1.         Alongside this, the ABI’s Climate Change Roadmap, with work done by Boston Consulting Group, identified an overall £0.9trillion of funds that can be invested in supporting the Government’s net zero ambitions, providing almost one third of the £3trillion investment required to meet the Government’s 2035 target for a 78% reduction in CO2 emissions. This would require a much wider set of reforms to deliver of which Solvency II reform would be the first.

 

  1.         Our proposals for reforming the Solvency II regulatory Framework are based on key changes that the regulators and HM Treasury can deliver on, including:

 

Reducing the risk margin to unlock investment

 

  1.         ABI members firms have also been calling for the Treasury’s Solvency II review to address overly burdensome and unnecessary reporting requirements as well abolishing branch capital requirements, while maintaining world leading standards of policyholder protection and prudent risk management.

 

  1.         Another area where the UK should look to take advantage of having more post-Brexit flexibility is to enable insurance and reinsurance companies to offer related (auxiliary) services which are not themselves regulated activities.  This would help spur innovation in the sector, without the set-up costs currently associated with firms having to establish a separate entity to offer services

How do the activities of the UK’s financial regulators affect the ease of carrying out commercial insurance and reinsurance business in the UK? What impact does this have on the availability and cost of insurance cover in the UK?

  1.         The OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting (IF) has agreed a two-pillar solution to address the tax challenges arising from the digitalisation of the economy. The implementation of these new global tax rules must not lead to UK (re)insurers being disadvantaged. As members of the IF, the UK must work with others to ensure there is equity and fairness in these rules and that they do not create distortive outcomes.

 

  1.         For insurance and reinsurance business in the UK, it is critical that the Government continues to support their exclusion, as part of wider financial services, from the scope of Pillar One.

 

With regard to Pillar Two we continue to be concerned that the calculation of the effective tax rate could lead to tax being paid by insurers when it is not economically due. We are also concerned that investment funds owned by insurance companies could be subject to tax when such entities are widely accepted to be tax neutral. Tax neutrality is crucial to avoid penal tax outcomes for insurers investing in such funds.

 

  1.         The UK is a global (re)insurance hub, and many multi-national (re)insurers are either headquartered or have regional holding companies here. Therefore international, not just UK, aspects of the application of the Pillar One and Pillar Two rules will impact the UK insurance industry.

 

  1.         The lack of a primary statutory objective for the regulators to consider the implications of its activities on economic growth and international competitiveness has resulted in numerous regulatory requirements that place unnecessary constraint and burden on insurance and reinsurance firms. There are many improvements that could be made which would support and improve competition and innovation in the UK, without undermining financial stability and consumer protection.  The addition of a primary statutory objective for the regulators to consider the implications of its activities on economic growth and international competitiveness would support this. This would encourage the UK regulators in support of the agendas of levelling up, economic growth and net zero. In addition, greater focus on market dynamics has the potential to improve competition and innovation. For example, brokers control £18.2bn GWP of the available £20.9bn across the UK commercial insurance market.  Regulators have and should be encouraged to apply the tools (both policy and supervisory) to ensure a more level-playing field, which would ultimately translate into better customer outcomes.

 

  1.         One of the consequences of Brexit, and the associated restructuring that firms (both UK and EEA-based) have undertaken, has been the increase in the use of internal reinsurance on a cross-border basis (i.e. reinsuring business from a UK branch back to EEA entity, or vice versus). It is important the UK insurance and reinsurance sector remains open to such arrangements and that the UK regulators and UK tax authorities do not attempt to restrict this.

 

  1.         There needs to be a proportionate capital and reporting regime for third country branches. Restrictions or additional requirements (e.g. reporting or collateral) increase the friction of operating in the UK with a branch model and risk creating an uneven playing field with the EU.  Where a regulator is concerned about the risk a branch poses to the UK's financial services sector and customers, there are already mechanisms available which the regulators can use to mitigate this.

 

  1.         The UK Review of Solvency II should be used to abolish branch capital requirements. A branch cannot fail independently of the legal entity of which it is a part, and thus local capital requirements can add friction cost without increasing financial strength.

 

  1.         Following the Review of the Future Regulatory Framework, we are expecting significant legislation on the future of financial services in the next Queen’s Speech. This legislation is a unique opportunity to deliver a more proportionate regulatory regime that recognises the differences of the Commercial insurance, reinsurance and London Market. The regulators should also recognise the key role that the London Market has to play in Green Finance as a world leading market.

 

  1.         The inability of the current regulatory framework to recognise the differences between the London Market and the other insurance markets that operate in the UK has the potential to make a negative impact on the UK’s commercial and reinsurance markets. For instance, the volume of ‘Dear CEO, CFO, CRO’ letters can be burdensome for London Market members. Interventions in the wider market can have the unintended consequence of facing the London Market with high costs, reputational damage or difficulties with compliance due to the specific nature of how commercial and re-insurance operates.

What is the status of the London Market’s global competitiveness, and how is this impacted by different regulatory approaches in other territories?

  1.         The UK has the fourth largest insurance industry in the world and the largest global insurance and reinsurance market. It remains the global centre for commercial and speciality risk, underpinned by its expertise in understanding and managing risk and ability to recognise new and complex risks as they emerge.

 

  1.         This global prominence, however, cannot be taken for granted, and there are several other financial centres who are well placed to compete for this position. The long standing, traditional regulatory framework has served the UK well, however, the changing nature of the risks (and opportunities) our country faces, as well as the moving away from the EU rules-based model of regulation, means this traditional approach needs to adapt if it is able to meet the reality of modern times.

 

  1.         There are several jurisdictions where their financial services regulators are expected to balance financial stability, market integrity and policy holder interests with other objectives aimed at supporting the economic interest.

 

  1.         In countries commonly recognised as having a thriving global financial services industry, such as Hong Kong, the US, Australia or Singapore, the regulators are often given a specific duty to promote economic growth or competitiveness:

 

  1.         In some other jurisdictions, financial regulators are mandated to balance risk, as opposed to only reduce or eliminate it, understanding risk as a necessary element to do business. For instance, in Canada the Office of the Superintendent of Financial Institutions’ (OSFI) mandate, as directed by parliament, states “the need to allow financial institutions to compete effectively and take reasonable risks.”

 

  1.         Finally, there is the case of New Zealand, where its Reserve Bank Act13 (1989) establishes that the purpose of the Act is, among others, “to promote the prosperity and well-being of New Zealanders and contribute to a sustainable and productive economy”. This is followed by the economic objectives, which includes “supporting maximum sustainable employment”.

 

  1.         All the examples above show objectives that promote growth, employment and competitiveness of their industries and economies in a way that are not mutually exclusive of the regulators’ objectives on financial stability, market integrity and policyholder protection, and indeed can be synergetic.

 

  1.         We are not calling for a “race to the bottom”, strong, robust regulation is essential for business and customer confidence, however the UK’s regulatory regime needs to be modernised,  if it is to remain competitive.

 

  1.         For example, the UK introduced its insurance-linked securities regime in 2017 and last year after a consultation, published draft tax legislation to exempt securitisation and insurance-linked securities arrangements from stamp duty. However, speed to market remains an issue, with regulatory approval still far slower than other ILS domiciles. Since 2017 there have only been five created in the UK. This is something the UK needs to look at if it really wants to take a meaningful share of the global ILS market’s issuance.

 

  1.         The UK signed a bilateral agreement with the US Department of Treasury and US Trade Representative in 2018, in which the US and UK governments recognised the appropriateness of group supervision for large international insurers. The agreement acknowledges that group supervision of insurers and reinsurers enables supervisory authorities to form sound judgments of the financial position of these groups. The agreement also provides that host supervisory authorities may exercise group supervision, where appropriate, with regard to a Home Party insurance or reinsurance group at the level of the parent undertaking in its territory. We believe this is a sound requirement for direct regulation of local entities, but suggest that one reform the UK could make in regard to implementation of group supervision is to rely more on the existing group supervision of the parent company rather than duplicating certain requirements at the level of the subgroup in the UK, especially where there are strong bi-lateral agreements in place such as with the US. These changes would both be a more effective use of regulators resources and would reduce the burden of regulation for international companies doing business in the UK. Duplication of regulation is both costly to the PRA, to insurance companies and, in consequence, UK policyholders.

 

  1.         We believe that there is opportunity for regulators to increase their reliance on Home Group supervision and identify opportunities to reduce duplicate regulation at the sub-group company level. Most international insurers operate as an integrated group, with a centralised governance, risk management and strategy. One such opportunity would be to rely on the group risk management systems at the corporate level as presented to the supervisor of the global group, rather than requiring a separate risk management plan for the UK subgroup. One of the provisions of the colleges of supervisors is that the group Own Risk and Solvency Assessment (ORSA) be shared with other supervisors for review. This reform would have the potential to increase the attractiveness of the UK to US insurance companies and would reaffirm the commitment of the UK to the group supervision process.

 

Cyber Insurance Market

  1.         The cyber insurance market has exceptionally high growth potential. This can be demonstrated by looking at recent growth, the total market potential, and by considering the fundamental drivers of cyber insurance market penetration.  Globally, an estimated $3.5 billion in cyber insurance premium was written in 2016. This is forecast by various industry commentators to grow to between $5bn and $10bn by 2020.[1]

 

  1.         Currently, the market with the highest level of cyber insurance penetration is the US, with around 85% of cyber insurance in the world written for US risk. Furthermore, there is little chance of the growth in this market stalling, with US cyber premiums growing by 37% in 2017.[2]

 

  1.         The central reason behind the high level of cyber insurance coverage in the US is normally cited as being the widespread adoption, at a state level, of mandatory breach notification laws. 48 out of 50 states have such laws in place, the first being enacted in California in 2003. These laws significantly increase the exposure arising from breaches, both in terms of first party (notification and defence costs) and third party (compensation) costs. This raises awareness of information security issues and strengthens the business case for firms to take out cyber insurance. 

 

  1.         In the EU, UK and rest of the world, a number of jurisdictions have passed mandatory breach notification laws in 2018, raising the prospect of significant cyber insurance market growth in these countries. The most well-known example of this is the implementation of the EU’s General Data Protection Regulation (GDPR) across Europe, however Canada, for instance, also passed such a law on 1 November 2018.[3]

 

  1.         There is also growing awareness and understanding of the cyber protection gap for business interruption losses. Using a detailed accumulation model AIR calculated the impact of a 3 to 6-day outage of a major cloud provider in the US. Their estimates suggest that of the $12 billion total insurable loss, only $2 billion would be insured at present. Later this year the PRA will be conducting a voluntary cyber insurance stress test to look at how UK insurers might deal with a number of scenarios including systemic attacks. The UK’s takes a leading, collaborative approach between industry and regulators to such issues.
  2.         The UK - through both the Lloyd’s and company markets – is well placed to service the large and growing need for cyber cover. The ABI outlined to HMT its analysis of aggregation risk in the ABI’s May 2018 paper, ‘Managing Catastrophic Cyber Risk’, examining why this is especially problematic in this class of business. The unique concentration of expertise, capital and infrastructure situated in London is effective at ensuring that this complex risk is underwritten in an appropriate way.

 

11 February 2022

10

 

[1] FT: Cyber-attacks: the risks of pricing digital cover

[2] US Cyber Market Update July 2018

[3] https://www.priv.gc.ca/en/privacy-topics/privacy-laws-in-canada/the-personal-information-protection-and-electronic-documents-act-pipeda/