Articles - What the FSA's timetable for implementing Solvency II means

 Speech by Julian Adams, Director of Insurance, FSA industry briefing

 I’d like to start by welcoming you here today. I suspect that many of you are people whom I also welcomed to the FSA’s last major event on Solvency II in April of this year. In the intervening six months, a significant amount has changed, some of it fundamentally, and now seems like an appropriate point to gather all together again for an update on what we are intending to do, and how we are intending to do it.

 Later on, we’ll be hearing from Paolo Cadoni, the Chair of the EIOPA Internal Model Committee, who has agreed to stand in and give Gabriel Bernardino’s presentation. Unfortunately, Gabriel – who is the Chairman of the European Insurance and Pensions Authority (EIOPA) – is unable to attend today due to a delay to his flight. Paolo will cover the wider policy context in Europe, how he sees the rest of the policy-making process falling into place over the coming months, and the European perspective on some policy issues that are particularly relevant for the UK. After that, there’ll be the opportunity for you to put your questions to our panel, and then we’ll be hearing an industry perspective of what we’ve said from Otto Thoresen, the Director-General at the Association of British Insurers.

 Before that, I’d like to cover two areas today. First, I’d like to recap on some of the decisions we made last month at the FSA about Solvency II implementation generally, and internal models specifically. I want to speak in more detail about what these decisions will mean for you and give you an insight into some of the practicalities we have to manage. And second, I want to give some more detail as to what our expectations of you will be in the run-up to implementation.

 
 Before I turn to any of those things, I would like to thank you for the way in which you have continued to engage with the challenges of implementing Solvency II, and the way in which you have continued to engage with our supervisors. Recently, we surveyed firms to gauge volumes of certain types of applications that firms were expecting to submit. I’m pleased to let you know that we received over 300 responses from the population invited to take part, a completion rate of just under 80 per cent. Some of the key findings that I found interesting were that:

 Over a third of the groups that responded indicated that they intend to use a group solvency calculation method other than the default methodology, which will require supervisory approval.
 In addition, fewer groups than expected stated that they intend to use a group approach for their ORSA or the Solvency and Financial Condition Report. This is also likely to add to our supervisory work load.
 Those respondents that said that they intend to apply to use undertaking specific parameters, either before day one or within 12 months of implementation, selected two of the four parameters available under the Directive. This helps us to prioritise the work we need to do to get ready to receive these types of applications.
 And finally, around 20 respondents claimed that they intend to apply to use an internal model within 12 months of implementation, meaning that we will have to deal with more applications for model approval after day one.
 The data received will assist us immensely to plan our own workloads in the run-up to implementation, so many thanks to all of you who took the time to assist us with this.

 
 Let me turn now to the announcements we made last month about the changes we’ve made to our assumptions about the implementation timetable, and how the FSA is planning to fit our work programme around them. We now expect that Member State governments and regulators will be required to have transposed the Directive into national law by January 2013, but that the rules will only become applicable to regulated firms from January 2014. This approach to split implementation is often referred to as ‘bifurcation’, and its aim is to help to solve practical implementation issues in some Member States, whilst also allowing more time for firms to prepare for implementation. What it is emphatically not is a wholesale delay in the implementation date, and there are a number of reasons for this:

 First, the expectation that Member States will be required to transpose the Directive’s rules into national law in January 2013 remains.
 Second, Member States are expected to use the period between 2013 and 2014 to ensure practical readiness in firms.
 And third, it is very likely that some form of Solvency II reporting will be required during 2013 as Member States will need to demonstrate readiness for the new regime. But the detail of what this might amount to is unclear.
 All of these factors mean that there should be no loss of momentum in firms’ implementation programmes.

 These issues will not be completely certain until the Omnibus II Directive is finalised, which we expect to happen in the first quarter of next year. We felt, nevertheless, that it was important to give you as much certainty as soon as we could about changes in our own expectations, so that you can adjust your plans and take advantage of the extra preparation time available to you.

 We are very conscious that the UK industry has invested many millions of pounds in Solvency II implementation to date, and we believe that the state of readiness here in the UK is at least as good as elsewhere in Europe. We want to make sure that we harness the efforts you have already put into implementation, while also ensuring that we are in as good a position as possible to manage the peak in activities in the run-up to the implementation date.

 At our event in April, I announced that we would start to accept internal model applications from firms at the end of March next year. I’d like to pause here to explain that although this ‘application’ will inform our review work in the run-up to implementation and will for practical purposes inform our eventual decision-making, this ‘application’ is not currently the official or formal application under the powers of the Directive; the timeline for the formal process will be set out in Omnibus II.

 So, as we have said more recently, we will still be open to receive applications from March next year, but there will no longer be a two-month window during which we will expect all firms to apply. Instead, we have allocated each firm or group that has already been accepted into pre-application a ‘submission slot’ during which we will expect them to submit their application. We have based the timing of these slots on a number of factors, principal among which was an assessment by our supervisors of the state of readiness of firms’ Solvency II programmes. Although each application will be considered on its own merits, we have sought to group together applications from firms with similar business models or approaches, in order that we can best ensure a reasonable degree of consistency. We have also taken account of situations where there is a dependency on our interaction with other Member States through a college, or on the resolution of significant outstanding policy issues, for example the matching premium, to allocate an appropriate submission slot in the schedule.

 We believe that in doing this we will ensure that we are using our resources, in particular our internal model specialists and actuaries, in the most sensible and efficient way. This means that we have to be as sure as we can be that applications submitted will be in a state where a sensible review can be undertaken and significant re-work will not be required.

 All firms should now be aware of what their submission slot is, and be working towards that. For our part, our work will include delivering the pre-application review work that we have agreed with you, although we will clearly be looking to re-plan the timing of some of it to reflect the new timescales for applications.

 Part of the pre-application work we are undertaking includes a variety of analytical tools that we have asked some firms to complete. These covered a number of areas, including ICAS comparisons and stress testing. What I want to stress is that these form a core part of our pre-application approach for some firms. So, if you have been asked to provide us with information in some of these areas, please try to do so in the timescale we have indicated since it will have a direct impact on our ability to deliver aspects of our pre-application work.

 The other point I want to be clear about here is that our allocation of submission slots has been based on the scope and nature of the models we are already examining. This means two things: first, we will not be allowing any other firm to enter our pre-application process in light of bifurcation – this is consistent with the position we laid out earlier in the year; and second, we do not expect to see significant changes to either model scope or approach from those which we are already discussing with you. If you do have in mind any such changes to your model, I would encourage you to discuss this with your supervisor as a matter of urgency, since we may not be able to accommodate such changes in our schedule prior to implementation.

 
 I want to turn now to the second area I want to cover, namely what we expect firms to do in the run-up to implementation.

 Let me start with what we’ll be expecting to see as part of a firm’s submission during its allocated slot. As well as an application for model approval, we will expect to see applications for any other pre-day one approvals required by the firm upon which our review of the internal model may be dependent. It is our ambition that we will be able to receive applications from you if you are intending to use a group calculation method that isn’t the default methodology or you are intending to make use of undertaking specific parameters for non-modelled parts of your SCR calculation. This will allow us to look at all such aspects together so far as is appropriate, and reach a meaningful conclusion in the most efficient manner. Naturally, we will make available to you as much supporting material as we can to help you make these applications, and hope to be able to do this by no later than February 2012. This is our ambition; but as you know, what we are able to do in practice will depend very much on the availability of policy from Europe, and we are particularly dependent on the availability of the level 2 text which will set out much of what we need to do for other approvals.

 A question that has been raised a number of times since our October announcement is what the effect of making an application will be, particularly if it is made early. I want to clarify further our intentions here. You will all be aware that the current UK solvency regime comprises essentially two aspects: the first is the capital resources requirement derived from the Solvency I Directives; and the second is the UK’s ICAS regime. As I as said earlier, our assumption is that the Solvency I Directives will now remain in force until January 2014 and until that time we will have no latitude to waive or alter those requirements.

 The ICAS requirements, by contrast, are unique to the UK. Our intention is to explore with firms possible ways of avoiding the costs associated with the dual running of an ICAS and Solvency II model, while continuing to secure a degree of policyholder protection, which we regard as appropriate and prudent. This could include investigating whether, where we are minded to approve a firm’s model, such a model could be used to demonstrate satisfaction of some or all of a firm’s ICAS requirements.

 What we will not do is remove from firms the current obligation in our Handbook to keep their capital position under review and to make use of their model in reaching business decisions. Removing such requirements in the run-up to the introduction of the new regime would in our view send the wrong message, and, as I have said, we need to strike the right balance between operational efficiency and policyholder protection.

 In the coming weeks and months, supervisors will be setting out in more detail what we might expect an application to consist of, and what particular details we will be requiring to support our decision-making. I hope you will appreciate that we are still to some extent aiming at a moving target here, but we will try to provide as much clarity to firms on all aspects of Solvency II implementation as soon as we are able to.

 It’s also worth saying at this point that firms should continue to develop contingency plans for what they would do if we did not give model approval, or we only gave approval for part of the model. We will have ongoing conversations about your progress and aim to give feedback as soon as possible to allow you to make the necessary contingency arrangements.

 
 Before closing, I want to assure you that ongoing Solvency II negotiation is something that we continue to take very seriously, and to which we devote a significant amount of senior management time. We are aware of a number of areas that affect key aspects of a firm’s business that are still under negotiation. The three areas that stand out are the non-life calibration of catastrophe risk, the matching premium, and contract boundaries and expected profits in future premiums or EPIFP. We are playing a major role in negotiations and Commission working groups as we want to ensure that we can achieve an outcome that makes sense in the context of the UK marketplace, and provides a degree of protection for policyholders that is appropriate and economic.

 Paolo will give the European perspective on the policy landscape, an update on equivalence assessments, with a focus on the importance of co-operation amongst Member States as part of the supervisory college.

 So, we’re aware that this uncertainty is going to stay with us for some time in the run up to implementation and beyond. Practically, it means that we will all need to make reasonable assumptions in our work programmes. Where we see an opportunity to share a working assumption with you, we will do so as soon as we can to reduce ambiguity and to help us to apply a consistent approach where it is relevant and helpful.

 I’d also like to take the opportunity now to remind you we are moving into a period of consultation. In the UK, we and the Treasury have aligned our consultations. Our first consultation paper on the implementation of Solvency II will be published next week. The Treasury plans to publish its consultation document later in the year. At a European level, we are expecting two public consultations from EIOPA next week – one on reporting and the other on the Own Risk and Solvency Assessment. I would urge you to take this opportunity to feed back on what the proposals mean for your firm, both individually and as part of the insurance sector, whether that’s by the nature, size or complexity of your business.

 I hope that I’ve been able to provide you with more clarity on the thought processes we have gone through in planning our implementation of the Directive, and what some of the implications of this will be for you. I’m sure there will be many questions, and my colleagues and I look forward to answering some of these later.