General focus: risk management and capital adequacy

The FSA has again raised concerns about the way insurers assess and manage the risks facing their businesses. The FSA wants insurers to consider seriously the effects that the deteriorating economic conditions are having on their businesses and customers. In particular, it wants firms to identify and remedy any weaknesses in current operating models and assess the long-term viability of their businesses. The FSA has stated that the current economic crisis has not raised doubts about the overall appropriateness of its capital adequacy regime for insurance companies. However, it has acknowledged that there are a number of risks that pose a particular threat in 2009, which can be summarised as follows.

  • The operational and capital adequacy risks arising out of the current economic climate and the consequent decline in earnings and effects on excess capital.  

Particular risks include:

  • the likely reduction in new business; and
  • greater exposure to market event-related claims and competitive pressures.  

The FSA is conscious that current market events are likely to lead to an increase in internal fraud, reduce managed risk taking and affect overall performance.

  • Longevity and credit risks for insurers operating predominately or exclusively in annuity business are likely to be significant. Insurers will need to manage their risk profiles carefully and assess the financial implications of any exposures.
  • The overall liquidity risks arising out of the financial and economic crisis. The FSA expects firms to manage potential liquidity risks and ensure they have appropriate funding strategies in place. Firms need to have strong internal risk management procedures to ensure matters are addressed effectively.  

The way in which firms measure and manage financial and operational risks are linked to a strong governance framework. The FSA expects insurers to be well prepared to deal with the current economic challenges and is actively pressing insurers to view operational risk and capacity adequacy issues together.  

Stress testing  

The FSA has stated in its Financial Risk Outlook that firms that make significant enhancements to their stress testing and scenario arrangements and address identified vulnerabilities are less likely to be exposed to liquidity and capital risks. Insurers must undertake robust stress testing to ensure they understand their resilience and overall exposure to current market movements. In particular, the FSA expects insurers to be undertaking ‘reserve stress testing’ that will enable them to consider plausible scenarios that could affect their business model. The proposed amendments to the FSA Handbook and the plan to publish a policy statement at the end of March 2009 indicates that the FSA has not ruled out thematic work and regulatory intervention, should the insurance sector fail to act in this area.

Treating Customers Fairly  

Treating Customers Fairly (TCF) will continue to be a key priority for the FSA in 2009. All firms were set a deadline of the end of December 2008 to demonstrate to the FSA (and satisfy themselves) that they are consistently treating their customers fairly. This has again been reinforced by the FSA in its Financial Risk Outlook and Business Plan for 2009/10 and the FSA’s expectation is that all firms must demonstrate that they are consistently treating their customer fairly. In the Business Plan, the FSA has stressed that firms should expect to see continued substantial enforcement action against firms, at all levels of the supply chain, and that there will be greater focus on the payment of compensation to customers.  

The FSA’s TCF work will include the following areas.

  • Further work on embedding the TCF agenda into the FSA’s core supervisory work as well as assessing firms’ delivery of TCF outcomes through the ARROW framework and enforcement action if standards are not met.
  • Monitoring firms’ drafting and enforcement of unfair contractual terms, particularly awareness of, and compliance with, the Unfair Terms in Consumers Contacts Regulations of 1999. The FSA will continue to work throughout 2009 to identify unfair contract terms through monitoring and customer alerts. Firms need to ensure that contract terms are interpreted fairly and that legitimate claims are met in a timely manner.
  • The quality of firms’ communications with policyholders. The FSA has confirmed that ‘providing clear and timely policyholder communications is a key aspect of firms’ treatment of consumers’. The FSA will continue its work in this area and will try to ensure that new risks arising from the economic downturn are clearly and explicitly communicated.
  • Increased focus on firms that provide with-profit funds, particularly firms’ ability to properly manage conflicts of interest between policyholders and shareholders. The FSA will continue its supervisory work in this area and consider if aspects of its rules need clarification or amendment.
  • Insurers need to maintain their focus on effective risk management because failure to do so may lead to customers not being treated fairly.  

The FSA now expects that firms have no serious TCF failings, particularly in areas where there has been previous regulatory interest by the FSA. Any TCF failings are likely to be met with rigorous enforcement action.  

Financial crime  

The FSA will be placing increasing pressure on firms to improve and maintain operational controls to address the risk of financial crime that may be exacerbated by the current market conditions. Through its supervisory activities, the FSA will focus on ensuring that firms manage prudential and operational risks to reduce instances of financial crime. The FSA has also indicated that it will continue its thematic review of anti-bribery and corruption systems and controls in commercial insurance brokers systems. Recent enforcement activity by the FSA in this area has also indicated that other parts of the insurance sector may also be subject to scrutiny in 2009.  


The FSA’s regulatory priorities for the insurance sector in 2009 include a strong emphasis on the need for firms to make sure their businesses and senior management adapt and respond to the changing economic circumstances. Firms and senior management need to act now to ensure that their businesses are compliant with the FSA’s regulatory objectives. The FSA intends to place greater scrutiny on the competence and actions of individuals that hold significant influence functions within firms. These factors combined with the FSA’s continuing commitment to be ‘bold and resolute’ in its pursuit of ‘credible deterrence’ through its enforcement outcomes means that there is a real tangible risk for senior management that they will be held to account if they fail to act accordingly.