When I was young, an elderly aunt gave me a "good luck plant". At first, I thought it was called a good luck plant because it brought luck to the people who nurtured and fed it. It was only after it had taken control of one corner of my bedroom, and was making a concerted effort to take control of a second, that I realised it wasn't a good luck plant after all. It was a plant, that came with a good-luck wish (…because you'll need it). That plant only had two leaves; but they had serrated edges, they dropped seeds onto the carpet at an alarming rate, and the seeds turned into plants with incredible speed.
I remembered that plant "fondly" this morning as I read the draft With-Profits Memorandum of Understanding (MOU) between the Prudential Regulatory Authority (PRA) and the Financial Conduct Authority (FCA), which the Financial Services Authority (FSA) published at the end of last week. (The MOU is available here.)
Like the good luck plant, the MOU starts simply enough. There's a green shoots reminder about what with-profits polices are, and how they work. And the first leaves are pretty harmless too: the FCA will make sure with-profits policyholders are treated fairly; and the PRA will make sure that fair is also affordable.
The first serrated edge is just visible under the heading: "How this will work in practice". "It is for insurers to set their own investment strategies [and to] articulate [them] through [the] Principles and Practices of Financial Management". However, the "FCA will review the insurer's strategy for consistency with its statements to policyholders...". And "The PRA will consider the effect of those … strategies on the insurer's overall solvency and liquidity position". These leaves seem more cutting than the leaves we've seen before – the FSA only did these things if there was a problem. The MOU suggests the FCA and PRA will be looking anyway.
After that, the MOU stakes its claim to the first corner of the insurer's bedroom:
- If the insurer is proposing to pay reversionary and terminal bonuses, which the FCA regards as fair, the PRA will still intervene if the benefits could adversely affect the safety and soundness of the firm;
- When the FCA makes a judgment about the fairness of an insurer's provisions for future benefits, it will rely on the firm's assumptions. When the PRA makes a judgment about affordability, it will test the validity of those assumptions;
- The FCA will make rules about the fairness of the charges with-profits policyholders can be asked to pay. If the allocation or amount of charges would compromise the firm's ability to meet its policyholder obligations, the PRA will intervene;
- The FCA will consider whether a reattribution is fair, whilst the PRA considers its effect on the insurer's financial soundness;
- The FCA and PRA will maintain separate supervisory teams. If the PRA is not concerned about affordability, the FCA will lead. If a decision has material consequences for affordability and fairness, the PRA will take responsibility instead;
- There "will not be an opportunity for serial iterations of decisions". Each regulator will notify the other before taking regulatory or supervisory action that is materially relevant to the other; and each will consult the other in advance of proposing changes to its rules or policy where fairness and affordability issues may overlap.
These seeds begin to explain why some insurers are just as worried about the other corners of their bedrooms, as they are about the first. The MOU describes the interaction between, and the overlapping responsibilities of, the FCA and PRA using a mix of complex and ambiguous language. In doing so, it hints at the trouble many insurers are already experiencing as they try to run a business and manage two regulatory relationships at the same time – especially when the regulators want to cover common ground in different ways, for different reasons, and at different times, unnecessarily using up precious management resource. These problems could easily be exacerbated by the apparent determination to avoid "serial iterations of decisions", a phrase which suggests that the regulators will make their decisions and hand them down without "negotiation". If that's right, it materially increases the risk that decisions that make sense in the Regulator's Ivory Tower, will make little or no sense when a firm has to implement them in the real world.