On October 14, the Prudential Regulation Authority (PRA) and Financial Conduct Authority (FCA) simultaneously published papers on their respective approaches to with-profits insurance business. The two papers are:

  • CP22/14: The PRA’s approach to with-profits insurance business. This CP clarifies the PRA’s role and objectives in relation to with-profits and explains how the new PRA Rulebook will affect the current designation of with-profits provisions within the existing shared Handbook. The CP also proposes changes in anticipation of prudential regulations associated with Solvency II.
  • FS14/1: Feedback statement on FSA 12/13 Solvency II – COBS rules changes. This paper provides feedback on the Financial Services Authority’s (FSA) July 2012 consultation on Transposition of Solvency II Part 2. The paper focuses primarily on the Conduct of Business Sourcebook (COBS) chapters 20 (with-profits) and 21 (unit-linked business).

PRA approach to with-profits

The PRA consultation applies to all insurance firms that write with-profits business, whether or not they are within the scope of Solvency II. The proposed new rules outlined in CP22/14 would replace the current PRA-designated rules in COBS 20. The PRA has a supervisory role to play in ensuring that with-profits firms maintain adequate financial resources to provide security of benefits for both guaranteed and discretionary policyholder benefits and that discretionary increases do not adversely affect the firm’s ability to meet the PRA’s safety and soundness requirements. The FCA meanwhile is responsible for ensuring that firms’ proposed bonus payments or other benefits are fair to with-profits policyholders.

The PRA proposes only rules as follows:

  • A requirement that firms hold, within each of its with-profits funds, assets that are sufficient to meet the with-profits liabilities of those funds. The PRA explains that the rationale for this rule is consistent with the Solvency II ring-fenced fund (RFF) regime. The PRA’s view is that the restrictions on assets resulting from the nature and regulatory context of with-profits business in the UK will generally mean that each with-profits fund gives rise to a RFF. The existence of a RFF will have prudential implications for a firm’s Solvency Capital Requirement (SCR) and the amount of own funds available to meet the SCR.
  • A requirement that with-profits firms ensure that their distribution strategies are affordable, sustainable and are not expected to have a significant negative impact on the PRA’s standards for safety and soundness.
  • The PRA notes that some firms have set up arrangements to support their with-profits funds to enable the firm to provide some degree of benefit security for policyholders where it would not be able to do so from the resources of the with-profits fund alone. The PRA is proposing that firms clarify and document the structure, terms and conditions of such support arrangements, including the extent of any restrictions on a firm’s use of those arrangements.

The deadline for comments on CP22/14 is January 14, 2015. The PRA is expected to publish feedback, finalised rules and a final supervisory statement in early 2015. The rule changes will come into force on January 1, 2016 in order to align with Solvency II.

FCA feedback statement on Solvency II transposition

While the PRA leads on transposing Solvency II into rules, as the majority is prudential in nature, the FCA is responsible for transposing a small number of Solvency II articles covering conduct issues, including information provision and permitted links in unit-linked business.

FS14/1 provides feedback on the conduct elements of the FSA’s consultation on Solvency II transposition. The FCA notes that firms were broadly supportive of the proposed changes to COBS 20 and 21. The FCA has amended some of its proposals based on the feedback received and has generally sought to clarify the consulted-on rules. A revised draft of the Solvency II instrument 2015 is included in the Appendix. 

The FCA notes that it plans to remove guidance which said that each with-profits fund will be treated as a separate RFF under Solvency II, as this is principally a PRA issue. Although, interestingly the PRA has pointed out that in the UK the regulatory obligation to treat with-profits sub funds which are participating in different assets/profits, as separate with-profits funds, is what will generally cause such funds to be treated as RFFs under Solvency II.

The FCA makes the point that some of what may be classified under the PRA rules as surplus funds may in fact be subject to FCA restrictions on distributions (e.g. planned enhancements). There will therefore be a duty to consider 'conduct liabilities' in making distributions.

The FCA is going ahead with amended definitions of key terms used in relation to with-profits funds - including a new definition of what constitutes a with-profits fund surplus (for Solvency II firms). The FCA has clarified that the 'risk margin' (which is an insurance entity requirement rather than an individual with-profits fund requirement) should not be included. The FCA also makes the point in relation to items such as loans to connected parties that the Solvency II requirement in the event of 'conflict' situations is that investment of a firm's assets must be in the 'best interests of policyholders'.

FS14/1 also includes additional draft rules following the FSA’s consultation on Solvency II and linked long-term insurance business (CP11/23). Partial feedback on CP11/23 was published in 2012. FS14/1 includes the draft Handbook text which will be put to the FCA Board in early 2015. Feedback is also included on three outstanding issues in relation to unit-linked rules (COBS 21): derivatives; stock lending; and governance.

The FCA intends to make all the changes required early next year and the rules will come into force on January 1, 2016.

For further information:
CP22/14 PRA approach to with-profits insurance business
FS14/1 Feedback on FSA CP12/13 Solvency II – COBS rule changes