In a speech given at the City & Financial Conference on 19 April 2012, (see our blog here) Julian Adams, Director of Insurance Supervision in the Prudential Business Unit of the Financial Services Authority (FSA), described the supervisory strategy to be followed by the Prudential Regulatory Authority when it takes over responsibility for insurance supervision in 2013.

In particular, Mr Adams described a four stage process that will replace the FSA's ARROW framework. First: assess the vulnerability of a firm's business model, taking into account the risks inherent in its business, and the macroeconomic and legal environment. Second: consider whether there is a reasonable resolution mechanism that could be used if the firm fails. Third: analyse the firm's financial strength. And fourth: consider the firm's risk management and governance arrangements.

Some of the work required for stages one, three and four will be done as firms prepare for Solvency II compliance.

Stage two is FSA work in progress: the FSA is considering the exit mechanisms available today, to see if they will work in all circumstances, or whether new mechanisms are required. Stage two is probably also linked to the changes proposed by the FSA on 27 March 2012, in CP 12/7: Financial Services Compensation Scheme: changes to the Compensation sourcebook (available here). Those changes include:

  • Increasing FSCS protection from 90% to 100% (i) for benefits attributable to life insurance premiums paid after an insurer has failed  (otherwise, policyholders may stop paying premiums or surrender their policies without fully understanding the consequences of their actions); and (ii) for income benefits, so that full payments continue for the period immediately after the firm fails, before being reduced to today's minimum of 90% (it could take up to two years to arrange a reduction from 100% to 90% if a firm has complex systems and there is consequently a risk of a gap in payments at present).
  • Introducing flexibility in verification that life insurance contracts are eligible for FSCS protection. One of the conditions for protection is that policyholders must have been habitually resident in the EEA, the Channel Islands or the Isle of Man when the policy was effected. Checking this creates a burden and could interrupt income payments.
  • Enabling the FSCS to be automatically subrogated to the rights of the claimant against the insurer to reduce the burden of obtaining individual assignments.

For most proposals, the FSA's consultation is open until 26 June 2012. FSA feedback should be available by the end of September.