The outlook for the European Insurance sector.
[Check Against Delivery]
Thank you for inviting me here today to share some thoughts on the future for the insurance industry.
I'd like to start by giving some background about the ABI.
Our purpose is to work with and on behalf of insurers to make markets work well for our customers and continue to contribute positively to the UK economy.
In 2013:
- ABI staff had over 200 meetings with the FCA and around 80 meetings with the PRA
- We met with politicians in Brussels every week
- We met with MPs in Westminster every week
- I met with Government Ministers on average every couple of weeks through 2013
In short, we do engagement with government, regulators and pretty well every stakeholder who can influence the landscape for insurance firms.
This afternoon I’d like to talk about what all that engagement tells me about the outlook for the European Insurance sector and I’d like to start with the environmental background.
I don’t need to tell you about where interest rates have been for the last few years.
The increase in life expectancy in the UK affects most aspects of government policy.
Not just pensions.
In their Fiscal Sustainability Report published last year, the Office for Budget Responsibility said:
"Population ageing will put upward pressure on public spending. Our central projection …shows spending rising from 36.7% of GDP in 2017-18 to 40.6% of GDP in 2062-2063 as demographic trends lift spending on health, pensions and long term care, an increase of 4% of GDP or £61 billion in today’s terms."
We have a new regulatory architecture that is still bedding in, evolving and getting comfortable in its own skin.
The pace of technology change is ferocious and consumer expectation changes with it.
With this change come risks and opportunities – for example understanding and mitigating cyber risks or revolutionizing the way claims processes are handled.
The political environment is unstable.
The recent European elections, a Scottish referendum in September and the UK elections in May 2015 … our first post coalition election.
For now though the main political battleground seems to fall across two fronts.
The economic recovery and how much credit can be taken for it.
And the cost of living and the extent to which the man in the street has seen improvements.
As we march towards the next UK General Election, the political rhetoric will continue to serve these arguments and, depending on who is listening, will in turn be anti-business, pro-consumer, pro-business and anti-red tape.
I have had a decade of experience of working with governments beginning with the last Labour Government.
I delivered an independent review for Ed Balls which gave rise to the creation of the Money Advice Service (for the record, our original recommendation was that it be called the Money Guidance Service).
Since 2011, in my current role, my work has brought me into contact with most Government Departments.
The Department of Transport, Ministry of Justice, DEFRA, DWP, Department for Local Government, Department of Health and of course the Treasury.
I have long believed that for an industry like insurance there should be a basis of ‘partnership’ between the industry and the state.
After all, to a large extent insurance – almost uniquely – runs like a thread through our daily lives.
Helping to manage the risks inherent in all our activities – home owning, travel, driving, running businesses, protection against illness or death in work, saving for life after work.
Insurance products and services overlap closely with the welfare state for example. And the economic power of the industry’s long term investments is critical to funding government’s spending and driving growth in the UK.
My experience, over the last three years, has persuaded me that this formulation – partnership between industry and state - is unrealistic and probably wrong-headed.
‘Partnership’ suggests alignment of interests, not only in terms of outcomes (the benefits to society, to customers, to voters) but also in terms of time horizon.
In my experience, the time horizon of the industry is always longer term than government.
Let’s look at some examples of this.
First, Mesothelioma.
Mesothelioma is a rare, incurable cancer of the thin membrane which protects internal organs in the chest, and which can also occur in the stomach cavity. It is caused by exposure to asbestos.
Why is the relevant to the relationship between government and insurers? Regrettably, historical practice by some insurers (who are no longer active in the market) led to obstacles for some claimants.
In recent years insurers have funded mesothelioma research and have worked with government to put together a package of measures to help deal better with those claiming from their employer’s liability insurer.
After years of work, the Mesothelioma Bill became an Act of Parliament this year.
But along the way, the goalposts moved regularly.
The parameters which framed the level of payouts where no insurer could be traced were changed, the basis on which the service to claimants was delivered changed, with potential consequences to the likely claims costs of the scheme.
And the issue of research funding into the medical treatment of mesothelioma, which had been a voluntary arrangement of contributions from the large players in the industry is currently being seen as a soft obligation on industry participants.
What started out as a package which the industry felt was fair and had been arrived at through extended negotiation was unilaterally ‘renegotiated’ and always in one direction.
We have arrived at a scheme which the industry will support, because the consequences for those affected of not supporting it would be utterly unacceptable.
But this experience shows that you must be realistic about the balance of power between an industry sector and the democratically elected government.
Next, flooding.
Flooding has become a more frequent and widespread risk for homeowners and businesses.
Six months on after the January floods, we are still meeting with Government to update them on progress in supporting those most affected – underlining the impact flooding can have on those it affects.
The old arrangement for ensuring access to flood insurance, called the Statement of Principles, had been in place since 2000, but had a number of flaws which made it unsustainable.
Firstly it distorted the market, obliging as it did property insurers to offer renewal terms to existing customers. This meant that new entrants to the market could ‘cherry pick’ low risk properties, leaving incumbents with an increasingly high risk book.
Also, the old system didn’t deliver ‘affordability’. There was no obligation on insurers to cap prices or policy excesses.
Again after years of negotiation, the publication of a ‘Memorandum of Understanding’ in June 2013 and the passage of the Water Bill through Parliament, the legislation received Royal Assent last month.
The Water Act looks very much like the ‘MoU’ we agreed last June. So why in this case has the ‘partnership’ worked better?
While the agreed structure is less than the industry would have liked in terms of the commitments made by government, the incentives to deliver a workable solution were perhaps more equal, and the ‘court of public opinion’ less likely to find the industry to be in the wrong, should the negotiations have fallen down.
And the agreement has broad cross party support, so is unlikely to be overturned should a different party find itself in power next May.
I could talk at length about the joint work done on personal injury claims, and in particular whiplash, which has led to reductions in the motor premiums – down 14% over the last 18 months - paid by consumers as fraudulent claims are squeezed out of the system.
This has also taken years, has yielded results, and has seen a strong and consistent contribution from government in delivering legal reforms. Sadly in the area of improving the experience of young drivers, where claims rates are unbelievably high and as a result premium rates are seen as unacceptably expensive, government has been reluctant to move on reforms which we believe could address the issue but which they see as politically difficult.
I could talk about social care, where the Care Bill is making law some of the proposals contained in the Dilnot report and where the industry has the potential to be a big part of the solution.
I could talk about last year’s Insurance Growth Action Plan. This was published in December, complete with industry commitments on infrastructure investment over the long-term, only to have the long-term nature of one of the industry's largest markets, annuities, fundamentally challenged by Government three months later.
I will talk in a moment about pensions, where – quite apart from the brave new world of auto-enrolment - we have had two big announcements this year, firstly in the Budget on retirement income, and secondly, a couple of weeks later, with the DWP command paper on pensions and charge caps.
But I believe after three years of working in this area that talk of ‘partnership with government’ distracts from the only good reason for an industry to modernize and improve, namely to improve outcomes for customers and shareholders.
And during times of political uncertainty it is more important than ever that an industry sector has a clear sense of purpose and values, and that it articulates those loudly at all times.
The current regulatory landscape has been shaped by the fallout from the financial crisis and high profile consumer scandals.
We have seen the formation of new regulatory structures in and outside of the UK that will fundamentally shape the way insurers operate.
Influencing regulation outside our borders will become even more important and we have seen some successes.
For example, with Solvency 2 and the treatment of long term guarantee products for the UK life industry and recognition from the Commission of the importance of insurers’ ability to invest in supporting economic growth.
Work on Global Capital Standards for insurance will be the next challenge.
Regulators are becoming more judgment based with emphasis on culture in organizations and the ‘spirit of the rules’ where there is no hard guidance, and they are increasingly scrutinized by the media and politicians to whom they are ultimately accountable.
All this means there is a need for the industry to engage with public policy in a more high profile way and be proactive in developing solutions and implementing forms of ‘self-regulation’ in order to maintain a competitive market that also meets the new regulatory (and political scrutiny).
I’d like to turn first to the FCA, and it has to be said that from my point of view, the working relationship with the FCA has recovered quickly from the difficult period immediately after the legacy thematic issue which created so much instability in markets at the end of March.
There is a huge agenda of work in progress and it is vital that we work collaboratively with the FCA to get that work done as effectively as possible.
A careful balance needs to be struck between the FCA regulating further to minimize bad consumer outcomes (possibly through reducing access to products for many consumers) and the need for the industry to be able attract shareholder capital to develop and provide products that meet consumer needs.
We are yet to see how the FCA will flex its competition power - there have only been two market studies so far – on annuities and general insurance ‘add-ons’. These market studies are powerful tools
Industry guidance vs. more rules from the regulator – the FCA would rather supervise and enforce current rules. This is a sensible approach, but balance is needed, as the industry is not always going to able to produce guidance or self-regulatory standards to fill a gap.
The industry’s role in developing social solutions - the FCA needs to see that the industry understands the significant role they have to play in developing social solutions. They also need to recognize that the landscape within which financial service providers operate is changing.
Emerging challenges around data management and transparency for consumers will be increasingly significant for the industry and the regulator.
Numerous FCA thematic reviews as an investigation tool - in the first nine months of the FCA existence, 10 thematic reviews were launched resulting in numerous requests for information.
There is a need for the FCA to exercise greater control over the organization and cost of data collection as these reviews include many of the same firms.
I have little doubt that the development of the FCA’s agenda and way of working over the next three years will be the most significant factor in dictating the insurance industry’s future prospects.
Turning briefly to the EU, the elections have resulted in an increase in MEPs from fringe parties – many of which are Eurosceptic.
How this set of smaller parties and individuals will translate into the European Political Groups will be the subject of much bargaining and bartering over the coming weeks.
The politics on the ground in Brussels could go two ways.
It could result in a Parliament now wholly built on deals (on legislation) between EPP and S&D. Helped by the arithmetic of the seats in the European Parliament, there can be a tendency of Brussels insiders to pretend little or nothing has happened.
Or it could have the opposite effect.
A very unpredictable Parliament where deals are made ad hoc dependent upon the issues of the time and how easy it is to rally a collection of smaller groupings. This would be a challenge, and an unpredictable one.
The industry has lost some key MEPs, individuals like Peter Skinner and Sharon Bowles who had built up an understanding of the issues. And in Sharon’s case, it is important to note that the UK, through her, chaired the influential Economic Committee of the European Parliament – a position we are not likely to hold again for some considerable time.
But the Solvency 2 file is too far down the tracks now to be diverted, and the ‘consumer package’ of conduct regulatory measures has some way to go before it has the potential to affect the UK market. So we have time to build new relationships.
Global capital v Solvency 2 v PRA regulation.
As we have touched on Solvency 2 let me use that as a link into some of the fundamental prudential regulation challenges that lie ahead for the industry.
As you know, levels of regulatory capital in the UK are currently set under the PRA's Individual Capital Adequacy Standards (ICAS) framework. This is a risk-based approach introduced after the failure of Equitable Life
ICAS will be overtaken in 2016 by the EU's Solvency 2 framework. Solvency 2 is also a risk-based system, based on similar principles to ICAS. Except of course that it will apply across Europe
However, there are enough differences between Solvency 2 and ICAS to make its introduction a costly business - implementation cost has run into the billions.
As all in this room will know, Solvency 2 was not easy to agree. In particular a workable regime for long term products was difficult to find.
Solvency 2 is by no means perfect, but it is agreed, we have it, and British insurers are committed to it.
At a global level historically there has been no insurance equivalent of the bankers' Basel accord. The IAIS produces supervisory principles, but they are not binding.
Last summer, the IAIS announced the intention to produce a capital standard for insurance.
For European insurers this was bad timing. Implementing Solvency 2 will be a lot of work, and we would have greatly preferred to avoid further upheaval.
So, if there has to be an international capital standard, we take the view that those who meet Solvency 2 standards should be deemed to meet the international standards, whatever they may be.
The alternative is a proliferation of capital measures. And - as the Swiss say - once you have two watches you never know the time.
Meanwhile, work continues on the resolution of insurers. This work used to have a timetable but does not any more ... but the work continues.
The key issue for insurers is that regulatory capital requirements should be predictable. This number of initiatives can only add to uncertainty, and makes it more difficult for insurers to plan over the medium term.
In the UK, the Bank of England is currently attempting to carve out a prudential regime based on forward-looking, judgment-based supervision. This is a difficult approach to pull off effectively.
The introduction of Solvency 2 in 2016 represents a major challenge to this approach. One of the primary objectives of Solvency 2 is supervisory harmonization across the EU. What is more, the EU has a centralizing institution in EIOPA to enforce supervisory harmonization.
Over time, the space for the Bank to exercise supervisory judgment independently will be further reduced.
While we are on the subject of conflicting objectives, the recent document released by the IAIS contains at least six separate objectives for the International Capital Standard: comparability, financial stability, policyholder protection, a consistent approach to capital adequacy, facilitation of cross-border insurance, and the advancement of financial inclusion. I read the list twice but I can’t find world peace in there, which must be an oversight.
This number of objectives is not sustainable. Any measure developed with this number of objectives will try to serve them all, and end up serving none. So we will need to see simplification as the work continues.
Finally, there is the work on resolution. This has yet another objective: ending too big to fail in insurance.
I have to start by saying that I completely agree with regulators that insurers should be resolvable. There should be no question of Governments bailing out insurers. So the regulators are quite right to require resolvability assessments.
However, it remains to be seen HOW they will do it. What structural measures, changes in business model or additional levels of capital will be required in the name of resolvability?
This is another important are of focus for our work in the ABI.
Where will all this land in 2019? The risk is that the outcome is more highly capitalized insurers, more expensive and less flexible insurance cover for households and business – leading to less private provision by citizens and a heavier burden on the state.
We can’t allow that to happen.
Pensions markets now and in the future.
I’d like to turn now to the Budget and the radical proposals to introduce much more flexibility into the process of converting pensions’ savings into retirement income.
There is no arguing with the fact that effectively forcing people to annuitize in their early 60s, tying them into an investment strategy (low risk fixed income), with expensive longevity guarantees (for potentially 30 years or more of life expectation) and fixed payment structure for the rest of the customer’s life was not a sustainable approach in a world of historically low interest rates as a result of QE and significantly improved longevity.
What the Chancellor announced was a new approach that effectively removed any constraints - other than marginal tax rates- on how people should take their income.
The lack of any consultation, and the short time period for implementation has created some big challenges and some big risks for the industry and society at large. We need to work fast to overcome the problems and manage the risks.
Most of the immediate challenges are around the delivery of the ‘guidance guarantee’ which the Chancellor described in his speech as ‘free, face to face, impartial, financial advice’.
The obligation is on the pensions industry (contract and trust based occupational schemes) to deliver this.
I’ll be happy to take specific questions on this aspect if you are interested in hearing more….it has been an area where I have been quite focused over recent weeks.....but as yet we have no answers to what the guidance guarantee will cover, who will deliver it, and how that will impact on consumer behaviour.
As to how this will affect the market, it is worth looking at the population of people coming up to retirement in DC schemes.
Currently there are around 400,000 a year (although many have deferred a decision this year pending the new rules coming in from April 2015).
About 60% of them have less than £30,000 in their pension pot. Less than 10% have more than £100,000.
Those with less than £30k will take cash, I suspect. Those with over £100k will have an adviser and will continue to use a combination of drawdown and annuities (and of course the new product solutions…variable annuities, drawdown with guarantee options, deferred annuities etc. etc.).
Those in the middle ground (between £30k and £100k) will see regulated advice as potentially too expensive or ‘not for them’.
The ‘guidance’ offered should help them identify the questions they need to ask (about their work plans, debt, dependents, welfare benefits etc.) and identify broadly the options open to them. But it won’t give them specific answers about the best product for them, or the best company from whom to buy it.
And it won’t protect them from aggressive selling of everything from new kitchens to solar panels which will follow their unexpected access to large amounts of cash.
Some of the new product offerings from the financial services sector will potentially be complex and the professional advice needed to make sound decisions will be critical to good outcomes for many savers.
So I think the outcome of these changes could be a much more flexible market which works much better for consumers, and creates good opportunities for insurance (and other) firms who understand customer needs and can develop product solutions which are accessible (i.e. understandable) to ordinary people.
In the short term, we will see a reduction in the level of annuity business written by firms, but this will be replaced by new product propositions and ultimately by annuity like products in later life.
The customer need (ultimately certainty that you won’t outlive your assets) will continue to play to the industry’s strengths, and the changes could offer an opportunity for a rebuilding of confidence in the sector far faster than normal regulatory intervention by the FCA might have done.
Finally, the pensions’ accumulation market.
Pension reform looks like being a success. It’s still early days and we haven’t yet seen the thousands of small employers move through their ‘staging’ dates. And contribution levels from employees are quite low to begin with so there has to be an ‘opt out risk’ somewhere up ahead.
But we are seeing a big move in savings habits as a result of this policy, and the industry is benefitting through significant new inflows.
The charge cap announcement was unhelpful because it was unnecessary….charge levels for new schemes are well below the 75bps cap, and old schemes are being reviewed through work the ABI is doing with member firms as a response to last year’s OFT review.
Where I think we will see change as a result of the charge cap introduction is an increase in the use of employers' charges to supplement the charge cap (which applies to employees' funds only) and the use of new, more capital efficient charging structures (as outlined in the DWP’s Command paper).
And I believe we will see less choice available for smaller employers as some providers move out of the market for small DC schemes.
But the combination of the governance rules in the DWP paper, the charge cap, the new freedoms around retirement income and the improvements in scheme service and the use of technology will see continued growth in asset flows from workplace pension schemes in the years to come, with the potential for many firms to broaden the range of products and services offered in the workplace to employees.
I haven’t talked about Collective Defined Contribution schemes, much trailed ahead of the Queen’s Speech tomorrow. If we have time for questions I’d be very happy to speculate on how these announcements might play out.
But I would make these points:
- The 30% potential increase in pension outcome claim is just not justified
- The policy seems confused…George Osborne arguing for more individual choice, and Steve Webb arguing for collectivism
- Because of the role of the actuary in determining outcomes the lack of transparency seems at odds with trends elsewhere in pensions policy
- Intergenerational cross subsidy makes this a challenging concept in today’s society.
I’m all for new ideas that enhance the pension reform ‘direction of travel’ but I do believe that coherent pensions policy is necessary if consumers are to have confidence in the stability and durability of the system.
Concluding remarks
I have covered a lot of ground in a short space of time to give you a sense of my perspective on where the industry stands with government, regulators and its place in society.
Looking ahead, the insurance sector as a whole is more relevant today than it has ever been.
Many insurance firms have significant and growing global activities, and the general insurance sector is one which continues to build strong customer relationships in a market which is extremely competitive.
The commercial market for insurers is strong too, with increasing risk from climate change, cyber and data risks, the continued demands of an ageing population on society, and the growth in emerging markets of the numbers of mass affluent consumers.
Underpinning all of this is the recognized excellence of the UK industry on the international stage.
So there are genuine opportunities – as society changes and adapts, so must we.
Yes we must modernize – and we are doing that.
Yes we must have consumer front and centre of our thinking – and many, many firms already do.
But there are genuine challenges too.
Of course the continued development of quality insurance products and services to meet the varied needs of individuals and society should happen within the bounds of regulations.
But the regulatory framework itself needs to be rooted in co-operation with the industry itself and crucially between regulators. And must avoid placing undue demands on the sector’s capital requirements and constraints on its ability to innovate to deliver insurance services to reflect the challenges faced by society.
In my role I will continue to build on the strong relationships established with UK and European governments and regulators to seek a balance.
To encourage the industry to lead in important areas of social policy and innovation to make markets work effectively for consumers, and to remind governments of whatever type that without the economic muscle to help drive economic recovery which the insurance sector provides, their fiscal challenges would be significantly tougher.
Thank you.