Select Committee on Treasury Minutes of Evidence


Supplementary memorandum by the Financial Services Authority

RISK MANAGEMENT IN INSURANCE COMPANIES

  1.  When the FSA gave evidence to the Committee on 15 February we undertook to provide a further note on two issues.

A.  COMPANIES ACT ACCOUNTS FOR LIFE INSURANCE COMPANIES

  2.  The Committee asked (Q 197) whether there should be a change to the legislation so that financial provisions reported by life insurers in their annual returns to the FSA would have also to be included in the insurers' Companies Act (CA) accounts. This note explains how financial accounts are drawn up by life insurance companies and describes some of the important differences between CA accounts for insurance and non-insurance firms. It then contrasts CA accounts for insurance companies with the financial returns submitted to the FSA under the Insurance Companies Act ("regulatory returns") and then deposited with the Registrar of Companies.

  3.  The purpose of CA accounts is to give a true and fair view of a company's financial position at the end of the financial year and profit or loss for the financial year.[6] Accounting standards issued by the Accounting Standards Board set generally accepted accounting practice for accounts for these purposes. These include Financial Reporting Standard (FRS) 12 on provisions and contingencies. This standard requires companies to set a provision (ie for a liability whose amount or timing is uncertain) at the best estimate of the expenditure required to settle the liability to which it relates. FRS 12 also requires a narrative description of the uncertainties of the amount or timing of the liability. For these purposes liabilities are defined as including both legal and constructive liabilities. The latter arise where a company's past practice creates valid expectations on the part of others (eg customers). This combination of "best estimate" measurement of both legal and constructive liabilities, together with a narrative description of uncertainities, is widely accepted as providing the most relevant information to users of CA accounts. This combination is also the basis of the relevant international accounting statement on provisions.

  4.  However, at present, FRS 12 does not apply to liabilities arising from insurance contracts. The Accounting Standards Board states in FRS 12 that this is because of "the special regulatory position of insurance companies (for which provisions are particularly important) and the [ongoing] review of the accounting framework for insurance companies." At present life insurance companies therefore typically only set provisions in their CA accounts for legal liabilities.[7] In this respect CA reporting for life insurance companies is closer to life insurance regulatory reporting than it is to CA reporting outside the insurance sector.

  5.  Regulatory reporting, by contrast, takes a more cautious view than CA reporting when measuring legal liabilities whose amount or timing is uncertain. Provisions in regulatory returns are intended to be sufficient not just in the expected (ie "best estimate") situation but also in a wide range of realistic alternative scenarios. This relects the different purpose of regulatory reporting which is to give reasonable assurance that financial resources are adequate—not (as with CA reporting) to ensure that performance (ie profit or loss) is fairly reported. Certain provisions in regulatory returns are required under current accepted accounting practice to be reassessed for the purpose of drawing up the CA accounts. However, the difference (if any) must be included in reserves (ie money set aside) even where it is not included as a provision.

  6.  The FSA recognises that the present reporting requirements may not provide readily accessible information to policyholders and other users. We believe that in the longer term the appropriate way forward for life insurance CA reporting is not for it to move even closer to regulatory reporting, but for it to move closer to non-insurance CA reporting. This change would result in a fuller narrative description of uncertainties[8] and provision being made for both legal and constructive liabilities. The FSA is actively participating in international work to draw up a new accounting standard for insurance based on this approach.

  7.  As we have already announced, we are undertaking a review of the operation of with profits life insurance business with a view to (amongst other things) bringing greater transparency to this. We propose to include financial reporting arrangements in this work and will liaise with DTI and the accounting profession on this point.

B.  COMPLAINTS BY EQUITABLE POLICYHOLDERS

  8.  The second issue on which the Committee requested more detailed information (Q 210/11) concerned the number of complaints by Equitable policyholders before 1998 about the company's bonus policy on GAR contracts.

  9.  Prior to 1999, when the FSA took over prudential regulation of insurance companies, the Department of Trade and Industry and the Treasury (during 1998) were the prudential regulators. A review of the relevant files indicates that there is no record of a complaint about Equitable's bonus practice before 1998.

  10.  The Personal Investment Authority (PIA) regulates conduct of business activities of insurance companies (for example, ensuring information disclosed to consumers is clear, fair and not misleading). There is no record of the PIA receiving a complaint about Equitable's GAR practice before 1998.

  11.  As for complaints to the Ombudsman, we understand that the data are not collected in a way which allows the questions to be answered on the timescale required by the committee.

12 March 2001


6   See Section 226 of the Companies Act 1985. Back

7   No provision is set for constructive liabilities, eg terminal bonuses. Back

8   At present the Companies Act exempts insurance companies from the requirement to include this narrative description for insurance liabilities. Back


 
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Prepared 30 March 2001