Select Committee on Treasury Minutes of Evidence


Memorandum submitted by the Financial Services Authority

THE FSA's EXERCISE OF FUNCTIONS RELATING TO INSURANCE COMPANIES UNDER AGREEMENT WITH THE TREASURY AND FSA POWERS TO INTERVENE IN RELATION TO EQUITABLE LIFE'S COMPROMISE SCHEME

A.  INTRODUCTION

  1.  In response to a request from the Committee, this memorandum is submitted in advance of the FSA's appearance before the Committee on 13 November.

  2.  The memorandum covers:

    —  the functions the FSA is authorised to exercise regarding insurance companies under agreements with HM Treasury; and

    —  the powers of the FSA to intervene in relation to the compromise proposal by Equitable Life.

B.  REGULATION OF INSURANCE COMPANIES

  3.  Insurance companies are authorised and supervised for solvency purposes under the Insurance Companies Act 1982 ("the 1982 Act"). They are regulated for the investment business they carry on under the Financial Services Act 1986 ("the 1986 Act").

  4.  The 1982 Act vested certain powers in the Secretary of State for Trade and Industry. In 1997, it was decided that as part of the preparations for establishing a single financial services regulator for the United Kingdom, responsibility for insurance regulation under the Act would largely pass to HM Treasury. This was achieved by the Transfer of Functions (Insurance) Order 1997 (SI 1997/2781), which came into effect on 5 January 1998.

  5.  The Treasury then decided, as part of its regulatory reforms, which included establishing a single financial services regulator, that it should largely contract out the exercise of many of its functions under the 1982 Act to the FSA. Accordingly the Treasury exercised powers under the Deregulation and Contracting Out Act 1994 to make the Contracting Out (Functions in Relation to Insurance) Order 1998 (SI 1998/2842). That Order specified certain functions under the 1982 Act and other enactments. It gave the Treasury the power to authorise other persons to exercise those functions on its behalf. The FSA was duly authorised to exercise the specified functions in December 1998. The functions which the FSA is authorised to exercise are set out in Annex A to this memorandum. The FSA's performance of these functions is governed by a contract between the Treasury and the FSA dated 18 December 1998 and as amended on 14 December 2000. Treasury Ministers remain responsible for insurance regulation and answerable to Parliament for its proper operation while the FSA is accountable to the Treasury for the effective exercise of the functions that the Treasury has authorised the FSA to carry out on its behalf.

  6.  Any functions under the 1982 Act not mentioned in the Annex continue to be exercisable exclusively by the Treasury or the Secretary of State. The most notable functions that have not been delegated are certain powers of investigation, the powers of the Treasury to make secondary legislation, and the power, by Order under section 68, to waive or modify specified regulatory requirements. The FSA does, however, advise the Treasury on the exercise of those powers. In particular, the FSA provides the Treasury with a draft of a suitable Order, advice setting out the background to the application and a recommendation and a letter for the Treasury to send to the insurance company if it decides to issue the Order. The Treasury retains the power to exercise any of the functions under the 1982 Act which the FSA has been authorised to exercise on its behalf.

  7.  The Financial Services Act 1986 created a framework for the regulation of the conduct of investment business, including certain activities in relation to long term insurance contracts. The 1986 Act conferred certain powers on the Secretary of State (now the Treasury) for the regulation of investment business, and those powers were delegated to the FSA (then the Securities and Investments Board). This was done by way of a number of orders made under section 114 (Power to transfer functions to a designated agency) of the 1986 Act. Details of the delegation orders under section 114 are set out in Annex B.

  8.  The 1986 Act made provision for investment activities to be regulated by self-regulating organisations ("SROs") which met the criteria for recognition as self regulating organisations. The most relevant for insurance companies is currently the Personal Investment Authority ("PIA") which took over the responsibilities of two earlier SROs, LAUTRO (and FIMBRA) in 1994. In preparation for the establishment of the new regulatory framework, the staff of the SROs were transferred to the FSA on 1 June 1998 and contracts were put in place for the FSA's staff to undertake work on behalf of the SROs. The FSA is accountable to the SRO boards for its performance under the contracts and against the standards laid down in service level agreements.

  9.  Arrangements similar to those outlined above have also been made to enable the FSA to regulate friendly societies on behalf of the Friendly Societies Commission and the self regulating organisations for friendly societies, of which the most significant is the PIA.

  10.  From 1 December 2001, these provisions and arrangements will be replaced when the regime established by the Financial Service and Markets Act 2000 comes into force.

C.  POWER OF THE FSA TO INTERVENE IN RELATION TO THE PROPOSED COMPROMISE

  11.  The powers of intervention into the management of a company are set out in sections 38 to 45 of the Insurance Companies Act 1982 and they are exercisable by the FSA, subject to certain limitations, on the grounds set out in section 37. The powers of intervention may be exercised by the FSA on behalf of the Treasury. Section 37(2) provides that the powers are exercisable on various grounds, including:

    —  if the FSA considers the exercise of the power to be desirable for protecting policyholders or potential policyholders of the company against the risk that the company may be unable to meet its liabilities or, in the case of long term business, to fulfil the reasonable expectations of policyholders or potential policyholders; or

    —  if the company is a UK or a non EC company and it appears to the FSA that any of the criteria of sound and prudent management is not or has not been or may not be or may not have been fulfilled with respect to the company.

  12.  Sections 38 to 45 provide various powers of intervention which the FSA may exercise. For example, section 45(1)(a) confers the power to require a company to take such action as appears to the FSA to be appropriate to protect policyholders or potential policyholders of the company against the risk that the company may be unable to meet its liabilities, or, in the case of long term business, to fulfil the reasonable expectations of policyholders or potential policyholders. Similarly, under section 45(1)(b), the FSA may impose appropriate requirements for the purpose of ensuring that the criteria of sound and prudent management are fulfilled with respect to the company. One relevant criterion of sound and prudent management is that the company should conduct its business with due regard to the interests of policyholders and potential policyholders. These interests are not, in the FSA's view, confined to contractual rights, but extend to policyholders' reasonable expectations.

  13.  The FSA will have similar powers under the Financial Services and Markets Act 2000 and these will be exercisable in similar, though not identical, circumstances.

  14.  Equitable Life is currently developing a proposal to compromise certain rights and claims of its with-profits policyholders. This would be done by way of a scheme of arrangement, or compromise scheme, under section 425 of the Companies Act 1985. Section 425 applies to any company and provides a mechanism for a company to compromise with its creditors. The company can choose to seek a compromise with particular classes of creditor only—there is no requirement for the company to compromise with all of them.

  15.  The section 425 procedure can be adopted by any company (including insurance companies and other financial services firms) at any stage, not just when in provisional liquidation or administration. There is no prerequisite of insolvency. The compromise is subject to the approval by a simple majority representing three quarters by value of the relevant class at meetings of the classes of creditors. It requires the sanction of the court before it can become effective. The benefit of a scheme under section 425 is that, subject to the safeguards described above, it can bind a dissenting minority to the settlement.

  16.  The FSA is not given a formal role in relation to section 425 of the Companies Act 1985. However, the powers of intervention available to the FSA under the Insurance Companies Act 1982 may be relevant—for example if exercised they may have a significant impact on the operation of the compromise scheme. The FSA will of course continue to consider whether it would be appropriate or desirable to exercise any intervention powers. Given the FSA's consumer protection roles it will wish to consider, on a case by case basis, whether it should convey its views on the scheme to policyholders. It will also wish to consider whether it would be appropriate to appear in Court (at one or more of the proposed hearings) either to make representations relative to its own role to protect the interests of policyholders, or to assist the Court where it can in assessing the effect of the scheme (and the alternatives to a scheme) on policyholders and by explaining the FSA's approach in assessing the scheme. It is common in our experience for the Court to be interested in the views of the regulator on any proposals of this sort relating to a regulated firm.

  17.  In deciding whether to exercise any of the powers of intervention, the FSA will wish to consider a number of separate issues including:

    —  whether groups of policyholders as a whole are being offered reasonable benefits in exchange for the rights they are being asked to give up;

    —  whether within those groups some are likely to benefit disproportionately to the detriment of others; and

    —  whether the information being provided to policyholders about the choices before them is clear, accurate and intelligible so that policyholders are able to take informed decisions on whether or not to support the scheme.

9 November 2001

Annex A

FUNCTIONS OF THE TREASURY DELEGATED TO THE FSA

PART I: THE INSURANCE COMPANIES ACT 1982




Section
Side headingNotes/limitations on delegation




3
Authorisation by the Treasury
5Submission of proposals
6Combination of long term and general business
7United Kingdom applicants
8Applicants from other member States
9Applicants from outside the Community Excluding subsection (7)
11Withdrawal of authorisation in respect of new business
12Notices of withdrawal under section 11
12ASuspension of authorisation in urgent cases
13Final withdrawal of authorisation
19(2)Appointment of actuary by company with long-term business
21A(1), (2), (3) and (5)Communication by auditor with Treasury Except insofar as it relates to the making of regulations by the Treasury applying to auditors
22Deposit of accounts with Treasury
23Rights of shareholders and policyholders to receive copies of deposited documents
24(1)Deposit of accounts etc by registered society
25(4) and (5)Periodic statements by company with prescribed class of business Except insofar as it relates to prescribing such period within which copies of any statement must be deposited with the Treasury
26Statements of transactions of prescribed class or description Except insofar as it relates to prescribing the classes or descriptions of agreements or arrangements appearing to the Treasury as likely to be undesirable in the interests of policyholders
29(3)Application of assets of company with long term business




30(3)
Allocations to policyholders
32(4)Margins of solvency
33(1) and (2)Failure to maintain minimum margin
37Grounds on which powers are exercisable Except insofar as it relates to functions under sections 43A, 44(2)(b) and (4A) and 44A.
38Requirements about investments
39Maintenance of assets in United Kingdom
40Custody of assets
40AProhibition of disposal of assets
41Limitation of premium income
42Actuarial investigations
43Acceleration of information required by accounting provisions
44(1), (2)(a), (2A), (2B), (3) and (4) Power to obtain information and require production of documents Except insofar as the exercise of those functions would require any individual to produce any documents at such time and place as may be specified
45Residual power to impose requirements for the protection of policyholders
46Notice of proposed exercise of powers on ground of unfitness of certain persons Except insofar as it relates to the functions under sections 43A, 44(2)(b) and (4A) and 44A
47(1) and (3)Rescission, variation and publication of requirements Except insofar as it relates to a requirement imposed under section 43A and 44(2)(b)
48(2A)Power of Treasury to bring civil proceedings on behalf of insurance company
52AIssue of certificates by Treasury
52BEffect of transfers authorised in other EEA states
54Winding up on petition of Treasury
56(6)Continuation of long term business of insurance companies in liquidation
60Approval of persons proposing managing director or chief executive of insurance company
61Approval of person proposing to become controller of insurance company where section 60 does not apply


61AApproval of acquisition of notifiable holding in UK company
62(2)Duty to notify change of director, controller or manager
63Change of manager etc of company from outside United Kingdom
64(1)Duty to notify change of main agent
65(1)Documents deposited with Treasury
69Power to alter insurance company's financial year
70(3)Services of notices
75(3)Statutory notice by insurer in relation to long term policy
78(4)Linked long term policies
83Requirements to be complied with by Lloyd's underwriters
83ALloyd's underwriters—insurance
directives
Except insofar as it relates to functions under section 44(2)(b) and (4A)
84Lloyd's underwriters—financial resources Except insofar as it relates to modifications as may be prescribed by the Treasury and to functions under section 44(2)(b) and (4A)
85Lloyd's underwriters—transfer of business
86(1)Statement of business by Committee of Lloyd's




Schedule
HeadingNotes/limitations on delegation


2A
Criteria of sound and prudent management
2BRestriction on disclosure of information
2CTransfers of insurance business
2DFurther provisions with respect to controllers of UK companies
2FRecognition in the United Kingdom of EC and EFTA companies Except insofar as it relates to functions under section 44(2)(b) and (4A)
2GRecognition in other EEA states of UK insurers




PART II: FUNCTIONS DELEGATED UNDER OTHER ENACTMENTS

  In addition to the functions described in part I above, and subordinate legislation, functions of the Treasury in relation to insurance companies are also delegated to the FSA under the following Acts:

      Lloyds Act 1871;

      Policyholders Protection Act 1975;

      Financial Services Act 1986;

      Friendly Societies Act 1992; and

      Policyholders Protection Act 1997.

Annex B

DELEGATION ORDERS MADE UNDER SECTION 114 OF THE FINANCIAL SERVICES ACT 1986

      Financial Services Act 1986 (Delegation) Order 1987 (SI 1987/942).

      Financial Services Act 1986 (Delegation) (No 2) Order 1988 (SI 1988/738).

      Financial Services Act 1986 (Delegation) Order 1991 (SI 1991/200).

      Financial Services Act 1986 (Delegation) (No 2) Order 1991 (SI 1991/1256).


 
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