The growing debate in the UK over how to regulate financial services has implications for the world's international reinsurers with a presence in the London market. Mark Baylis reports.
It is less than a year since the Labour Party won its first UK general election for more than two decades but, such is their dominance of the political skyline, the previous Conservative regime is now little more than a distant memory. In opposition, Labour's shadow Chancellor of the Exchequer, Gordon Brown, went out of his way to reassure the City, which is home to London's giant financial services industries, that they had nothing to fear from a change of administration. That claim will be put to the test during the summer.
The new government is committed to changing the way financial services are regulated, and the international insurance and reinsurance industries, which produced an estimated $30 billion premium income in the London insurance market during 1996, are certain to be affected. All the world's top 20 reinsurers and about 60 smaller ones are active in London.
Progress or more red tape?
Three specific regulatory issues are of interest to reinsurers: the creation of a new regulator known as the Financial Services Authority (FSA), the planned unveiling in June of new legislation and regulatory reforms for Lloyd's. While the government has sought to clarify its overall aims, there is still much to be decided. Reinsurers view the present situation as both an opportunity and a threat.
On one hand, the London market is highly regulated, and this review throws up the hope that a lighter regime may emerge in line with rival centres in Europe and elsewhere, as many in the industry would like. On the other, there is a fear that the government, in seeking to address shortcomings in financial services industries such as banking and UK retail insurance, could be tempted to impose wholly inappropriate conditions on the wholesale insurance industry.
"If the government draws a clear distinction between wholesale and retail insurance, the reforms could be very beneficial", says Marie-Louise Rossi, chief executive of the trade association for London market companies, LIRMA.
"Governments have sometimes been slow to appreciate that there are at least two discrete industries and we are seeking to ensure that the distinctive needs of reinsurers are met."
Labour has set itself the ambitious target of introducing new legislation to regulate the City by the end of 1999. At the same time, the FSA will replace the plethora of existing regulatory bodies, becoming effectively a new super authority. Although welcomed in many quarters, the plans have ruffled a few important feathers.
The governor of the Bank of England reportedly considered resigning after learning that he was to lose responsibility for banking supervision.
The government, however, has been positively Thatcherite in its willingness to tough it out against opposition. The minister leading the government's reforms, Treasury Minister, Helen Liddell, is especially determined to see that they succeed.
Public support for reform
The legislation to be published in the summer is partly in response to a series of scandals in the late 1980s and early 1990s, including major banking failures such as BCCI and Barings, both of which resulted in successful criminal prosecutions.
Perhaps the most emotive scandal - and certainly the one that directly affected most voters - is that of pension misselling. During the 1980s, then Chancellor of the Exchequer Nigel Lawson changed the law to allow portable pensions, including the right of individuals to opt out of pension schemes run by employers or the state. Life insurance companies, whose salesmen were often on commission, used some highly questionable sales techniques.
Many of the 5 million individuals who bought private pension schemes would have been much better off staying put. The cost of transferring, and the consequent loss of their employers' contributions, hit the retirement prospects and security of hundreds of thousands of individuals, many of them on modest incomes.
The scandal continues to cause outrage. Most of the UK insurance industry's top domestic names were involved. Although companies have agreed to a voluntary compensation scheme, progress has been painfully slow. More recently, a further scandal has hit the domestic insurance industry, this time relating to the sale of worthless employment protection policies.
Public support for reform is guaranteed. Even The Times, normally considered conservative and pro-business, declared in January: "The insurance industry has a fine disregard for its customers. Its prime concern is to sell regardless of the consequences."
Fall-out for the London market?
In theory, none of this should have an impact on the London market, since it is international and distinct from the UK industry, but the government review of regulation will include every aspect of financial services conducted in the UK.
Furthermore, it comes at a time when the status of Lloyd's is about to change. Lloyd's has always been self-regulatory - a situation that both the government and the market itself regard as outdated. It is likely that the new framework will be extended to both Lloyd's and the international insurance and reinsurance companies in London. Indeed, since insurance and reinsurance companies own a substantial and growing slice of Lloyd's capacity, they cannot have totally separate regulatory regimes.
The FSA itself is an object of suspicion in some quarters, even though its director Howard Davies is well regarded. When it comes on-stream, it will be one of the most powerful regulatory bodies in the world, and the industries it will be supervising are anxious that it should be held publicly accountable for its decisions. Insurance companies accustomed to dealing with the National Association of Insurance Commissioners (NAIC) in the United States are especially cautious.
There are, therefore, several reasons why the international insurance and reinsurance companies in London are closely watching regulatory developments.
As their trade association, LIRMA has been campaigning for lighter regulations for the London market, especially in the area of red tape. "It is a good thing to be regulated, because people like to know you are regulated," says Peter Donovan, chairman of the LIRMA committee that monitors UK financial regulation. "However, the government already requires us to supply a lot of information that in many cases is not used to any great extent and the concern is that we will be asked for even more."
What reinsurers hope
LIRMA argues that, since buyers in the London market are highly sophisticated and knowledgeable, they do not need the same degree of protection as domestic consumers. It would like to achieve four main concessions from the government:
* More practitioner involvement in the decision-making process.
* Separate regulatory regimes for wholesale and retail insurance.
* No cross-subsidy of the more expensive regulation of retail insurance by the wholesale sector.
* Moves to bring the UK into line with the rest of the European Union, either by reducing regulation at home or through achieving a common regulatory regime throughout the EU.
The government responds
In the most detailed response so far to these issues, the government has written to Global Reinsurance accepting the first three aims, but in a way that poses as many questions as it answers, and apparently rejecting the fourth.
On practitioner involvement, Treasury Minister Helen Liddell said: "The FSA must draw fully on the experience of practitioners in making its rules and in the exercise of its other functions." A spokeswoman said, however, it was too early to say how this would be achieved. While the industry will be encouraged, there remains a suspicion that, given the tight deadlines demanded by the government's programme, this consultation process may prove superficial.
On separate regulatory regimes for wholesale and retail insurers, Mrs Liddell's response is also encouraging, but one where the practical details will be all-important. She says: "The new regulator must distinguish between the wholesale and retail markets for financial products. In practice this distinction is likely to be most apparent in the regulation and conduct of business, where the expertise of the customer is a material consideration; prudential regulation of solvency and capital adequacy raises much the same issues whatever the customer."
On the cost of the new regime, Ms Liddell comments: "The government is determined that the costs of regulation should match its benefits." Again, however, her department would not talk about the detail or how costs would be allocated.
Only on cross-EU regulation does there appear to be a clear cut decision, albeit one that will disappoint some reinsurers, by ruling out changes to bring the UK into line with other parts of western Europe: "In many member states such companies are not subject to the same level of scrutiny as direct insurers. The government does not expect that the changes it proposes will result in any material change in the way in which the UK reinsurance companies are supervised."
The overall effect of these responses will be to confirm the view that neither the government nor the regulatory authorities have yet given the wholesale insurance market much detailed consideration. They will be broadly welcomed by the industry, but only as far as they go. A recent survey within the City found that only 2% of senior executives agree with the proposition that politicians have integrity. The City is naturally suspicious of any governments, especially Labour ones, and will want to see what it all means in practice before reaching a verdict.
Mark Baylis is a marketing consultant and author of a recent report on the London market.