The FSA and risk based capital

The FSA has published proposals for a new framework for risk-based capital rquirements for both life and non-life insurers. Although the details of the calulations differ, the overall structure is the same for both types. The proposals were issued in July and August 2003; the consulation period ends on 30th November 2003.

General framework

Insurers will be required to hold the higher of:

Minimum Capital Requirement (MCR)

as set out in EU directives

Enhanced Capital Requirement (ECR)

a more risk sensitive calculation specified by the FSA

The ECR calculations are obviously different for life and non-life insurers. However, for both types the calculations make various industry-wide assumptions that may not be met by individual firms, whose risk profiles may be different from the average. The FSA proposes to take these differences into account through the Individual Capital Adequacy Standards (ICAS) mechanism. They say that ICAS will

• mean that firms will hold capital more appropriate to their business and control risks
• emphasise the responsibility of senior management for ensuring that firms have adequate financial resources
• Provide incentives for better risk management

ICAS will operate through Individual Capital Guidance (ICG). The ICG will usually be at or above ECR, and will be affected by whether firms' risk assessment processes follow all the FSA's guidance. The ARROW assessments will be a major input.

Although ICG is only guidance, firms will be expected to notify the FSA if capital falls below the ICG level. In addition, firm that fail to meeet the ICG will be expected to set out a plan to restore adequate capital.

Resources

PS04/16: Integrated Prudential sourcebook for insurers

This Policy Statement reports on the main issues arising from Consultation Paper 190 (Enhanced capital requirements and individual capital assessments for non-life insurers), Consultation Paper 195 (Enhanced capital requirements and individual capital assessments for life insurers) and the audit and reviewing actuary proposals in Consultation Paper 202 (Insurance regulatory reporting – changes to the publicly available annual return for insurers) and publishes the associated rules and guidance. It is available at http://www.fsa.gov.uk/Pages/Library/Policy/Policy/2004/04_16.shtml.

CP190: Enhanced capital requirements and individual capital assessments for non-life insurers

Consultation paper 190 from the FSA discusses how capitial requirements will be determined for non-life insurers. It was issued in July 2003, and the consultation period ended on 30 November 2003. The overall effect of the proposals will be to introduce a new risk-based minimum requirement, the ECR (Enhanced Capital Requirement), and the concept of ICG (Individual Capital Guidance) which will take into account both the ECR and the systems and controls that firms have in place. CP190 is available at http://www.fsa.gov.uk/Pages/Library/Policy/CP/2003/190.shtml

CP195: Enhanced capital requirements and individual capital assessments for life insurers

Consultation paper 195 from the FSA discusses how capitial requirements will be determined for non-life insurers. It was issued in August 2003, and the consultation period ended on 30 November 2003. The overall effect of the proposals will be to introduce a new risk-based minimum requirement, the ECR (Enhanced Capital Requirement), and the concept of ICG (Individual Capital Guidance) which will take into account both the ECR and the systems and controls that firms have in place. CP195 is available at http://www.fsa.gov.uk/Pages/Library/Policy/CP/2003/195.shtml

Quantifying operational risk in general insurance companies

A paper presented to the Institute of Actuaries in 2004. The paper is available online from my publications page.