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.