Insurance Market Update - December 2005 - Regulation.

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Insurance Market Update - December 2005 - Regulation.

Capital adequacy goes strategic

The implementation of the FSA's Individual Capital Adequacy Standards regime in the UK has far-reaching consequences for all stakeholders in the insurance industry. The "Use Test" in particular, which seeks to embed a firm's capital adequacy calculations in its risk management framework, will bring prudential capital into the boardroom as a tool for shaping strategy. Deloitte's Roger Jackson explores the benefits of the new regime and suggests that firms that get on board early will be at a distinct advantage.

The Individual Capital Adequacy Standards (ICAS) regime in the UK has now been in place for nearly a year and the challenge has moved from discussing the proposals to calculating the number. This is set to change over the next couple of years, to how to embed a firm's capital calculations into their risk management processes; what the FSA calls the "Use Test". As we shall see, this article explores some of the potential consequences on key stakeholders of embedding this regime.

Stakeholders

Key stakeholders within the insurance industry in the context of capital requirements are:

investors;

insurers and reinsurers;

policyholders;

the regulator; and

rating agencies.

Depending upon the stakeholder, the purpose of capital varies. Investors, enacted by the insurers and reinsurers that they invest in, focus on maximising post-tax profits given a certain level of capital (assuming that the level of capital is fixed). On the other hand, policyholders see capital as a measure of their security. The key to understanding the potential impact of the new regulatory regime, though, is to understand how the roles of the regulator and rating agencies interact with respect to capital.

Drivers of capital

Rating agencies provide independent financial strength ratings, usually based on a qualitative and qu...

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