TUESDAY 20 NOVEMBER 2007

Mr Peter Vipond and Mr Philip Long

  Q40  Lord Steinberg: Would it not mitigate against smaller insurance companies? I can understand that Prudential is keen on it, but smaller insurance companies may have difficulty in meeting the requirements.

  Mr Long: Looking at Solvency II I would say the good thing is that it is about making sure you understand your risk. It is not about smaller companies or larger companies. There are large companies that historically have had huge concentrations in equity positions and they have suffered for it during the equity market pressures in 2001 and 2002. I think it is about risk management, it is about understanding the risk; simplistically it is about saying: If you are writing insurance business you need to understand it, measure it and manage it properly. It does not seem to make good business sense to write business that you do not understand. There are a lot of small companies even now, if we look at the UK for example, entering the bulk annuities market (pension schemes that are then sold on so that someone else manages the pension schemes). A lot of new entrants have come in. They are not big players; they are not diversified players but they have specialist expertise and they think they can make money from it. It is really about understanding the risk that you are underwriting.

  Q41  Lord Kerr of Kinlochard: Can I first ask, really for the record, for a definition of the Lamfalussy process which is being followed in this case? As I understand it there are two principles here. Unlike the original single market programme—the 1992 programme—the aim is not standardisation with a single regulator, the aim is mutual recognition, cooperation within a framework of agreed common standards. Principle two is that the form of the legislation should include firstly the framework directive—which is what we are thinking about today—and a second directive or regulation with more detail; but a third layer should largely be left to the Member States to legislate as they wish, provided that the requirements of layer one and layer two are met. Is that broadly correct? Is it a good thing or a bad thing? Are we in favour of Lamfalussy or against?

  Mr Vipond: I think that is broadly correct although the place where we might differ somewhat is at level three which you were leaving to the Member States if I heard you correctly. Now the EU has CEIOPS (the Committee of European Insurance and Pension Supervisors) a similar body for banking (CEBS), and one for securities (CESR). I think the idea is that it is not just left to each and every member state to go their own way; in fact quite the contrary. These bodies develop a set of rules, a set of understandings at level three—as you call it—which is binding on them and which they implement collectively. The point there is that a medium sized or a small insurance company in Holland should end up being regulated and supervised in much the same sort of way as one in the UK. That does not mean precisely the same but in much the same sort of way. That is what I understand from the three levels. My understanding is that there is even a fourth level which is the European Commission who, if they see that one of the above levels are not being dealt with properly, have a right and an obligation under EU treaty to intervene and bring cases.

  Q42  Lord Kerr of Kinlochard: If that is broadly right, can I ask three supplementaries? Can you explain what is meant by the "compact approach" to calculating risk capital? What role will you, the ABI, play in ensuring that the detailed models for calculating capital requirements will be appropriate and provide adequate consumer protection? And why do you say in your paper (for which we are very grateful), "When it comes to public disclosure more is not necessarily better"?

  Mr Vipond: Of the three questions the first is relatively straightforward. The compact approach is a reference to the minimum capital requirement (the MCR) in the proposed directive. The idea of a compact approach is that you calculate it as a percentage of the solvency capital requirement (the SCR). Essentially, as the Directive is envisaged—it is not quite the same way as the British have done things but it draws on that—if a firm breaches its SCR (which will be a higher number) then the regulators will be coming to see you fairly soon and you will have to have an explanation of why you are below it and what your plans are to get above it. If you breach your MCR they will be coming and they will be staying and you will be going. That is essentially, in broad terms, how it is designed to work. The European industry very much liked the idea of a compact approach which is to take a percentage of the SCR because it is easy to calculate and it relates to the model, if you are using a model. It is a more modern and sophisticated approach. Some regulators have reservations about that because they have reservations about models and they are more cautious; they want an alternative approach and that alternative approach is being discussed at the moment but no decision has been made. That is the issue around the compact approach.

  Mr Long: Can I just add on this that there is the compact approach which Peter described and there is this so-called modular approach. The problem is that if you have an MCR that is based on a model that is different from the SCR you may get slightly different results, especially when the MCR model is less sophisticated. For example, under QIS 3 (the Quantitative Impact Study that has just been carried out in Europe) we had problems where the MCR sometimes could be larger than the SCR because it did not take into account proper risk mitigation or proper treatment of profit sharing for with profits funds. What you do want is a proper ladder of intervention between the SCR and MCR so the regulators can do what they need to do in an appropriate manner. If you have the compact approach you will find that the ladder of intervention will be too close or you may get strange results. This is why we are so pro the compact approach.

  Mr Vipond: On the question of models, this is one of the very exciting features of this directive and marks it as being a generation beyond where the banking sector got to in Basel 2. This directive proposes to allow European insurance companies, large and small, to model part or all of their business. What that means is that they can use sophisticated modern mathematics to be measured against certain performance criteria by the regulators to show that they can deliver a degree of certainty about the risks of losses on their book. This modelling approach is a big move on from Solvency I. It is a very innovative approach and of course it is not something you can write in detail in a Directive because almost the day you write it, it looks out of date. Going back to your earlier remarks, Lord Kerr, this is where the importance of level three comes out because it is British and French supervisors (and others) who are going to have to look at these and evaluate them and prepare them. If a major European company submits one for approval it is those supervisors, working across the European single market, hopefully working together, that will approve it. That is what the model debate is about. You then raised the question of consumers which I think is terribly important here. Consumers should benefit from that because consumers should benefit from a system of prudential supervision which will give them greater comfort that risk is being perceived properly and measured properly and capital is being put against it. People then go on and say, "What does that mean to the price I am going to pay?" and it is a hard one to answer in 2007 for a directive in 2012. I think what we can say is that moving to a more efficient and modern system should mean that consumers generally will get a better price, a fairer price and one that is less distorted by outdated regulation. That is where I think consumers would benefit out of this. The final point you made is about public disclosure, what is called Pillar Three in the directive (the directive has, like Basel, three pillars). Clearly public disclosure is very important not just so that customers can understand the status of the companies, but I think more importantly that institutional investors can make a judgment about the price of capital in that company and how much they want to invest in it. I think public disclosure is a good thing but a danger that we have—we have seen this on the accounting front already—is that as volume after volume of disclosure arrives investors switch off. Like the rest of us they do not want to spend all their time poring through these matters. I think what the industry was concerned to do was to get market consistent values, modern numbers that are accurate and fair, in the public domain quickly so that judgments can be made. We are strong supporters of more and better public disclosure, but not more and more forever. There comes a point when you have to make a judgment about the quality of what you are getting and the usefulness of that for institutional investors and for other key stakeholders.

  Q43  Lord Steinberg: May I come in on the point about the cost to the consumer. It would seem to me that when new regulation comes in and where it benefits larger players as against smaller players, that the price to the consumer usually goes up. Why do you think in this case that the price may stay the same or come down?

  Mr Vipond: At the moment, as Philip was saying in some of his earlier remarks, we have a situation where the capital required for certain lines of business is disproportionately high and it is high because traditional regulation measures it badly and requires certain numbers to be maintained. We believe a more modern approach would allow a big European group to diversify, for example, its Italian operations against its French operations, to diversify its non-life business against its life business, to take account of the business hopefully it writes internationally. To put that into a common framework for measuring and offsetting the risks, remembering that these risks are not always closely correlated, then the amount of capital they should need should fall in some cases. There were a couple of "shoulds" in there of course because, as we all know, markets evolve over time, they change and I would not want to guarantee that, but I think that should lead to better allocation of capital and in some cases lower prices. For smaller firms—whom we are very robust about because the ABI represents a good number of small firms and we are very proud to do so—the way they can win is not by trying to compete head on and cover all the products in all the areas of the big guys, but by being more focussed on their niche markets where they have specialist pricing skills and good knowledge, and by modelling those particular parts of their business which are terribly important to their business and not trying to model everything.

  Q44  Lord Woolmer of Leeds: On the matter of disclosure, the solvency capital requirement is the level at which initial warning signals would start to flash red if you went below that and the minimum capital requirement is where you really hit serious trouble. Going below the solvency capital requirement is a pretty important trigger. Would the regulatory authority be aware on a day to day basis what these figures are and what is actually happening? Or is this something every three months or every six months? Are they aware of the way in which markets have very quickly shifted in recent months? Northern Rock has shown that serious problems can happen and the regulator did not really know what was going on. How speedily does the regulator know? If you are not telling the public, will the regulator know if things are going wrong?

  Mr Long: The solvency capital requirement is calibrated to the one in 200 year event, however you calibrate that stress because these are hard things to do. There has been some convergence of thoughts about what is a stress. For example, market stress for a one in 200 year event, what is a stress in the bond markets, what is a longevity stress and so on and so forth. This is what capital is for, in order to meet the position where there is a stress in the market. You could say that this capital amount needs to be recalculated so that at least at the start of the year (or the end of the year) the regulator knows what the capital requirement is because we tell him. We calculate the liabilities, he or she knows what the capital requirement is and we can see how that capital requirement gets used up through the market stresses as time goes on. There is also pillar two where, for example, the FSA has a constant dialogue with the major companies in the UK (which we think is a similar approach to the one that Europe will adopt) so they are very well aware of the risks and the situations facing a company. I have regular meetings with them and they understand the issues and the problems facing the industry.

  Mr Vipond: There is a difference, I think, to some degree in the history between the continent and the UK here, or least between those continental supervisors who would tend to be perhaps a little bit more mechanistic, looking for the submission of the right forms at the right time, and the kind of relationship which Philip Long describes where certainly in the UK for any firm of any size there is a close and continuing relationship whereby the FSA would want to know precisely what the numbers were on a fairly regular basis and they would certainly expect to be told if there was any departure. If anything was looking surprising or unusual, if there was a strong shock, then the FSA would expect to be the first people you called to explain what was going on and have a meeting with them. Under Solvency II pillar two a supervisor can require more capital on an exceptional basis. For example, if they took the view that the management of a firm were running risks badly, if they took the view that the management were lacking in competence in some way or lacking in appropriate risk management skills, the directive allows—as do UK rules—the imposition of additional capital requirements above the SCR. There is a clear capital mechanism which can be used. I would say that, depending on how you calculate the numbers, there are over 4000 insurance companies in Europe; there are a lot of very, very small insurance companies out there which have a very small per cent of the market. It is not practical that Europe's supervisors will have the staff or the numbers to be forever in all of those 4000; they will have to look with more detail on a continuing basis with the major players.

  Q45  Lord Kerr of Kinlochard: Can I come back for a moment to my question about disclosure and the way in which there can be too much disclosure? In your paper you give two types of too much. First, you say it has to be proportionate; the model being described in disclosure should be the one actually being used. I totally agree. However, you also say that if the SCR or the MCR are breached the company in question should be given time to straighten things out, to produce its strategy or plan, before being required to disclose. I wonder. You said yourself that if the solvency ratio is breached you would expect the regulator to come in for a chat and keep an eye on you, but if the minimum capital requirement is breached you would expect him to stay, and you to go. These are public acts and I really find it hard to foresee the circumstances in which a breach of the MCR could be kept out of sight, or why it should be.

  Mr Vipond: There is a balance to be struck and I take your point very seriously. Clearly any breach of the MCR would require the supervisor to be informed immediately; there is no question of delay or debate about that. Indeed, a firm approaching the MCR—because this is not necessarily a one-off falling off a cliff event, it is a continuing process—would be in regular discussion with the supervisor as things deteriorated. Frankly that is what the UK would expect and would expect nothing less. If we get to a point when the MCR is breached then the only debate about not making it public immediately would be the debate about whether that would give the management, working with the FSA, time to arrange the sale of a portfolio of business or sale of the company. I think that is the history of the way supervision has worked in the UK. My sense, with the increasing reliance on listing and disclosure rules, is that in practice the company, under stock exchange rules, would be obliged to make an announcement and that would be at the end of the business as a going concern. We are not trying to hide from that, we are just looking to give supervisors a modicum of non-transparency in their dealings with firms.

  Chairman: Mr Long, if you have anything to add as these points come along I rely on you to say so. If not, Lord Giddens has a supplementary on that question.

  Q46  Lord Giddens: I just wanted to go back to what Lord Steinberg said because, speaking as an economist, the scenario you sketch out seems sort of impossibly benign and it cannot be the case that every form of company can benefit from innovations of this sort. There must be downsides for certain kinds of companies. The whole document is very kind of gung-ho about this; there must be some problems and difficulties for certain types of firms and certain types of businesses by any innovation surely.

  Mr Vipond: I think if we are gung-ho then it is because the design of the directive is looking good and this is a radical and good development for the single market. That is perhaps why we are keen to be positive about it. You are quite right, from an economics perspective this kind of structural change will bring about new competitive pressures and that should lead—or may well lead—to their being fewer insurance companies in Europe going forward as this industry develops, and I would not want to pretend that that was not the case. Where that would hit hard is that it seems to me first of all diversification is a very big win. We are advocating it so if, as a firm, you are not diversified, you are likely to lose out. A large firm with a very common book of business that it cannot diversify will lose out relative to a large or even a smaller firm that is well diversified. If you are a firm that does not manage your risks in a very sophisticated way—so you do not move the risks out through re-insurance or securitisation and you keep it on your balance sheet—then you have less flexibility about managing your business and I believe you will lose out. This modelling process that we have talked about is complex and demanding; it requires specialist staff, and it requires that senior management are engaged in it. It is easy to say that people should model this, but incredibly difficult to actually do it on a continuous basis to the right quality for supervisor approval. Undoubtedly many small firms will have difficulty—in fact it may be impossible—to get that kind of modelling in. Some will be able to do it because they will know precisely what they need to model but others, I think, will suffer from that. In parts of the European insurance market perhaps traditionally competitive pressures have been weaker because of traditional regulation about who can sell what and the kind of products that exist. I think this will also come as a wake up call and people will have to be able to use their capital more efficiently and adapt it more aggressively to the market. All of that should lead to a more efficient market and it would be disingenuous to suggest that there will be no casualties in terms of takeovers along the way, I am sure there will be.

  Mr Long: May I say something on this? The key problem is if people are pricing their risks improperly, for example if a small firm offers guarantees that it cannot meet or a large firm offers guarantees that it cannot meet, then they ought to take responsibility for it. The key thing is that we are moving from a system where there has been conservatism that is effectively hit and miss in trying to get things right to a system where we are saying that risks need to be modelled and priced properly. People need to go into the business with their eyes open. That must be a good thing in preventing failures of companies; it must be a good thing in protecting consumers. The price for certain products will rise and the price of certain products will fall. In terms of winners and losers, it could be large companies or it could be small companies; it really depends on people's expertise in managing their risks. I hope that is not too simplistic. It is about winning and losing, yes, but there is a fundamental issue about how you run a business which people may miss if they just talk about protecting smaller companies. The key issue in the credit markets currently is that it is the big banks that are being affected. The new CEO comes in and says, "It is a good business; but there is inadequate risk management". That is the source of the issue. I think historically we have seen big companies come and go, they get broken up; big companies fail; small companies who are innovative come in and may be they become big later on but they can then become small again through being broken up.

  Q47  Lord Giddens: I would say that the current travails of some of the big banks show the limits of the modelling because we just do not know how much systemic risk you create if you create a model for a particular company and since there are so many arcane ways of holding risk upon risk it does not follow that the outcome for the overall system is less in terms of a risk, it might be more. To put too much faith in mathematical modelling is a mistake.

  Mr Long: I would agree but the problem is perhaps trying to model things that you cannot actually model or the lack of the information.

  Lord Giddens: It is what is happening in the wider world, as in Russia when people were unprepared in the banking system, something completely outside any mathematical models.

  Chairman: Lord Giddens, talking about the wider world, I know you wanted to ask about the IMF.

  Q48  Lord Giddens: I was going to ask two things really, how do you see this relating to the service directive because in principle it should surely facilitate the services directive in the European Union? Secondly, do you think it is important that the European Union has a connection with the attempts of the World Bank and the IMF to set up regulatory regimes because they have regimes in 12 different sectors? The one I know about is the ICR standard for banking but I guess there is also one for the insurance industry as well which I know less about.

  Mr Vipond: There is a lot of interest in Solvency II at the international level and a lot of belief that it is a serious move away from current practice and a much improved approach. I think, certainly from conversations we have had with, for example, regulators in China, there is a lot of support for adopting something like Solvency II in parts of Asia. In Australia, not surprisingly, they already have something that looks not unlike the kind of approach to these issues that we are trying to get to. My sense is that through the International Association of Insurance Supervisors a great deal of work is being done in moving from that initial stage of general broad principles to something much more detailed and substantive, in the way in which the banking regulators did a generation ago. Of course it will not solve all the problems of the world but it will improve the robustness of insurance supervision around the globe and that should in turn support trade. Lest I be thought to be giving too rosy a picture, it is not a one way move. For example, at the moment in the United States you still have a system where essentially insurance regulation is on a state by state basis. When they turn up at these meetings there are 20 or 30 states from the United States and anyone who is not a US state is designated an "alien". They are working perhaps a generation behind in terms of the geographic organisation and the move to have an optional federal charter in the States is certainly four or five years away at least I think.

  Mr Long: I think the IAIS is a fine body and it is very much in line with Solvency II in its approach looking at the papers that they have written. In terms of influence, unfortunately I do not think they have as much influence as the Basel Committee but perhaps that could be improved if more people truly subscribed and supported them. Secondly, in terms of the US, I think the US is really the key country to crack essentially in terms of convergence. The interesting thing about the US is that while they do have state regulation, essentially the rating agencies play a large role. I think they are the de facto regulators, at least of the larger companies. Where some of the NAIC requirements may be deemed a little light, they may require something a bit more substantial in terms of capital requirements. The trend is for the rating agencies to adopt market consistent approaches; they have embraced economic capital modelling. One rating agency has developed its own economic capital model which it requires companies like mine to populate with data; another has an enterprise risk management initiative where it seeks to score companies on the quality of their risk management as well. As the rating agencies adopt more of these approaches I think that is probably where you will find the US companies starting to think more widely and adopt new approaches to measurement of risk and managing risk.

  Chairman: Lord Renton.

  Q49  Lord Renton of Mount Harry: I come to this very much as a newcomer; I have only been on this Committee for two or three days and I read these papers for the first time over the weekend. In a way I find there is a certain amount of contradiction, it seems to me, because on the one hand you are generally approving the steps taken and yet you are worried. You say at page four of your notes under Pillar 2, "The current text on the risk management functions is very prescriptive". Is this not inevitably going to be prescriptive if it is going to work? But that goes against your feeling, particularly from Mr Long, that this is still a very competitive industry and you want it to be a competitive industry. You say particularly: "The framework directive should be principles-based in this area and state outcomes". What do you mean by that exactly?

  Mr Vipond: There has been a lot of concern about the nature of financial services regulation both in prudential and conduct of business areas and the propensity to write ever more of it in ever more detail and for good outcomes not to be achieved, both in terms of looking out for things like fraud, but also in terms of protecting customers. What you get is a game of people working round the rules and box ticking and the whole approach to regulation which has produced counter-productive results. What this paragraph refers to is a concern which the ABI has had and taken up with the FSA about the need to move to something called principles-based regulation. As the text talks about, it refers to outcomes. It refers to getting substantive, agreed outcomes that will be of benefit to the consumer, and in this case to the firm, in terms of the way risk management works. Rather than telling the risk management team they should have 20 people, they should have the following computers, they should report on Thursdays and all this kind of stuff, rather than getting into that minutiae you move to a position where you look to specify the criteria for what a good risk management operation will be, how it will operate and then you judge, through supervision, whether the firm has reached it. In particular, you allow them perhaps to reach the same outcome through different routes. That is the thinking behind this.

  Q50  Lord Renton of Mount Harry: What do you mean by outcome in this context? Do you mean that a company with £100 million of capital should make £10 million profit a year, for example, to show that it is capital worthy? Or what? What I find very difficult to fit into this—as I say, I am very much a newcomer—is that I have always regarded the insurance industry as deeply competitive. If the Pru gives me too big a quote on insuring my house I immediately go to AON see if I can get a cheaper quote and very often I get a much cheaper quote because they are taking a different view of the risk. I should perhaps also declare an interest in that I was for 20 years a member of Lloyds and I have seen Lloyds through good times and bad times; painful some were and very profitable others were. Is the essence of the insurance industry competition and that is risk management and also risk assessment? That is really at the heart of it. What one man thinks is too risky is actually another man's profit and I do not see how that fits in your thinking at the moment.

  Mr Vipond: I am sure Philip will want to add something from a more directly commercial background, but we were saying here that the UK industry undoubtedly is competitive in the retail product areas; there is no doubt that it is fiercely competitive in many areas. We have particularly in mind smaller firms here. It would be very easy to write into a European directive a list of rules and detailed regulations for risk management and accountancy, and audit and compliance, that would be very bad news for a small firm which did not need them perhaps because it dealt with professional counter-parties or it dealt in a very specialist product area. What we were trying to get at here in our thinking, a particular case of a general theme, is the need to focus on outcomes by which we do not mean profitability because it is not our job to determine or to ordain profitability—we cannot do that and we certainly do not try—but rather to say that the outcomes should mean that the risk management of the firm was appropriate and proportionate to the business they were transacting, and could give a supervisor and the auditors general comfort that risk management processes were in place and they were substantive and they were subject to review. That is the kind of thinking we were trying to get in there.

  Mr Long: Can I just outline something about the market consistent framework that is being proposed? We think that is a way of trying to establish an objective price for risk essentially. When you say that one firm may say that this makes them a profit of £10 whereas another firm may say it makes them a loss of £20, we need to see if there is an objective market price first of all. What the market consistent framework is saying is that first of all if there is a price in the capital markets that replicates your liability cash flow, use that price. So you have some objectivity there. Essentially what has happened in the past has been that I would price my product saying "I am going to invest the assets that I receive from you—your premiums—in equities, for example, and because equities earn eight to ten per cent per annum in the long run I can factor that into my pricing". Another firm says, "I am actually going to invest in bonds; they only earn six per cent in the long run so I factor that into my pricing". The company that prices it based on investing the proceeds of premiums into equities can then say, "I give you a lower priced compared to the company who has invested in bonds". This is really why we need a risk management framework. Equities have a risk premium because they are risky assets. Yes, they may earn you eight per cent per annum over the long run but you may suffer the fact that equity markets can suddenly tank, and it does tank from time to time. Essentially you will have to hold capital for the fact that you want to invest in equities. Essentially what happens is that the price is driven down to a market price on it and then you compete on the basis of how efficient you are and the sort of risk that you are then prepared to take on it. People are going into it with their eyes open.

  Q51  Lord Renton of Mount Harry: I think we could go on talking about this for a long time, but could I just ask two more short questions. Could you say, out of interest, where you think Lloyds will fit into this? Secondly, do you think that if Solvency II had already been in existence, it is possible it would have helped with the present credit crisis?

  Mr Long: I do not know anything about Lloyds.

  Mr Vipond: Let me give you a straight answer, this will apply to Lloyds.

  Q52  Lord Renton of Mount Harry: Of course, yes. How will they get on?

  Mr Vipond: These days many of the more sophisticated risk players are in syndicates and in the central structures of Lloyds. I do not speak for them and I do not represent them, but I am sure that they will be able to accommodate this and do very well out of it. The nature of some of the risks that Lloyds runs, as you know, are at the end of the fat tail as it were; they are the extreme risks that happen infrequently or used to happen infrequently before climate change suggested that things might be changing. Those things require very specialist modelling for CAT risks and that kind of work, but Lloyds has the expertise for that and I am sure they will do as well as anybody else out of it; I am sure Lloyds will be in a good position.

  Mr Long: In terms of the current credit crisis in the markets, I think we have to accept that a model is a model. If you put garbage into the model you get out garbage of course. Models continue to be developed; we continue to develop technology and our thinking about risk issues. Essentially what I am saying is that models should be used but they need to be used sensibly and they need to have the correct information and data. The current FSA regime, for example, accepts that and I think there is some rigour in the regime which can be commended in that people use the models, and the supervisors use the models sensibly. Just because it produces one capital number they do not accept it as that. The regulators start looking at the assumptions and stress testing them to see whether the capital numbers are resilient. It is really about the interaction with the regulators, a regulator who understands things and can properly challenge a company under a pillar two process and not just about one single number that comes out from a pillar one capital requirement. I am not a banker but you can see, at least from the statements that are being made from the banks themselves, that there has been a problem with both credit and liquidity. There have been problems with people who have no desire to look at the risk properly because they can package it and sell it on. You have to ask those counter parties why they have been so willing to accept those risks.

  Q53  Lord Renton of Mount Harry: Because they can make a profit.

  Mr Long: Exactly, but again, as I said about the whole market consistent thing, you take on asset risks; there is say an equity risk premium and it is not called a risk premium for nothing. Yes, you may be able to get higher yields but you have to understand where those higher yields are coming from and whether the underlying assets are actually not very good quality assets.

  Chairman: It sounds to me like the old saying that if you think it is too good to be true, it is too good to be true. Loath though I am to move the discussion on, I must because we have two very interesting areas to explore, one in the hands of Lord Steinberg.

  Q54  Lord Steinberg: Before I ask this question, I have to say—and I am sorry to say it—that I remain unconvinced that prices will not go up quite significantly because you have said that there will be a requirement for greater investigation of risk and senior managers will be required. I am not convinced that prices will not drop; I am equally well not convinced that this will not very much mitigate against small companies, some of whom, in an effort to compete, may very well stray beyond the risk factors to which they have normally worked and they will be saddled with the same percentage of overhead increase. Now I will ask my question. Is there a political will amongst the Member States of the EU for this directive to happen? The second part of the question which is really an add-on, is have all the Member States agreed to buy into these changes? In other words, is it a unanimous thing or are there some countries who are holding back because either their insurance market is weak or because they have other economic problems (as we know some of the more recent entrants have got economic problems)?

  Mr Vipond: There is, I think, something close to unanimity about the case for doing Solvency II and about using an approach to measuring assets and liabilities that Philip Long has gone into, in some detail, in this session. I think consensus probably starts to fade after that. In particular I think some countries are wary about the move towards a radical approach for group supervision, for example, and some are concerned about particular domestic issues that they have. It is not always the smaller eastern European countries; they often have the concern that most of their industry is owned by western European businesses so they are looking very carefully at what that would mean for group supervision. Some of the east Europeans, as is often the case, have a more modern approach to the maths of this and to the measuring of risk than others and so they should not be lumped together, as it were, as the laggards in this. That is far from true. We have recently visited Slovenia, which will be taking over the presidency on 1 January next year. We have had long discussions with the Slovenians, and they are very much to speed with the Directive and what they think the key issues are, and they are in a position to play a very positive role.

  Q55  Lord Steinberg: You are saying that there is not unanimity; do you expect unanimity soon or are you going to try to bang some heads together to get unanimity?

  Mr Vipond: I think the European Parliament and the Commission are working hard to build a consensus and build a common deal. I am relatively confident at the moment that they should be able to do that.

  Q56  Chairman: Perhaps I could just ask, this is clearly going to be a very demanding regime on the quality of supervision and having people in the regulators who understand about risk management. How do you feel that is going to play? Have we got enough people sufficiently sophisticated in regulation? When I say "we", I mean the EU as a whole.

  Mr Long: I do not know whether the FSA is a good example, but I think as far back as in 2001 they did issue a document that talked about the future regulation in insurance business where they talked about smarter regulation. They talked about the need to interact more closely with insurance companies, the need to look at boards and governance structures; they looked at being more proactive generally in their supervision. We are now five or six years down the line and essentially I think they have managed to get where they set out to go in 2001. It does take some time; it does take regulators' investment in expertise and technology, but it can be done. I am more optimistic and if there is a will I think people can move in the correct direction.

  Chairman: I will now ask Lord Woolmer to start exploring the question of what it will do for us.

  Q57  Lord Woolmer of Leeds: So we have some information to look at, could you give us a bit of advice on which areas of insurance do you think you may see a fall in prices to the customer whether retail or wholesale and in which countries? In other words, where do you think the benefits are most likely to be felt in product and in Europe and then we will turn to what this means for London.

  Mr Long: We do not operate in Europe so it is hard to say, but there are certain products that currently look more attractive under this sort of framework, protection products, unit linked products. For products where there have been traditionally a lot of guarantees (and it is quite right that the insurance industry provides guarantees): Sometimes in the past those guarantees have not been priced properly so for example in the past we know of cases where guaranteed annuity options have been provided at very low costs. They were provided at low cost because they were not the right price for it which is why companies got into trouble. I think where companies are offering products with guarantees perhaps the costs may rise if they have not priced it properly in the first place.

  Q58  Lord Woolmer of Leeds: So things like guaranteed annuities might turn out from the customer's point of view to become more expensive.

  Mr Long: That is the right price, if that is the case.

  Q59  Lord Woolmer of Leeds: Where might consumers—retail or wholesale—expect to get benefit from this?

  Mr Long: A lot of it is driven by the transient longevity of course, so unit linked products to the extent that they are not risky; there will be benefits.

  Mr Vipond: It is perhaps important to say—I hope it does not sound too defensive—that we are now in 2007 and this is a 2012 implementation. We have just come to the end of something called QIS 3 and of itself that is a remarkable innovation. Before legislation is enacted at the European level we are in the third comprehensive quantitative impact study and we are now designing the fourth one for next spring. There will undoubtedly be a fifth before this happens whereby the European Commission, through CEIOPS and through work with Member States, can work to calibrate the capital in a way that is genuinely market sensitive and allows firms to hold the right amount of capital for their businesses. Clearly that is a factor and clearly it is also the case that the pricing of goods as I believe Lord Renton pointed out earlier is a product of fierce competition as well. It is not just what regulators decide, thankfully, or trade associations; it is very much a market feature of what the market will stand, what the particular marketing campaign allows. Being precise about pricing I think is difficult, but I would want to reinforce this idea that where products are low risk, where they do not have so much in the way of guarantees and optionality about them, they are the ones which I would think would easily benefit under this directive. Motor insurance or something like that which is a year to year business almost, is a cash flow business, and does not require the same amount of capital as some of the things that Philip Long was talking about such as guaranteed annuity options. I would flag, the case of with profits in the UK as an example of what might happen or the way things could develop. This was a product with a great number of options and guarantees built into it which often were not priced properly at the end of the last century and into the market at the beginning of this. When the FSA insisted on stochastic modelling of those guarantees and putting proper capital numbers, suddenly people who provided them found that they were more expensive than they thought, and customers found they were more expensive to buy. That market has undoubtedly declined a lot because of those considerations.