FSA weighs in for cost of capital

UK Financial Services Authority (FSA) chief executive, John Tiner, has spoken out forcefully in favour of a cost-of-capital approach to Solvency II quantitative capital requirements.

Speaking at a conference organised by the Association of British Insurers (ABI) in April, Tiner said, "The cost-of-capital method seeks market-consistent pricing for unhedgeable risks ... by looking to the capital market for the provision of capital to insurance companies. All insurance companies have capital and have access to EU capital markets. The market-consistent price is the cost of capital that needs to be held to cover those risks."

Tiner characterised his opponents as seeking a defined percentile technical margin in order to "support the run-off in liabilities without recapitalisation". Criticising the "arbitrary, non-intuitive assumptions" used to model claim distributions in run-off, Tiner argued that cost-of-capital could not only be simpler, but also would encourage the growth of secondary insurance markets. "The FSA argues that recapitalisation should be the main aim of the regulatory design of technical provisions," he said.

Support for the FSA view may come from current UK trends. After the capital crisis that hit the UK with-profits industry in the late 1990s, a wave of fund closures swept the industry, leaving a total of 43 closed funds of significant size according to FSA figures. Now these funds are undergoing a wave of recapitalisation, led by Resolution Life and the Pearl Group. However, the damage to policyholder expectations and consequent legal fallout at closed fund Equitable Life continues to provide ammunition to continental critics of the UK.