The FSA plans to update and extend its rules governing unit-linked and indexed-linked policies to bring the requirements in line with Solvency II.
The regulator has published a consultation paper today on Solvency II and linked long-term insurance business.
The UK unit-linked long-term life sector has managed assets of £815bn relating to benefits under unit-linked policies and represents the biggest sector of the insurance industry. A further £24bn of assets relates to index-linked policies.
Investment risk with linked policies is borne by the policyholder rather than the insurer. The FSA says much of the recent growth in unit-linked funds in recent years has been driven by the increasing popularity of defined contribution pension schemes, which it expects to continue with the introduction of auto-enrolment in 2013.
The FSA wants to ensure that policyholders have the same protection under Solvency II as they have under current Conduct of Business Sourcebook rules.
Solvency II requires insurers to comply with a set of rules on how the assets they hold must be managed and how associated risks are controlled.
Under Solvency II firms will no longer be restricted to the list of assets previously prescribed for designing linked policies.
However it also allows member states to restrict the assets available should they wish to do so to protect retail policyholders and prevent them from being exposed to assets that carry “inappropriately high levels of risk”.
The FSA has decided to impose certain restrictions on the assets used.
The FSA says: “Individual policyholders who hold for example personal pensions, whole-of-life plans, insurance bonds and also members of DC occupational pension schemes invested in unit-linked life assurance policies bear all of the investment risk inherent in the assets backing their policy benefits.
“We consider restrictions on the assets that can be used to determine their benefits to be appropriate to meet out statutory objective of consumer protection.”
The regulator proposes that the revised list of assets which can be used to back linked policies will be expanded to include the assets allowable in UCITS funds that are not currently allowed under COBS.
Assets that will be allowed include approved securities, listed and unlisted securities, deposits and cash, money market instruments held by an insurer, and collective investment schemes.
Residential mortgage-backed securities will not be allowed.
The FSA expects the revised rules to be introduced as Solvency II is fully implemented.
It has also highlighted concerns over the way some firms are managing their unit-linked business with investments in non-permitted assets, or assets being managed in a way that does not comply with FSA rules.
The FSA notes that guidance on governance of linked policies is still being worked on by the European Insurance and Occupational Pensions Authority. The regulator says when it has greater clarity it will bring forward proposals to improve governance in this area.