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Changes To The Approved Persons Regime

Changes To The Approved Persons Regime

An overview of changes to the Approved Persons Regime

1.0 Introduction

This document has been produced by the AFM Regulation and Governance Committee, to provide an overview of the various consultations issued by PRA and FCA; with special thanks to Gary Morley of Oddfellows and Robert Wharton. The notes below are not definitive, and the regulatory rules are still evolving, and therefore AFM members should consider for themselves the specific implications.

In preparation for Solvency II implementation, 1 January 2016, and as a consequence of the Banking Sector reviews the Regulators (PRA & FCA) have issued a number of publications which detail their expectations of Insurers Boards and Senior Management. The Regulators have stated: 'the proposed rules, along with the expectations set out in the draft supervisory statements, will set out the regulatory framework to ensure those individuals who run insurers have clearly defined responsibilities and behave with integrity, honesty, skill, care and diligence, and deal with the Regulators in an open way'. This reflects the movement towards stronger individual responsibility and individuals having the requisite knowledge and skills to undertake their roles.

What is clear from these publications is that the focus on Insurers Boards and Senior Management will continue to intensify in the lead up to Solvency II implementation and beyond.

2.0 PRA Solvency II Directors Update

On 19 December 2014 the PRA published a Solvency II Directors' Update, which provided guidance for internal model firms on the PRA expectations of insurer's Boards and Senior Management. The update confirms that insurers must ensure that members of the Board and others involved in running the insurer have an understanding of the model. One of the methods the PRA might use to assess this is to speak to Board and/ or Senior Management (either individual or collectively) to gauge their understanding.

The PRA does not believe that it is necessary for Board members to be technical experts in modelling techniques in order to meet regulatory expectations. Rather, the PRA would expect Board members to understand and be able to explain areas such as:

  • Key strengths, limitations, and judgements within the model;
  • Assumptions and judgements that have the most material impact on the model output; and
  • Key sources of information and advice the Board has relied upon in order to satisfy itself about the appropriateness of both and the model design and model output.

Board members should expect support from their Executive Team to ensure the key features of the model are explained and third lines of defence (Auditors) to provide independent validation. For both it is critical that the information presented to the Board is presented appropriately for Board level audience.

The changes will become effective from 1 January 2016.

3.0 Non Executive Directors, Key Functions and Senior Management

On 21 February 2015 the Regulators issued consultation paper: CP15/15: Approach to Non Executive Directors in banking and Solvency II firms & Application of presumption of responsibility to Senior Managers in banking firms. The regulators are using 'Senior Insurance Managers Regime (SIMR) to describe the new Approved Persons regulatory regime.

The aim of the new regime is to hold individuals responsible and accountable for the safety of the firm and to provide protection for policyholders. The SIMR has been based on the regime used within the banking sector, but it has been applied on a less stringent basis and more proportionally, and, as an example, senior insurance managers will not face criminal sanctions which are something that their banking counterparts face. However regulatory censure would still apply.

The SIMR will see more focused allocation of individual responsibilities, however is not intended to undermine or change the fiduciary, legal and regulatory responsibilities of the Board of Directors (BoD) which will retain ultimate decision-making power and authority over all aspects of the insurer's affairs.

3.1 Governance Map

To assist with the allocation of responsibilities the SIMR will require insurers to have in place a documented 'Governance Map' which will record Controlled Functions, Key Function Holders, Senior Management/personal and their allocated responsibilities. PRA has conceded now that the governance map need not now be a single document, which should be helpful to members (see PRA PS3/15).

The Governance Map must be kept up-to-date and describe the insurers' management and governance arrangements including:

  • details of the reporting lines and lines of responsibilities;
  • reasonable details about the persons who are part of these arrangements and the responsibilities of those persons;
  • the names of the insurers approved persons and other senior management / personnel and the responsibilities held by each;
  • details of the management and governance arrangements relating to all of the prescribed responsibilities;
  • the FCA business function the insurer has and details of the person performing the role(s) and the person having overall responsibility for them;
  • Matters reserved to the Board (including its committees);

Where responsibilities have been allocated to more than one person, the insurer must show clearly how these responsibilities are shared or divided.

An insurer must retain each version of its Governance Map for a period of 10 years and at least once every 12 months certify in writing to the Regulators whether or not it has complied with its Governance Map. If it has not done so, the certificate must give details of the non-compliance. The insurer's board must approve (sign) the content and issue of the certificate.

3.2 New Controlled Functions (CF)

The SIMR proposes to create six new CF also known as Senior Insurance Management Functions, which are:

  • Chief Executive Officer (SIMF1);
  • Chief Finance Officer (SIMIF2);
  • Chief Risk Officer (SMIF4);
  • Head of Internal Audit (SMIF5);
  • Chief Actuary (SMIF20); and
  • With Profits Actuary (SMIF21)

Diagrammatically, the proposed structure of the senior insurance managers regime looks like this:

PRA indicates that individual insurers should consider for themselves which roles in addition to those specified might be 'key functions'. PS3/15 suggests that for some firms this might include the investment function, the IT function, claims or reinsurance.

3.3 Prescribed Responsibilities

The SIMR will require insurers to allocate the following responsibilities to one or more CF holders:

  • Responsibilities of the insurers performance of its obligations under the SIMR;
  • Responsibility for the insurers performance of its obligations in respect of assessing the fitness and propriety of CF holders, and induction, training and professional development of all persons performing CFs;
  • Responsibility of the insurers performance of its obligations under the certification rules;
  • Responsibility for compliance with the insurers obligations in relation to its Governance Map;
  • Responsibility for ensuring and overseeing the integrity and independence of the compliance function in accordance with SYSC;
  • Responsibility for ensuring and overseeing the integrity and independence of the risk function in accordance with SYSC;
  • Responsibility for leading the development and embedding of the insurers culture and standards in relation to the carrying on of its business and behaviours of staff in the day to day management of the insurer;
  • Responsibility for the development and maintenance of the insurers business model;
  • Responsibility for the management of the allocation and maintenance of capital, funding and liquidity, and treasury management;
  • Responsibility for the production and integrity of the insurers financial information and its regulatory reporting in respect of regulated activities;
  • Responsibility for the insurers recovery plan and resolution and for overseeing the internal processes regarding their governance;
  • If an insurer outsources its internal audit function, responsibility for taking reasonable steps to:
  • supervise and oversight of outsourced function; and
  • ensure that every person involved in the performance of the function is independent from the persons who perform external audit, including management of potential conflicts of interest.
  • Responsibility for maintenance of the independence, integrity and effectiveness of the insurers policies and procedures on whistleblowing and for ensuring staff who raise concerns are protected from detrimental treatment; and
  • Oversight of the insurers remuneration policies and practises.

Insurers will be required to complete and send to the Regulators a form containing relevant information about the individual who are taking up CF post. This information will include, amongst other things, information about their skills and experience, along with the scope of all their responsibilities at the firm. The SIMR includes a requirement that insurers must not make a CF application unless it is satisfied that the person is fit and proper to perform the role and allocated responsibilities.

3.4 Conduct Standards and Assessment of Fitness and Propriety

The SIMR is proposing to amend the current conduct standards. Three generic standards will be introduced for CF and key Function Holders, which are:

  1. To act with integrity
  2. To act with due skill, care and diligence and
  3. To deal with the regulators in an open and co-operative way

The Regulators have set out draft rules on the assessment of individuals and there will need to be specific reference to:

  1. Personal character (reputation/integrity)
  2. Level of competence, knowledge and experience
  3. Qualifications, and
  4. Training past and future

3.5 Non-Executive Directors (NED)

The following NEDs will be subject to the SIMR:

  • Chairman;
  • Chair of the Risk Committee;
  • Chair of the Audit Committee;
  • Chair of the Remuneration Committee;
  • Chair of Nominations Committee; and
  • Senior Independent Director.

The rationale behind the decision to include the above NEDs is that these roles have a certain amount of oversight and influence over the business and as a result they should also be held personally accountable and subject to regulatory censure. The SIMR will not apply to NEDs that do not perform delegated responsibilities. The Regulators have commented that the revised regime reflects the fundamental difference in the role played by standard NEDs and applying the presumption of responsibility, could encourage standard NEDs to take on a more 'executive' role contrary to their purpose as independent members of the Board. Having a narrower SIMR will allow the Regulators to focus regulatory resources on those responsible for key business areas and Board Committees.

The Regulators have also now consulted on transitional arrangements (this is covered separately in FCA (CP15/16) and PRA (CP13/15)) and this confirms that incumbents will be grandfathered from existing controlled functions using the forms provided in that consultation.

3.6 Key Function Holders

Key Function holders will be Senior Employees who help run the insurer: risk management, compliance, internal audit and actuarial, with others in more complex insurers. Key Function Holders will also hold CF, but even if they don't the Regulators will need to be informed and will be subject to a 'fit and proper' self-assessment by the insurer. The Regulators will assess an insurers assessment of whether a person is 'fit and proper' on an ex-post basis. After carrying out their assessment, insurers will need to provide the Regulators with relevant information about their Key Function Holders (including Controlled Function holders). Relevant information includes their skills and expertise and the scope of all their responsibilities for the insurer.

As previously noted the Regulators will require insurers to maintain a Governance Map covering those who effectively run the insurer, along with those in Key Functions. The map will be used by the Regulators in their supervision of insurers and is intended to promote effective governance arrangements. The Governance Map will also enable the Regulators when undertaking supervisory activities and/or regulatory censure to focus on those individuals responsible for the area where the breach occurred.

The Regulators are required to ensure Solvency II rules take effect from 1 January 2016. The final papers for the transposition to Solvency II (which is driving the SIMR changes) are supposed to be out by 31 March 2015 to allow full implementation by 1 January 2016. As with all things regulatory there is a high chance these timeline will slip, however insurers will need to consider these changes and what actions to take to avoid pressure later in the year.

It is expected that the Regulators will provide a more detailed technical consultation paper later in the year, which will cover forms, consequential changes and transitional arrangements.

4.0 Non-Solvency 2 firms

PRA and FCA have also consulted on streamlined proposals for a senior insurance managers' regime for non-Solvency 2 (non-directive) firms: see CP12/15 (PRA) and CP15/15 (FCA). Changes to the regime for non-directives are intended to take account of the requirements for Solvency 2 firms, but also to be proportionate to the scale of firms outside the scope of the Directive. Any non-directive firm with assets above 25 million in respect of regulated activities though will need to apply the full SIMR.

PRA is proposing a single small insurer senior management function (SISMF). Non-Directive Firms would be required to seek approval for at least one person for that SISMF role. A list of four responsibilities, would be allocated to one or more persons in the SISMF, covering:

  • business plan and management Information;
  • financial resources;
  • legal and regulatory obligations; and
  • oversight of proportionate systems and controls, and risk management.

Individuals holding existing controlled functions will be grandfathered into the new SISMF regime without reassessment.

FCA intends to require pre-approval of all individuals taking up executive governing functions whom the PRA has not otherwise approved. These individuals will become FCA significant individual function (SIF) holders, and subject only to the FCA's approval processes. This means that the following NED roles are also included in approval requirements for the FCA SIF regime where they are not otherwise approved by the PRA: Chairmen, SIDs and the Chairs of the Audit, Remuneration, Risk and Nominations Committees.

5.0 Implementing actions for mutuals

The full implementation of the SIMR is due for 7 March 2016, which coincides with the commencement of the Banking Reform Act. However, PRA has brought forward the implementation of the 'fit and proper' requirements to 1 January 2016, for individuals in Solvency 2 firms who perform key functions.

Whilst we await the outcome of the various consultations, the direction of travel is very clear. We think AFM members will need to take a range of actions to review who does what now and whether those responsibilities will change in the future. Assessment will also be needed of whether individuals have the appropriate qualifications and experience to obtain pre approval for the new PRA and FCA regimes. Those actions may result in staff changes or variation of contracts of employment which may then have remuneration implications. Your own assessment procedures need to be tested robustly and not least be reflected in written "Governance Map(s)". For NEDs, there may need to be an assessment of suitability in terms of skills they bring to the insurer. The regime for non-directive insurers will be simplified, but it is likely that work will be required to assess how readily individuals can be grandfathered into the new regime, and whether any changes are required in the composition of the Board.

Association of Financial Mutuals, April 2015

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Headingx

 

Corporate Governance Questionnaire Keyx

A

AFM PREDECESSOR

AFM Predecessors are Association of Mutual Insurers and Association of Friendly Societies

Annual election

Annual election of all board directors has become commonplace in PLCs, since it was incorporated into the Code in 2010. This was a reaction to governance failures and their contribution to the financial crisis. Annual elections give members an opportunity to react to the performance of the company and are also required for directors that have served for more than nine years.

B

BOARD

Board includes committee of management.

C

CODE

The UK Corporate Governance Code (previously called The Combined Code), subject to the annotations made by AFM in the Annotated Corporate Governance Code (current version dated 2012).

COMPANY

Company means a mutual insurer and includes a friendly society.

CP

Code Provision of the Code.

D

Diversity

Diversity includes but is not limited to gender. Directors may differ in many important characteristics, such as educational and functional background, industry experience, social connectedness, insider status, gender, and race. The Davies report in 2011 put forward a voluntary target for gender diversity for the boards of listed companies of 25% by 2015.

E

Entrepreneurial leadership

The organising of a group of people to achieve a common goal using proactive entrepreneurial behavior by optimising risk, innovating to take advantage of opportunities, taking personal responsibility and managing change within a dynamic environment for the benefit of the organisation

Externally facilitated performance evaluation

An external facilitator brings rigour and struture to the performance evaluation of a board, as well as an independent and impartial perspective. Evaluation of the board of larger companies should be externally facilitated at least every three years. The external facilitator should be identified in the annual report and a statement made as to whether they have any other connection with the company.

F

Fair, balanced and understandable

This broad definition of the basis on which the annual accounts was prepared is intended to address the concern that the narrative report should reflect the board's considered view of the information that members and other users of the annual report and accounts needed, rather than being viewed as promotional in nature, and to ensure that the narrative and financial sections of the report were consistent.

I

Independent non-executive director

Member of the Board of Directors of an entity who is an outsider, meaning he or she is not an employee of or otherwise closely connected with that entity. An example is a broker sitting on the Board of a client company. Such directors are important because they bring unbiased opinions regarding the company's decisions and diverse experience to the company's decision-making process. In order not to have a conflict of interest, independent directors should not participate on the boards of directly competing businesses. Directors are typically compensated based on a standard fee for each board meeting, or on an annualised basis.

L

LARGE COMPANY

A Large Company is any mutual that does not meet the definition of a small mutual i.e. because it has gross premium income on average over the preceding three years of £20 million per annum or more and/or it has assets on average at the end of the last three financial years of £100 million or more.

M

Major shareholders

Although mutual insurers do not have shareholders, the principles underpinning the provisions of the Code are relevant and should be considered in relation to appropriate methods for facilitating direct member dialogue and involvement that may be in place (such as member forums or panels and/or delegate systems) and/or any members with significant membership rights. Also referred to as principal shareholders and significant shareholders in the Code.

MP

Main Principle of the Code.

MR

A recommendation from: "The Myners review of the governance of life mutuals published in December 2004"

P

Performance evaluation

Performance evaluation is a key means by which boards can recognise and correct corporate governance problems and add real value to their organisations. Boards who commit to a regular evaluation process find benefits in terms of improved leadership, greater clarity of roles and responsibilities, improved teamwork, greater accountability, better decision making, improved communication and more efficient board operations.

S

Senior independent director

The role of the Senior Independent Director includes the following:

  • Providing support for the Chair in the delivery of his or her objectives;
  • Ensuring the views of the other Directors are conveyed to the Chair;
  • Attending sufficient meetings with a range of members, perhaps in company with the Chair, to develop a balanced understanding of their issues and concerns;
  • Ensuring that the Chair is passing on the views of the members and especially that any concerns are conveyed to all Directors;
  • Ensuring that appropriate succession planning procedures are in place in relation to Board succession;
  • Carrying out the annual evaluation of the Chair in conjunction with other Non-Executive Directors while also taking account of the views of the Executive Directors; and
  • Taking responsibility for an orderly succession process for the Chair.

SMALL COMPANY

Small Company means a mutual with gross premium income of under £20 million per annum on average over the preceding three financial years and assets of less than £100 million on average at the end of the last three financial years.

SP

Supporting Principle of the Code.

Statutory duties

The Companies Act 2006 codified certain common law and equitable duties of directors for the first time. The Act sets out seven general duties of directors which are:-

  • to act within powers in accordance with the company's constitution and to use those powers only for the purposes for which they were conferred
  • to promote the success of the company for the benefit of its members
  • to exercise independent judgement
  • to exercise reasonable care, skill and diligence
  • to avoid conflicts of interest
  • not to accept benefits from third parties
  • to declare any interest in a proposed transaction or arrangement.

The statutory duties do not apply to the directors of friendly societies, although they must comply with very similar duties under the common law.

U

Unfettered powers of decision

No one person should be able to make major decisions about the organisation on his or her own.

Unitary board

Unitary boards include both executive and non-executive directors and make decisions as a unified group. By comparison a two-tier board has a separate management and supervision board

Y

YEAR

"Year" means the financial year of the company in respect of which the questionnaire is being completed