GIM3010 | Regulatory framework: legislative background

The state exercises greater supervision over insurance than many other activities. This is for two reasons. First, because, for retail customers, there is likely to be an imbalance of knowledge and financial sophistication between the contracting parties. Secondly, because the economic and social purpose of insurance is the transfer of risk from the policyholder to the insurer.

If an insurance company fails then the object of this transfer of risk is not achieved. A buyer of goods or services will usually know very quickly if a trader is unable to supply the goods or services promised, but a buyer of insurance will not know whether a claim can be met until it arises. Even if a company is financially sound when the policyholder pays the premium the situation may have altered by the time a claim arises through, for example, mismanagement or even misconduct. An insolvent insurance company would leave its policyholders exposed to claims which they may not be able to meet.

The regulatory legislation in this area aims to prevent insurers getting into difficulties by laying down authorisation, solvency and reporting requirements. If prevention fails, policyholder protection legislation provides a mechanism for the policyholders of insolvent insurance companies to be covered through a guarantee fund in certain circumstances.

In the UK insurance was one of the first types of business to be regulated: the legislation first appeared as the Insurance Companies Act 1870 when responsibility for supervision of all insurance business, including general insurance business, lay with the Board of Trade, and subsequently in the Insurance Division of the Department of Trade and Industry (DTI). In 1997 the responsibility was transferred to the Treasury, although most of the day-to-day regulatory functions were delegated to the Financial Services Authority (FSA), before the FSA took responsibility for regulating insurance companies from 2001. GIM3020 gives further details.