France Telecom: lessons for UK employers following 'institutional harassment' ruling
Out-Law Guide | 19 Jan 2011 | 11:28 am | 6 min. read
This guide is subject to UK law and was last updated on 19th January 2011.
The FSA's revised Remuneration Code may not apply directly to insurers, but this does not mean they will be able to avoid remuneration issues entirely.
Non-insurance entities, such as asset managers within insurance groups, may already find themselves caught by the Code's expanded scope.
But for insurers generally, a new set of remuneration principles may be just over the horizon, courtesy of the implementing measures for Solvency II, the new pan-European solvency regime.
Bruno Geiringer, an insurance expert at Pinsent Masons, the law firm behind OUT-LAW.COM, said insurers not caught by the revised Code could not afford to be too complacent:
"Insurers should expect remuneration principles in some form to apply to them from 2013 and should be considering now how these might affect the future design of any long-to-medium term incentive schemes for their senior management."
The revised Code, which came into force on 1st January 2011, requires firms to set up and maintain remuneration policies that are consistent with good risk management.
In particular, it requires a proportion of any bonus payable to significant employees (known as Code Staff) to be paid in shares (or similar) and for payment to be deferred over several years (see The FSA's Remuneration Code, an OUT-LAW Guide).
Until the end of 2010, the Code only applied to the largest banks, building societies and broker dealers. In its revised form, however, its scope has widened to include all banks, building societies, asset managers, hedge fund managers, UCITS investment firms and some firms that engage in corporate finance, venture capital, the provision of financial advice and stockbrokers.
The Remuneration Code does not apply to insurers. But it does now apply to asset management companies that are Capital Adequacy Directive investment firms and so it may have an impact on insurance companies that have asset management subsidiaries within their group.
Asset management companies will be classified as "tier 4" firms under the FSA's proportionality system, which means they must comply with some - but not all - of the Code and they can take into account specific features of their activities when setting up remuneration structures.
As a result, tier 4 firms will not have to set up a remuneration committee (although the FSA says it would be desirable for larger firms). Nor are they bound by the rules on paying a proportion of "variable remuneration" (bonuses) to Code Staff in shares or similar instruments, nor by the requirement to defer bonus payments over a period of years.
And if the individual or the firm underperforms, tier 4 firms are not required to make an adjustment to any deferred bonus that has not yet been paid.
It is possible that few, if any, directors of asset management companies would be subject to the remuneration provisions in any event. The Code applies to Code Staff - employees within the organisation that have "a material impact on a firm's risk profile," such as senior managers and risk takers.
A "de minimis" concession, however, excludes Code Staff who earn less than £500,000 per annum and whose variable remuneration is less than 33% of their total remuneration.
If the Code does apply, then under the FSA's transitional rules, the firm will have until 1st July 2011 to comply.
How might this affect a parent insurer that owns an asset management subsidiary covered by the Code but which is itself outside scope?
The FSA says that in this situation, it will apply two tests. Firstly, it will consider the extent to which the risk profile of the asset management company can have an impact on the group as a whole. Secondly, it will take into account the significance of that company within the group in terms of the responsibilities of the group-level managers.
Looking at it from a different angle, the regulator will consider the influence the unregulated entity (the parent insurer) might have on the asset management company and whether inappropriate remuneration policies in the parent insurer might lead to excessive risk taking.
For example, the FSA might look at the link between risk and reward (if any) in the current remuneration structures of the group, including whether the typical type of investments are likely to be those of high risk/high reward.
If the FSA suspects that the parent insurer's inappropriate remuneration policies could threaten the asset management company, it might require the asset management company to put in place additional risk mitigation measures, including possible additional capital requirements.
Bruno Geiringer, however, believes the likelihood of this happening is fairly remote:
"The insurer and the asset manager will probably already have strict investment risk management protocols and restrictions in place due to the nature of the products that they sell and the obligations owed to policyholders.
"In this situation, it seems very unlikely that the risk profile of the parent insurer would encourage greater risk-taking in the asset manager.
"In any event," Geiringer added, "given that, in reality, only a few directors of asset management companies will qualify as Code Staff, it would seem wholly disproportionate to apply the Code to the whole of an insurance group on account of one or two individuals."
He concluded that it is unlikely, although not impossible, that an insurance group would be subject to the Code on a group-wide basis. "Unfortunately, the FSA's guidance on this is still not very clear."
Even if the Remuneration Code may not impact insurers, remuneration provisions which are to be brought in under Solvency II will.
The Committee of European Insurance and Occupational Pensions Supervisors (CEIOPS) (which, until the beginning of 2011, was advising the European Commission on Solvency II) said that high-level remuneration principles developed by the Committee of European Banking Supervisors should be generally applicable to the insurance sector.
The detail, however, will be contained in implementing measures which have yet to be agreed.
But in its final advice to the Commission in October 2009 (15-page / 145 KB PDF), CEIOPS included a draft set of remuneration principles, taking into account issues specific to the insurance sector. In many respects these are similar to the provisions in the Remuneration Code, although expressed in more general terms.
The principles include that insurers should adopt remuneration policies and practices in line with their business and risk strategy, objectives, values and performance. The policy should be applied in a proportionate and risk-based way, taking into account specific roles and functions.
And depending on the nature, scale and complexity of the insurer's activities, CEIOPS suggests a remuneration committee should be created to oversee the firm's remuneration policies.
On the issue of bonuses, the principles state that fixed and variable remuneration should be "appropriately balanced" so that employees do not become overly reliant on the bonus element. The variable component should be based on a combination of the assessment of the individual and the collective performance and overall results of the business.
Where a significant bonus is payable, a "major part" should contain a flexible, deferred component that takes into account the nature and "time horizon" of the business.
As under the Code, when measuring an individual's performance, financial and non-financial performance should be considered and risk adjustments should be made when assessing performance for bonus awards. Lastly, the remuneration policy should be transparent internally and adequately disclosed externally.
It is not clear at present how remuneration principles might apply to mutuals. CEIOPS' paper simply states "In the case of mutual undertakings, the principles should be applied taking into consideration any necessary adaptations.”
CEIOPS' advice was submitted to the Commission in November 2009. At the beginning of 2011, the committee was replaced by EIOPA, the European Insurance and Occupational Pensions Authority, which has taken over its advisory role.
In the meantime, implementation of Solvency II is expected to be put back two months to 31st December 2012, which means that any remuneration provisions are unlikely to apply until 2013.
Bruno Geiringer, however, sees this as just a temporary reprieve for insurers:
"Until Solvency II comes into effect, there is good reason to treat the revised Remuneration Code as some sort of best practice benchmark," he said. "Insurers can start using it to help them set up remuneration policies and practices that fit in with the risk management and risk appetite of the company and which link in to the long-term performance of the business"
"I'm not suggesting a wholesale read-across of the Code to insurers," Geiringer added. "The remuneration practices and risk profiles of banks and insurers are very different - and insurance company bonuses tend to be lower than those paid by banks.
"But clearly there are some sensible requirements in the Code, as there are in the CEIOPS principles, which should certainly be considered as part of any redesign of incentive schemes for insurance company senior management."
Contact: Bruno Geiringer ([email protected] / 020 7418 7306)
France Telecom: lessons for UK employers following 'institutional harassment' ruling