The Treasury Committee's report follows a four-month inquiry
into the FSA's regulation of inherited estates – the surplus assets
that have built up over the years in their with-profits funds.
A with-profits fund is made up of policyholder premiums,
investment returns and shareholder contributions, sometimes going
back over generations. The inherited estate is that part of the
fund that exceeds the firm's realistic liabilities to
policyholders.
This surplus provides working capital for the with-profits fund
and is used to smooth out returns to policyholders between good and
bad years. But it can also be used for the life company’s own
purposes, to strengthen its capital base or to fund future growth
plans. In some cases, it can be used to pay the shareholder's
corporation tax bill following a distribution.
Anything that reduces the size of the surplus reduces the funds
that might be available to distribute to policyholders. The concern
is that, given the very different interests of shareholders and
policyholders, policyholders are not being adequately
protected.
"We are not satisfied that the [FSA] have done enough to provide
a robust framework in which these conflicts of interest can be
managed," the report concluded.
"Whilst we accept that the with-profits sector is a complex
business, all stakeholders in with-profit funds deserve a framework
which provides as much simplicity, certainty and clarity as
possible," it said. "We would welcome a reopening of the debate
about the fundamental design of the regulatory system for
with-profit funds and will continue to monitor the FSA's progress
in its regulation of the with-profits sector".
Policyholder detriment
The committee found that the payment of shareholder tax from the
inherited estate is "a striking example of how certain life firms
are able to use their discretion in a way that furthers shareholder
interest to the detriment of policyholders".
Current rules allow some life companies pay the corporation tax
(at 28%) that arises on the share of profits attributable to
shareholders on a distribution, provided it is the company's
established practice and the policy is set out in its Principles
and Practices of Financial Money document (known as a PPFM).
The committee considered it unfair that policyholders should pay
anything towards shareholders' tax bills and urged the FSA to
consult on the issue by the end of the year.
The payment of compensation costs from the inherited estate was
also found to be inappropriate and the committee has welcomed the
FSA's own consultation on changing the rule, launched earlier this
month.
Phased payments
Another practice the MPs would like to see eradicated is the
"phasing" of payments made on a special distribution of surplus
funds.
The rules state that, at least once a year, a life company
operating a with-profits fund must consider whether to make a
special distribution of any excess surplus. If retention cannot be
justified, the excess should be distributed to policyholders and
shareholders, usually on a ratio of 90:10.
The committee suspected some companies do not try as hard as
they might to identify such surpluses. And even when they decide to
make a distribution, many of them phase the payments to
policyholders over time. Policyholders wishing to receive their
full payment are effectively prevented from leaving the fund during
this period.
The report said that the FSA "must put forward a very strong
case indeed if such phasings should be allowed to continue".
New business
Another area of concern is the use of the inherited estate to
fund new business, particularly if the life company is already
considering buying out policyholders' rights in the inherited state
(a process known as a reattribution). The company may have an
incentive to set aside as much as it can, even if the new business
might be unprofitable.
For this reason, the report said it is "vitally important" that
the FSA conduct a rigorous assessment of the company's assumptions
made during reattribution negotiations.
Other proposed reforms include greater transparency in the way
companies "smooth" out returns by holding back a proportion of the
investment return during a good performance year to ensure a
reasonable return can be paid to policyholders during years of
poorer performance.
The MPs would also like to see a more effective role given to
with-profits committees, whose job it is to ensure the fund is run
fairly and that policyholders' and shareholders' conflicting rights
and interests are properly addressed.
Bruno Geiringer, a life insurance law specialist with Pinsent
Masons, the law firm behind OUT-LAW.COM, welcomed the Treasury
Committee's call for further strengthening of the regulatory regime
and governance for with-profits funds.
"The life industry continues to fall short of doing enough to
win back the trust and confidence of the public who invest in
with-profits products," he said. "At a time when this sector is
seriously challenged on many fronts, it is failing to get across
the benefits of a product that is still attractive to many. This is
an opportunity the life industry can't afford to ignore."
Want more content like this? This story was written by the insurance and reinsurance legal experts at Pinsent Masons, the law firm behind OUT-LAW.COM. We've recently launched a new section, legal info for Insurance and Reinsurance, giving free legal information to anyone working in that sector.
