With-profits oversight 'failing'

The Financial Services Authority (FSA) is failing to protect policyholders in with-profits funds, says a report by a committee of MPs.

The Treasury Committee says not enough is being done to stop insurance firms managing the funds in the interests of shareholders rather than policyholders.

The issue is particularly relevant if surplus funds, known as orphan assets, are then shared out, the MPs say.

They say firms can run their funds in such a way as to reduce the surplus.

"Policyholders need to have confidence that their interests are being protected, but the current oversight by the FSA gives no such assurance," said John McFall, chairman of the Treasury committee.

"Conflicts of interest arise because shareholders, through the management of life firms, control fund strategy and therefore stand to gain at the expense of policyholders from certain uses of inherited estate," the MPs report said.

Conflicts of interest

The problem identified by the MPs was that in the day-to-day management of the with-profits funds, the insurance companies had far too much leeway to spend some of the surplus for their own purposes.

The report said the problems were:

• the opaque nature of the smoothing process used to allocate investment returns to policyholders in good and bad years
• the use by companies of the surplus to subsidise the selling of new with-profits policies
• the use of the surplus instead of shareholders' funds to pay compensation to people who had been mis-sold endowment policies
• the use of surplus funds to pay the shareholders' corporation tax bills which arise when surplus funds are divided up - "reattributed" - between shareholders and policyholders
• the phasing of payouts to policyholders during a reattribution, instead of the money being paid in one go.

Surplus

Billions of pounds of "orphan assets" have accrued over the decades as a financial cushion in the huge with-profits funds of the UK insurance industry.

"I hope the Financial Services Authority responds positively to it"
Clare Spottiswoode

At the end of 2007, the Prudential had an inherited orphan estate estimated at nearly £9bn.

The orphan assets are deemed to be those in excess of the funds needed to pay the policyholders their fair due when their policies mature, and in excess of the cushion needed by the insurers in case investment returns are poor.

If a company decides it has so much surplus that some can be divided up between shareholders and policyholders, the FSA has to decide if the proposal is fair.

Both the Prudential and Aviva are going through a reattribution exercise.

But critics, such the consumers' association Which?, have argued that any surpluses should generally be split 90/10 in favour of policyholders.

"This is a damning indictment of the FSA's lax regulation of the with-profits industry, which has allowed firms to take huge sums of money from their customers' pockets," said Which? chief executive, Peter Vicary-Smith.

"Giant leap"

The MPs do not say that a different division of any surplus is necessarily unfair and they point out that legally, all of a surplus is owned by a company's shareholders.

But they argue that policyholders are in a weak position to negotiate over any proposed division, even though since 2005, the FSA has required the appointment of a specialist advocate to argue for policyholders if a reattribution process starts.

The Treasury committee recently took evidence from a wide range of insurance companies and other interested organisations.

Among them were the Prudential and Aviva, the FSA, Which? and Clare Spottiswoode, the policyholder advocate at the Norwich Union.

The report was welcomed by Ms Spottiswoode, who was appointed to look after policyholders' interests at the Norwich Union in 2006 and to negotiate with the firm over the division of £5.5bn of orphan assets.

"This report represents a giant leap forward in bringing clarity to a poorly-regulated area and is policyholder-focused, in marked contrast to the FSA's approach," she said.

"I hope the Financial Services Authority responds positively to it," she added.