'Be fair' to with-profits policyholders, says FSA

image captionThe FSA plans to bring in tighter rules in the autumn of 2011

Investment companies that sell with-profits policies have been told to give their policyholders a better deal.

The Financial Services Authority (FSA) is proposing to bring in stricter rules on the way companies manage their with-profits funds.

Among other changes, it wants to stop firms imposing punitive charges if someone cashes in their policy early.

In 2009 there were 25 million with‑profits policies in existence with assets worth £330bn.

"The proposals focus on addressing practical issues where policyholders are not always getting the fair treatment that they deserve," said Sheila Nicoll of the FSA.

"Policyholders expect to receive a fair return on their investments and that is what we want firms to be able to deliver for them," she added.


With-profits policies were at the centre of a huge mis-selling scandal in the 1990s.

They underpinned most of the mortgage endowment policies sold at the time, which were often sold with a promise that they would eventually pay off someone's mortgage.

Although very few with-profits policies are still sold to repay mortgages, they are still widely marketed as straightforward savings or pension investments, typically lasting for either 10 or 25 years before they mature and pay out.

The funds, usually invested in a mixture of shares, bonds and property, are supposed to smooth out the ups and downs of year to year investment returns.

But they have been widely criticised for being run in an opaque fashion, with little opportunity for policyholders to challenge either the wisdom of the underlying investment decisions or the decisions on how much each policy is worth and how much they should eventually pay to policyholders.

Exit penalties

One of the FSA's proposals is to limit the ability of firms to impose what are called "market value reductions" (MVR) whereby someone suffers a cut in the value of their policy if they cash it in early.

The idea behind an MVR is that it should stop someone leaving with more than their proper share of the underlying fund, which would undermine the investments of those people remaining.

But the FSA, in common with many critics of the industry, suspects that MVRs may often be far too harsh.

It believes they should not be applied just because lots of people may be leaving a fund early; but only if the face value of a policy is more than the underlying assets.

"We don't want them to be used as an exit penalty," said an FSA spokeswoman.

Excess surpluses

Over the many decades in which with-profits funds have been operating they have often built up huge surpluses, even over and above the normal financial cushion needed to protect policyholders in the event of a sudden investment downturn.

Critics have said that these so-called orphan assets have simply reflected a practice, over many years, of not distributing enough of the investment returns to the policyholders when their policies matured.

Holding a financial cushion in a with-profits fund is standard practice, but the FSA says it wants firms with an excessive surplus to have a plan to distribute it to policyholders.

Firms have been criticised for using these excess surpluses to pay for the day-to-day running costs of their wider operations, or of using them to subsidise the selling of new policies.

"A substantial minority of firms have been writing new business into their with-profits funds that is loss leading in itself - that is it is priced in such a way as to make it attractive to advisers and/or customers but it will never break even - or not enough of it is being sold to cover the cost of acquiring it," the FSA said.

"In both cases the consequence is that the new business being written erodes the value of the with-profits fund."

'Appropriate conduct'

When surpluses in with-profits funds have been disposed of in a reattribution process - as at Aviva - firms have been accused of not giving enough to policyholders and of giving too much to shareholders.

A key feature of the FSA's plans - which it hopes to enact this autumn after its formal consultation - is that the management of all large funds should be overseen by an independent committee and a specialist actuary.

"For years, insurance companies have plundered with-profits funds to pay shareholders' tax bills, subsidise new business, pay mis-selling costs and make strategic investments of benefit to shareholders," said Which? chief executive, Peter Vicary-Smith.

"The so-called independent with-profits committees have proved ineffective at protecting policyholders' interests and need to be given more teeth to address this," he added.

The FSA plans to bring in its new rules this autumn.

"The purpose of these proposed changes is to ensure that with-profits policyholders are able to feel more confident that firms will conduct themselves appropriately now and in the future," said Sheila Nicoll of the FSA.

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