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With-Profits governance
Rajeev Shah from the life team discusses the impact of the FSA's feedback statement on the governance of with profits funds.
The FSA published its feedback statement on its with profits review in May 2002 setting out its initial views. This followed a year in which the FSA published five issues papers as part of its with profits review. Though the statement covers all the areas raised in the issues paper, the area most affected is the governance of with profits funds. A feedback statement on the future role of appointed actuaries was also issued in conjunction with the feedback on governance of with profits funds.
The broad proposals in the statement will be followed by more details in a series of consultation papers that the FSA expects to publish by June 2003. The detailed proposals on governance of with profits funds and the role of actuaries in the governance of life insurers are expected by the end of 2002. When drafting the detailed proposals, the FSA will take into consideration other relevant work underway including the recommendations from both the Sandler Report on savings and, as they emerge, the Penrose Inquiry into Equitable Life.
Aims of with profits governance changes
Proposals for the governance of with profits funds have been drafted by the FSA with the aim of strengthening the current governance framework to give greater confidence over the fair treatment of customers. The key elements that the FSA considers essential for a strong governance framework are:
Though the board of directors is responsible for meeting the obligations placed on them in respect of their policyholders, under the current governance framework, directors are not required to set out how they have sought to ensure that the firm has met its obligations regarding the fair treatment of policyholders. In practice, the responsibility for ensuring that policyholders are treated fairly has fallen to the appointed actuaries for insurers via the advice provided to the board. Further, there is no specific or transparent mechanism by which directors are required to set out how, in exercising their discretion, they have managed potential and actual conflicts of interest.
The proposals
The FSA have proposed that all the responsibilities currently resting with appointed actuaries would be transferred to the board of directors for all insurers. The role of the appointed actuary, currently a "required function", would be abolished except for with profits funds where it would be narrowed considerably to focus on the exercise of discretion by the insurer. The board would then be required to manage the conflicts of interest arising between their new obligations to policyholders and their existing obligations to shareholders. However, recognising the board's need for actuarial advice, a new "required function", the "actuarial function" would be created for insurers.
To promote transparency in the exercise of discretion, insurers transacting with profits business would be required to define and publish their "Principles and Practices of Financial Management (PPFM)" which would set out the nature of the discretion retained by the board, the parameters within which it would be exercised and the factors considered when exercising it. To support this, the board would also be required to set up a with profits committee to monitor the exercise of discretion by the board and the consistency with its PPFM.
Separate PPFMs may be needed if a firm has multiple with profits funds.
The FSA expects the PPFM to be provided to new customers alongside policy documentation as well as firms' marketing literature to explain its importance and how to obtain it. Directors would also be required to publish an annual statement, to be sent to all policyholders and included in the regulatory returns, explaining how the with profits fund was managed in compliance with its PPFM.
Future consultation papers will set out the FSA's proposed guidance on:
- An appropriate framework within which areas of discretion are disclosed on a consistent basis including firms' explanations of the principles and practices that they will follow to ensure that customers are treated fairly. The FSA may also include a "model code" for PPFM reflecting their view of good practice.
- Application of PPFM to new and existing business.
- Arrangements to balance the need to maintain firms' freedom to take action to meet changing circumstances where necessary to meet policyholders' interests, and to ensure that sweeping changes cannot be made at will.
- The form of the published annual statement by directors on how the firm has met its PPFM.
Further consultation
The FSA will also consult on making it a requirement that firms should ensure that their governance structure for with profits funds offers:
- Assurance that directors have paid due regard to policyholders' interests when exercising discretion.
- Assurance that directors are transparent in managing the conflicting interests of different groups and generations of policyholders and shareholders in line with the PPFM.
- Some form of independent assessment, available to consumers, of the firm's compliance with its PPFM.
The FSA believe that these objectives could be achieved through the firm's with profits committee if it were constituted as committee of the board and with some external non-directors, as well as including independent non-executive directors on the board.
Rajeev Shah, September 2002.