Home > News > 2003 > February 2003 > Tightening the reins on with-profits
Tightening the reins on with-profits
Pete McGurk, a partner with the Life team discusses the FSA's proposals for the With-profits sector of the insurance industry.
There were no major shocks as the FSA published its proposals arising from its With-profits Review conducted in the wake of the Equitable Life debacle. A series of "Issues Papers" were published in early 2002 followed by Feedback Statements in May 2002 setting out the regulator's initial policy conclusions. CP 167, published in January 2003, puts some flesh on the bones of the earlier proposals rather than reflecting any major re-thinks, including drafts of proposed changes to the regulatory Handbook. This article concerns one main area of proposed change, the governance of with-profits business. A second article discusses the future role of the actuary in the governance of life insurers in general and some proposed alterations to the regulatory reporting system.
The deadline for responses to the consultation is 25 April 2003 and the FSA expect to respond in Summer 2003.
The PPFM
Insurers of with-profits business will be required to publish a detailed Principles and Practices of Financial Management (PPFM) that they will apply to the running of that business. The main objective of publishing this document is to ensure that firms have some defined framework within which to exercise the numerous areas of discretion inherent in with-profits business. These areas include:
- setting of annual and terminal bonus rates including the smoothing of returns
- investment strategy
- the apportionment of the insurer's expenses to with-profits business
- the risks to which the with-profits business is (or may be) exposed and the rewards (or otherwise) of bearing such risks.
- the management of the inherited estate and the uses to which it may be put
- arrangements for review of new business volumes and what would happen on closure to new business
- approach to equity between policyholders and shareholders
The proposals draw a distinction between principles and practices. Principles are intended to be broad standards and the insurer's approach to meeting longer-term changes in the business and economic environment. Practices describe the insurer's approach to shorter-term changes in these environments and are also intended to contain sufficient detail to enable a knowledgeable observer to understand the risks and rewards inherent in taking out a with-profits policy. Exactly what should be included under each heading is set out in the proposed Handbook text. Although the distinction is rather blurred at times, it is practically significant under the proposals because different rules apply should the insurer wish to make alterations after publication. A change to a principle requires three months' written notice to affected policyholders whereas a change to a practice (which the FSA expects to be relatively frequent) requires notice but there is no requirement as to how or when this must be given.
The FSA have ducked the issue of publishing a model of what a PPFM might look like in practice on the grounds that the variation in the management of with-profit funds would make any single model inapplicable to most other insurers. They say only that firms "should comply with the proposed rules and guidance in a way that is appropriate to the scale and complexity of their business". What this means in practice is open to conjecture and it would surely be helpful to publish some hypothetical examples in respect of, say, a small friendly society, and and a large proprietary office.
The PPFM would be given to all new policyholders with their policy documentation and to any other person on request, a charge being permitted for non-policyholders. Where insurers run more than one with-profits fund, they will need to consider whether separate PPFMs are published for each fund.
The FSA propose that insurers will have defined their PPFMs by the end of 2003.
The WPC
The basic intention of the other governance proposals is that, having defined the principles and practices by which an insurer should run its business, the insurer should put in place arrangements to ensure that these are carried out and report this fact to policyholders with details of how it has done this.
How the insurer should comply with the requirement to implement its own PPFM is the subject of guidance. The FSA strongly favours the formation of a With-profits Committee (WPC) for all insurers whose with-profit liabilities exceed £250m. The FSA recommends that the membership of the WPC should be "independent" and drawn from a mixture of non-executive directors and external non-directors (but not recent professional advisers to the insurer).
The role of the WPC would be to provide the governing body with an independent assessment of the insurer's compliance with the PPFM and the way in which it has exercised its discretion and addressed any areas of conflict between different groups of policyholders and, if applicable, shareholders.. It would not be a decision-making body as the responsibility for decisions would rest with the main governing body.
The WPC would be required to report annually to with-profits policyholders and annexe the report to the insurer's annual report to these policyholders. In making this report it would take account of the report from the with-profits actuary (see separate article).
The proposals are less clear on how smaller firms demonstrate and report compliance if they opt not to set up a WPC. One option suggested is to get a single non-executive or external person to report.
The FSA propose to give insurers six months to decide how to comply with with-profits governance requirements and a further three months to implement the arrangements and currently envisage them taking effect in Spring 2004.
The governance requirements will apply to all insurers writing with-profits business with the exception of the (small) registered "non-directive" friendly societies or Holloway sickness business written by friendly societies.
Pete McGurk, February 2003.