Delving into the world of unit-linked business: FCA findings

Last week saw 'thematic review' enter the lexicon of life insurance jargon. The Financial Conduct Authority (FCA) published the results of its first thematic review covering governance of unit-linked business.  The FCA have essentially looked at how 12 firms manage their unit-linked business and have used their findings to set out some lessons for the industry.

The review’s findings can be grouped into three main topics: systems and controls, assets appropriate for customers and benefits that are calculated fairly and accurately.  The findings under each topic are summarised in the tables below.

Systems and controls


Possible actions

Insufficient oversight of outsource providers e.g. mandate compliance

Good practice regarding outsourcing includes:

o    Engagement at various levels (e.g. executive, middle management, subject matter expert)

Insufficient assurance of outsourcing provided by risk, compliance and internal audit

o    Separate forums for issue and change management

Where outsourcing is intra-group there is too much reliance on the group’s control functions

o    Contractual requirement for outsource provider to adopt “industry best practice”

Problems where one outsource service providers oversees another

o    Comprehensive management information

Few firms carry out checks on unit prices over periods longer than daily. Over time, small errors falling under daily tolerance levels can build up into material issues

o    Regular reviews of data used by outsource service providers

Firms could work faster to rectify errors

A comprehensive governance structure might include:

o    Overarching senior committees

Lack of awareness of need to notify FCA of errors and rule breaches

o    Supported by specialist individual sub-committees

Conflict of interest policies do not fully consider specific unit-linked issues

o    Working groups oversee key functions such as stock-lending, mandate compliance and unit-pricing

Investment mandate descriptions are very broad


Assets appropriate for customers


Possible actions

Lack of controls on whether asset links are permitted

Policy documents and marketing material make it clear who bears default risk if invested in another insurer’s fund

Where firms invest in another insurer’s unit-linked funds, there is a default risk. Generally this is a risk to the insurer. Sometimes passed on to the policyholder. There is no recovery from the FSCS in the event of default.

If the insurer bears default risk it will need to hold capital against this risk under Solvency II and ICA

FCA’s view is that default risk lies with the insurer unless policy documents explicitly state otherwise

Insurers need to be careful when trying to change who bears the risk of default on existing policies: must comply with contract law and FCA Principles of Business

FCA is generally happy with how firms manage liquidity risk


Benefits calculated fairly and accurately


Possible actions

Some firms had established sophisticated valuation methodologies. Nearly half of the firms surveyed could make improvements

Consider whether the range or independence of asset valuations could be enhanced.

Lack of controls to manage the risks associated with a historic pricing methodology

Remove manual processes for valuing assets

Problems exist where firms price on bid or offer based on the long-term trend and a material transaction goes against trend

Ensure approach to taxation is consistent, especially for “funds of funds”

If funds are exposed to any risk from stock lending then this should be disclosed to customers.

Clearly set out the approach to stock lending

If a fund is exposed to the risk associated with stock lending it should also receive all recompense. If the risk is borne outside the fund then the fund should receive “fair and reasonable” recompense


Around half the funds surveyed required improvements in how tax was allocated


Where the FCA found material problems their solution was to appointed a Skilled Person under Section 166 of the FSMA to investigate whether customers have lost out and whether compensation is required. We noted in our previous blog how there seemed to be an increasing number of Skilled Persons reviews being ordered. This seems to be a pointer as to how FCA intends to approach conduct of business regulation: reviews of a sample of firms covering a particular theme, backed-up with Skilled Person reviews to investigate anything where they think that further information is needed.

What should firms do?

There is no mention of the FCA looking at any firms other than those chosen as part of this review. The report does note however that firms that were not part of the review have been proactively reviewing their practices: this is clearly something that the FCA is in favour of. Firms should also watch out for changes to the ABI’s good practice guide for unit-linked funds, which will be made more detailed following the review.

We anticipate that there are particular issues for smaller firms. In particular, smaller firms tend to outsource the administration and fund management of their unit-linked business and they may struggle to find the resources to put in place the kind of monitoring arrangements and governance structures that the thematic review regards as good practice when it comes to outsourcing. We also have concerns about whether the outsource provider will be able to provide sufficient data to insurers.

A final point to highlight is that firms should review their processes and make these as automated as possible. The FCA clearly does not like processes that require manual inputs: the example cited is one where an insurer obtained unit prices from an outsource provider and these were manually typed into the insurer’s systems.

The full thematic review can be found here.