INTRODUCTION

  1.  The Association of British Insurers (ABI) is the trade association, which represents the views of the UK insurance industry to the Government and to regulatory and other agencies. The ABI represents over 400 insurance companies, which between them account for over 96 per cent of UK insurance business.

  2.  As a trade association we represent the interests of insurance companies collectively. It is not part of our role to comment upon or investigate individual companies or cases. Accordingly this memorandum addresses generic issues.

  3.  We do not believe that the unique circumstances at Equitable Life reflect generic weaknesses in the industry as a whole. As we understand it, the problems at Equitable Life derive essentially from a business decision relating to future interest rates and appropriate levels of capital, not from the nature of insurance-linked savings vehicles.

  4.  Nevertheless the Equitable situation has given rise to a number of possible misconceptions about the industry, the value of saving, the security of investment and the "with profits" investment vehicle. This memorandum aims to address these issues in a summary form.

CONTEXT

  5.  Our ageing and increasingly healthy population means that increased financial provision for retirement is essential. The state cannot do this alone, given the costs. A mix of state and private provision must therefore be the way forward. The Government has recognised this in, for example, their proposal to introduce a new pension credit from 2003; and the launch of stakeholder pensions later in 2001. More broadly, the Government is keen to increase the general level of saving in the UK and there is widespread recognition that many people are not saving enough.

  6.  The only way of ensuring that money being saved for the future is not eroded by inflation, and more importantly, actually grows in value in real terms, is to invest it in the financial markets. There it can be put to work in the economy and so generate economic growth and earn a return for the lender. Historically, returns from investment in stocks and shares have been significantly higher than from corporate or Government debt.

  7.  The total amount of money invested by the insurance industry in the economy is currently running at just over £1,000 billion. For example, in 1998, the latest year for which figures are available, £275 billion and £140 billion were currently invested in insurance company administered personal and occupational pensions, respectively. This move towards funded pensions in the UK has helped avoid the "pensions time-bomb" facing some other developed countries.

IMPLICATIONS

  8.  Against this background it is important that:

—  confidence is maintained in the financial system through an effective regulatory system;

—  there is an appropriate degree of protection for consumers where, exceptionally, a company faces financial difficulties;

—  savers are able to choose from a range of investment products so that they can achieve a risk/reward balance with which they are comfortable; and

—  relevant and clear information is made available to potential savers/investors so that their choice is well informed.

PROTECTION FOR POLICYHOLDERS

  9.  The primary responsibility for protecting policyholders rests of course with the relevant insurance company/other financial service providers. But this is reinforced by several further layers:

—  the regulator (Financial Services Authority) responsible both for the prudential regulation of companies and for the regulation of conduct of business;

—  the Financial Ombudsman service which deals with complaints in individual cases that cannot be resolved between the policyholder and the company; and

—  the Policyholder Protection arrangements as currently set out in the Policyholders Protection Act 1975. These provide for action in the event of an insolvency including arrangements for compensating policyholders in such circumstances.

  These arrangements have recently been considered by Parliament during the passage of the Financial Services and Markets Act 2000. The ABI supports the statutory responsibilities given to the FSA in this legislation and supports the broad approach the FSA has set out in its document "A new regulator for the new millennium". It welcomes the inquiry which is now being conducted by the FSA's Head of Audit to see whether there are lessons to be learned from the events surrounding Equitable Life.

CHOICE AND INFORMATION

  10.  There are many ways of investing in the markets. At one end of the spectrum, there are various kinds of deposit account, where the risks are lower than in other kinds of investment, withdrawal relatively easy, and the returns commensurately low: typically 5 per cent per annum net of tax in the last 10 years. At the other end of the spectrum is direct investment in individual equities and other traded instruments. Next along the spectrum are collective investments into broad-based funds which spread the risk but nevertheless leave a direct exposure to market movements. These include unit trusts and products linked to life insurance (often an important additional benefit for the saver and his or her family) such as unit-linked bonds and endowments. Such investments have typically yielded 12 per cent per annum in the last 10 years. These higher returns are balanced against the need to be able to keep the money invested for longer periods, and against the higher risks—for example the recent drop in the stockmarket.

  11.  Towards the middle end of the spectrum lie with profits policies. Like some of the higher-risk vehicles, these can give investors and their families the security of life insurance. But they also remove some of the risks of direct investment in stocks while allowing savers to benefit from higher returns than deposits. Typically, they have yielded 11 per cent per annum in the last 10 years, comparing well with unit linked products.

  12.  With profits allows the company to smooth the returns on market investments so that the saver continues to receive a return even in "bad" years. The policyholder gets a so-called "reversionary" bonus regularly (often yearly) during the life of the policy. Once awarded these bonuses are guaranteed on maturity and cannot be removed even if the value of the underlying investments falls. Additionally, savers who keep their money with the fund right through to the maturity date of the policy (or if there is a death claim) get a "terminal" bonus. These are not usually guaranteed (any more than is a straight unit-linked investment), but reflect the value of the investments at the end of the policy.

  13.  This two-bonus approach allows the policyholders to get a combination of guaranteed returns, a lower risk of exposure to stockmarket downturns, and the potential of higher returns at maturity. It also means that although it is not possible to be completely certain of the final value of a policy until it matures, or is surrendered, the value will be less volatile than that of the equivalent unit trust or unit linked plan. Nonetheless, the track-record is good, as indicated above. And with profits are a popular form of investment representing around 40 per cent of both existing and new life and pensions business.

  14.  Despite this, with profits has attracted criticisms. Some of these—for example about the performance over the long term—are unjustified, as explained above.

  Others—such as calls for greater transparency—are justified. The industry has already begun to address these criticisms. A key step in doing so is the ABI's Raising Standards Quality Mark Scheme launched last autumn. The scheme will set new standards for accredited brands, thereby ensuring that consumers (of all types of investment/protection products) receive plain English literature, regular annual updates, consolidated and clear information about charges and—for with profits investors—a special new "with profits" summary to explain the operating principles clearly and openly.

  15.  But the industry recognises that it needs to do more with regard to "with profits". The Faculty and Institute of Actuaries set up a working party in late 1999 to consider how the transparency of "with profits" might be further improved. Its report is expected shortly and—in the light of it—the industry will do whatever more it sensibly can.

  16.  Even so, it is important to recognise that the essence of with profits—smoothing investment returns over time when the future is unknown—means that some discretion must be retained by the company. The aim should be for increased openness about the investment and smoothing policies being followed whilst retaining the degree of discretion needed to allow smoothing to work for policyholders as a whole.

  17.  Finally, although the Equitable situation has prompted some public and media focus on the with profits concept it is important to emphasise that the problems at Equitable have a very specific cause which is not in any way intrinsic to the nature of with profits. With profits remains a valuable and popular investment vehicle and the aim should be to strengthen it further through greater clarity and transparency.

26 January 2001