Regulating the with-profits sector

Over recent decades, the with-profits sector has suffered from conflicts of interest on the part of the management of life funds by proprietary companies, leading to concern among some holders of with-profits policies that their interests have not been adequately protected. We are not satisfied that the Financial Services Authority (FSA) has done enough to provide a robust framework within which these conflicts of interest can be managed. Rather than developing clear principles for the regulation of inherited estate, the FSA has become embroiled in making judgements "in the round" and micro-regulation of particular firms' situations. This approach seems a long way from the philosophy of 'principles-based regulation' to which the FSA aspires. Whilst we accept that the with-profits sector is a complex business, all stakeholders in with-profits funds deserve a framework which provides as much simplicity, certainty and clarity as possible. We would welcome a reopening of the debate about the fundamental design of the regulatory system for with-profits funds and will continue to monitor the FSA's progress in its regulation of the with-profits sector.

Smoothing

The use of inherited estate in smoothing returns to policyholders between good and bad years is clearly appropriate, but more should be done by the industry to improve the transparency of their application of smoothing techniques. If the industry fails to do so, the FSA should enforce such transparency.

Funding of new business

The funding of new business from the inherited estate represents an intergenerational transfer from current policyholders to the future beneficiaries of the inherited estate. This recycling causes particular problems during reattributions because the future beneficiaries of this intergenerational transfer will be shareholders, who have (through the firm's managers) discretion over both the strategy and portion of the inherited estate to be put aside for the funding of new business. It is vitally important for the FSA to conduct rigorous assessment of the reasonableness of assumptions made by the firm during reattribution negotiations, ensuring that these assumptions reflect the trend of the declining popularity of with-profits products.

Mis-selling compensation costs

We view the charging of mis-selling compensation costs to the inherited estate as inappropriate. The vast bulk of mis-selling costs must be borne by shareholders, because it is the duty of shareholders, through the managers of the firm, to ensure that staff behave appropriately when selling products. We are unconvinced by the argument that the charging of mis-selling compensation costs to inherited estates has no impact on the likelihood of current policyholders receiving special distributions. Any use of an inherited estate that reduces the estate's size has a direct bearing on such a prospect.

Shareholder tax

The charging of shareholder tax to the inherited estate is, in our view, a striking example of how certain life firms are able to use their discretion in a way that furthers shareholder interest to the detriment of policyholders. It seems unfair that policyholders should pay anything towards this charge. The FSA allows shareholder tax to be paid from inherited estates only if that is the established practice of the firm concerned. We urge the FSA to consult on the charging of shareholder tax to inherited estates by the end of 2008.

Phasing of special distribution payouts

We were not convinced by the arguments put forward for the phasing of special distribution payouts and the FSA must put forward a very strong case indeed if such phasing should be allowed to continue.

With-Profits Committees

We are concerned that With-Profits Committees lack adequate resources, remit and visibility for them to protect policyholders' interests in with-profits funds. We recommend that the FSA consider granting With-Profits Committees an explicit role to ensure that a fund is run in accordance with the FSA's principle of treating customers fairly, rather than merely considering the firm's compliance with its own internal rulebook.