The FSA has published the text of a letter on the reattribution of inherited (or orphan) estates. The letter confirms that the FSA’s approach to this issue remains broadly unchanged since 1995, although it has agreed to consult early next year on whether it should continue to allow insurers to chargemisselling compensation costs to the inherited estate. Any proposed change in this respect is likely to be controversial. In the case ofmutuals, it would be unworkable as there are no shareholders who canmeet those costs if they cannot be taken fromsurplus.
The FSA’s letter was written in response to a request by Clare Spottiswoode for clarification of certain issues relating to the use an insurermight make of its inherited estate.Ms Spottiswoode is acting as Policyholder Advocate in connection with Norwich Union’s wellpublicised reattribution project.
Treating customers fairly in the context of reattributions
It is important to note in the first instance that the inherited estate is owned by the insurance company itself and does not belong to policyholders. However, it is also clear that policyholders have rights and interests in respect of the inherited estate and the insurer cannot dispose of assets representing the estate without regard to those rights and interests.
Froma regulatory perspective, the overriding concern for an insurer when it is considering a reattribution of its inherited estate is whether its proposals are fair to policyholders. Applying a test of “fairness” can, however, be difficult to apply to surplus with-profits funds that have built up over many years, usually without any clear statement of how those funds were intended to be used. Proprietary companies also owe duties to their shareholders andmust satisfy themselves that any reattribution strikes the right balance between the interests of both groups.
Considerations of fairnessmay also be difficult to apply as between various sets of policyholders – in particular, one approach to a reattributionmay benefit one class of policyholders at the expense of others and the insurer will need to justify its proposal in relation to each class. An area of particular concern here is the need tomake sure that current and future policyholders are treated fairly vis-à-vis each other.
Guidance on questions of fairness So where should insurers look for guidance on questions of fairness? Chapter 20 of the FSA’s New Conduct of Business Sourcebook (COBS) contains the FSA’s requirements on treating with-profits policyholders fairly. These include rules specifically directed at the reattribution process, such as requirements to appoint a PA to represent the interests of policyholders and a reattribution expert to prepare an objective assessment of the proposals.
Other considerations for an insurer will be whether reattribution proposals are consistent with its Principles and Practices of FinancialManagement and how the FSA’s Treating Customers Fairly initiativemight applymore generally to with-profits business. Fairness is not, however, a question that can be answered by use of a checklist, whichmeans that it is almost inevitable that different parties will hold different views about the acceptability or otherwise of a particular set of proposals.
The FSA has confirmed that its approach to fairness in this context continues to be based on principles established by a Ministerial Statementmade in February 1995. In broad terms, thismeans that the starting point for allocating surplus assets held within a 90:10with-profits fund should be to apply the same ratio as to distributions of surplus out of the fund – in other words, the basis for a reattribution of assets should be 90%to policyholders and 10%to shareholders. Any other division of assetswould need to be justified on the basis of “clear evidence” that it was appropriate.
FSA’s view on use of inherited estate
In its letter toMs Spottiswoode, the FSA addresses the extent to which an insurermight properly use its inherited estate for:
- financing new business;
- paying tax on transfers to shareholders;
- financing strategic investments; and
- payingmisselling compensation costs.
Ms Spottiswoode has expressed her disappointment in the FSA’s response and believes that its position on each of these issuesmakes itmore difficult for her to achieve a fair incentive payment for policyholders in return for giving up their interests in the inherited estate. Allowing insurers to use the inherited estate in each of the ways described abovemeans that less will be available for policyholders on a reattribution.
The FSA accepts that insurersmay use the inherited estate as capital to support new business in the with-profits fund, provided that the business ismanaged with a view to recovery of those costs in due course and their repayment to the inherited estate. Use of the estate in this way may mean that future policyholders benefit at the expense of current policyholders, which raises difficult questions of fairness for companies.
The FSA’s 2003 consultation on rules relating to the reattribution process included whether insurers should be allowed to chargemisselling compensation costs to the inherited estate. In the light of further representations, the FSA intends to look again at whether shareholders should be required to bear such compensation costs and will consult on the issue during the first half of 2008. Any proposal to change the current position is likely to bemet with strong resistance fromindustry. Formutuals, which have no shareholders tomeet the costs of such compensation, such a change would be unworkable.