TCF issues with with-profits funds
With-profits funds are complex and managing them gives rise to a number of TCF issues. The most challenging is ensuring that conflicts between different interest groups are resolved fairly. Examples include:
- conflicts between shareholders and policyholders over the treatment of any inherited estate;
- conflicts between policyholders whose policies will not mature for some time and whose interest is in maximising capital growth through higher-risk assets and policyholders whose policies are approaching maturity and whose interest is in ensuring that the fund’s assets are matched to its liabilities through investment in lower-risk assets. This conflict affects, for example, funds’ investment policies set out in their Principles and Practices of Financial Management (PPFMs) and, consequently, the bonuses they pay; and
- conflicts between policyholders who wish to leave funds early and those who keep their investments until maturity. This affects the level at which Market Value Reductions (MVRs) are set.
The FSA is not an economic regulator and does not prescribe the way in which these conflicts should be resolved. However, firms must be able to show that they have been resolved in a way that treats all of their customers fairly. A number of recent FSA communications indicate concerns over whether governance arrangements are appropriate for resolving these conflicts and about the quality of post-sale communications to policyholders.
The FSA’s rules require firms providing with-profits funds to ensure that governance arrangements for those funds are appropriate and ‘involve some independent judgement’ in the assessment of compliance with PPFMs and how conflicts should be addressed.
In its September 2007 ‘Dear CEO’ letter to with-profits insurers, the FSA indicated that its thematic work in the with-profits sector suggested that some firms were failing to ensure that:
- the independent review properly addressed TCF and the management of conflicts of interest (such as those discussed above). In particular, some firms’ arrangements complied with FSA guidance to ensure compliance with PPFM, rather than thinking about the broader outcomes that governance arrangements are intended to achieve;
- the independent reviewers were provided with sufficient and timely information and access to the main board of the life insurer to enable them properly to review and challenge proposals; and
- conflicts of interest arising where firms employed those who provided the independent review (for example where With-Profits Committee members were also executives of the firm) were properly managed.
Post-sale communications with policyholders In May 2007, the FSA published a sector briefing on postsale communications in the life sector and the availability of ongoing advice to with-profits policyholders. The FSA indicated that it was concerned that communications such as consumer-friendly PPFMs and annual statements issued by with-profits insurers did not comply with FSA Principles 6 (TCF) or 7 (a firm must pay due regard to the information needs of its clients and communicate in a way that is clear, fair and not misleading).
The FSA made it clear that providing accurate information is not sufficient to comply with these principles. Instead, firms must provide accessible and sufficient information to enable customers to make informed decisions. The FSA suggested that an ‘insurer’s responsibility to provide communications that are clear, fair and not misleading extends to being proactive in some key respects’ and that this responsibility can include:
- providing explanations where a product’s performance will be significantly different from what the insured would have expected at the time of sale (for example, because of changes in investment strategy) so that a consistent message is communicated across products’ lifecycles;
- explaining important contractual rights such as MVR free dates and guaranteed annuity rates;
- avoiding the use of technical terms without explanation and using checks (such as consumer testing) to ensure documents are comprehensible; and
- identifying and tailoring specific messages to particular groups of customers who are more reliant on the proceeds of their policies.
However, the FSA’s approach to communications to policyholders is problematic. The ‘outcome’ it wants is customers making informed decisions and it is concerned that financial advisors are reluctant to provide post-sale advice on with-profits investments. Insurers may argue that it is inappropriate for the FSA to expect them to take additional steps to achieve particular consumer outcomes that would not be expected were it not for financial advisors’ unwillingness to provide post-sale advice.
The FSA’s TCF concerns in relation to governance and communications apply with particular force to closed funds and to the large number of funds that, while not formally closed, operate as such in economic terms because they attract few new investors. The FSA is concerned that these funds are often managed passively, without regard to TCF issues.
In its November ‘Dear CEO’ letter, the FSA highlighted concerns that certain firms were unable to demonstrate that the run-off for closed funds was being managed in a TCF-compliant manner. It stated that it expects firms to be able to demonstrate that they have an orderly and fair approach to the final distribution of the funds (and any inherited estate) and effective control of the run-off. The letter also warned that closed funds should ensure they had ‘a communications strategy that enables policyholders to make informed decisions’. For example, policyholders may require information on changes to investment strategy made on closure of a fund (such as a significant switch from equities to gilts) that change the risk profile of their investment.
Two important TCF deadlines are approaching. By March 2008, firms must have management information systems in place to test whether they are treating their customers fairly. The FSA’s November 2007 statement on management information provides guidance and examples to help firms achieve this. By December 2008, firms must also be able to demonstrate that they are consistently treating their customers fairly. The FSA has made it clear that responsibility for meeting these deadlines rests firmly with firms’ senior management.
The FSA’s December 2007 announcement that it is considering referring a number of firms to enforcement over TCF failures by appointed representatives indicates that TCF-based enforcement action is likely to be a key theme for the FSA in the new year. The FSA is likely to focus its enforcement efforts on sectors, such as the withprofits funds sector, in which previous TCF failings have been identified. The senior management of firms that provide with-profits funds (particularly closed funds) should therefore take steps now that will enable them to assure the FSA that the ways in which with-profits funds are governed and customers are communicated with are TCF compliant.