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Accounting Standards

Standard Life&#39s decision to consider demutualisation is a result of pressure from three areas – the effect of poor equity returns on its solvency mar- gin, the effect of the new “realistic” reporting regime for with-profits funds and the growth of its non-with-profits business.

We have known for two years that the new accounting rules were likely to make life harder for with-profits funds and the unusually heavy actions of the FSA in unilaterally going public on their negotiations with Standard makes it crystal clear that the new rules make mutuality harder to maintain.

If the board&#39s recommendation – due in the summer but with an update expected at the AGM in April – does propose demutualisation then we should all be prepared for a long and public debate about the benefits of mutuality.

Back in 2000 independent insurance analyst Ned Cazalet valued Standard at £16bn, translating into an average windfall of £7,000 for eligible policyholders. After three bear market years with Standard clinging on to equities, Cazalet now values the business at around £3bn-£4bn, some of which is being used to bolster the company&#39s financial strength, giving average windfalls of less than £1,000.

The level of windfalls will be further depressed by a move in last year&#39s Budget that made all increases in surplus assets generated by mutuals, including future profits, subject to tax. Hargreaves Lansdown head of pension research Tom McPhail says windfalls could now be as low as £500.

With no big payouts to tempt Standard&#39s 2.5 million with-profits policyholders, what is in it for them to vote for demutualisation?

Standard finance director John Hylands denies that the strategic review is being forced by concerns over solvency, whether caused by the new rules or not. He says: “This is not to do with capital, it is to do with the business and changes in the business. We used to have the vast majority of our business in with-profits business. Today, only half of our in-force business is in with-profits and only a quarter of our sales are with-profits.”

He says: “There is an issue for us over having potentially a large diversified financial services business with all the capital in a with-profits fund when the with-profits part of the business is a relatively small part of the whole. That is not where we are now but it is where we could foresee ourselves going in the future.”

The FSA has clearly gone the full 15 rounds with Stan-dard over these negotiations and has taken the unusual step of publicly appointing an independent expert to investigate the accounting procedures. This could lead some to conclude that the FSA sees demutualisation as a way to secure payouts because they know something about Standard that the rest of us do not.

Standard says its available assets have increased by 9.5 per cent in the year to Nov-ember 15, 2003 to £4.6bn from £4.2bn the previous year and these figures have been agreed with the FSA. If the overall balance sheet is improved over the year, and equity markets have risen further since last November, then it must follow that mutuals are losing flexibility to write business under the new regime.

Hylands says: “The new regime offers particular challenges to mutuals in the effective restrictions it places on our ability to show our with-profits policyholders what benefits they can expect to get from our being a mutual company. The new regime represents particular challenges for mutuals compared with plcs. There are issues there that proprietary comp-anies do not have to address.”

In May 2000, defending the firm&#39s status against Monaco carpetbagger Fred Woollard&#39s demutualisation attempt, Standard director of corporate affairs Gordon Arthur said: “Not having shareholders has allowed the company to concentrate its efforts on meeting the needs and expectations of is customers.

“Our mutual status – which means that the company is owned by its members and run primarily for their benefit – is an important contributor to the strength and stability which attracted them as customers in the first place.”

Some IFAs argue that pol-icyholders would benefit from a demutualisation where they exchanged their mutuality ownership benefit for share ownership and had the added benefit of owning a stake in a company that had more flexibility over raising capital..

But the way this whole affair came into the public domain raises a lot of questions. Why did the regulator chose the unusual step of issuing a stockmarket announcement two working days before the life office itself was ready to come with its statement to the market?

One life office chief executive who wants to remain anonymous says: “I have to factor in the fact that the FSA could leak a story to the press when I am dealing with them.”

The FSA says it put out its statement to protect policyholders after an article appeared in The Guardian newspaper but refuses to confirm whether the statement was put out with the consent of Standard.

FSA spokeswoman Kate Burns says: “It is unusual for us to comment on individual companies but, because of the article, we thought that not to do so would be more damaging to policyholders. This leak did not come from the FSA.”

Standard is now a company where more than three-quarters of its new business is not with-profits and part of the logic for a change of status seems to be the reality of having a business where the tail is wagging the dog.


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