The £730bn unit-linked life and pension sector now has a new set of rules on the assets it can use to back the promises it has made to policyholders.
These rules give companies greater freedom over how they deal with the assets that can be used to back the benefits paid by unit-linked policies and how they should apply them to their individual businesses.
The permitted links rules – so-called because they relate to the assets companies are permitted to link policy benefits to – are deregulatory and are an example of more principles-based regulation. This gives greater latitude to how companies interpret the rules but means that senior management must engage more closely with the rules to ensure they apply them properly.
The new regulation comprise a set of high-level rules which embed what treating customers fairly means within unit-linked funds, which are then underpinned by a list of assets that can be used to back policy benefits.
This list of assets is a requirement of the EU’s Consolidated Life Directive. However, we have widen the definitions of some of the assets where we can and where we believe it will not undermine policyholder protection.
The main changes are as followed:
Assets must be fairly valued and realisable in time to meet the policy obligations. This moves away from the previous, rigid formula which led to a large number of requests for waivers to it.
Companies have to take account of an asset’s economic effect over its legal form. This is to prevent firms using legal labels to include assets that would otherwise not be allowed to back unit-linked policies.
If a collective investment scheme is authorised or regulated and is available direct to the general public, then it qualifies as a permitted link.
The rule where “land and property” may be situated is changing from a list of specific eligible territories to a principles-based one allowing investment where there is a properly functioning market.
Indirect investment in land and property is now allowed provided the intermediate vehicle does not add any extra material risk over and above the risk involved in investing direct.
A new category of institutional policyholder with access to a wider range of assets has been created. This is defined as trustees of a defined-benefit occupational pension scheme.
There is now no limit on the proportion of a fund that can be made up of unlisted securities. Previously, they were limited to 10 per cent. However, any unlisted securities must conform to all our high-level rules and be realisable in the short term.
The change to the rule on CISs means that non-EEA schemes recognised by us under sections 270 and 272 of FSMA will be allowed to be used as permitted links in retail funds for the first time. Unauthorised collective investment schemes and qualified investor schemes will be able to make up a total of 20 per cent of a fund provided they only invest in permitted links.
The new category of institutional policyholder allows trustees of defined-benefit occupational pension schemes to invest in unit-linked funds that invest in QIS or their EEA equivalents and hold up to 100 per cent of the fund in unauthorised CIS.
The change to the definition of land and property, so that it must be situated in a properly functioning market, gives firms the opportunity to hold assets in a wider range of territories. However, it is up to firms to ensure that the markets are properly functioning and to demonstrate that, if required.
We do not expect to see companies using their new investment powers to alter the assets held in existing unit-linked funds. If they do, one of our new rules tells firms they must inform policyholders of any change they make to a fund’s risk profile and investment strategy at any time. More commonly, we would expect to see companies taking advantage of the new rules to launch new funds.
While there was broad acceptance of our rules, there was one area where respondents to consultation raised concern. This is how the 10 per cent limit on gearing on property would impact on member-directed funds. Typically used in Sipps, these funds are set up by one or a small number of policyholders and they, not the firm, select the assets and the risk profile.
The gearing on property held in member-directed funds is often far higher than 10 per cent as policyholders have followed HM Revenue & Customs’ rules in this area. Applying our 10 per cent gearing limit to these funds, it was argued, would have a detrimental impact on policyholders who may have to sell assets and firms who may be forced to restructure with no obvious overall benefit.
We have accepted firms’ arguments and have exempted member-directed funds from the 10 per cent gearing limit. We have defined what constitutes a member-directed fund very tightly and we are clear the exemption only applies to these specific types of fund. All the other permitted links rules apply to member-directed funds.
So if a member-directed fund has a highly geared property holding it must not make the fund so illiquid that it is unable to pay benefits when they fall due.
This could be an issue where there is more than one policyholder in a fund which is mainly invested in property. If one policyholder is due to retire earlier than the others, the property investment and gearing must not prevent money being paid out to meet those benefits.
The policy statement and rules can be found on the FSA website: www.fsa.gov.uk.