Revised rules on how companies should calculate the value of their assets and liabilities (or statutory reserves) were set down in May by the FSA's ins urance directorate.
These revised rules are intended to force life companies to increase their statutory reserves. This will affect all life companies that write unitised with-profits contracts such as endowments or with-profits bonds.
The rationale behind the new regulations is to protect policyholders in the event of adverse economic conditions. Higher reserves will help ens ure companies have enough funds to meet their liabilities in adverse conditions and satisfy policyholders' reasonable expectations.
Policyholders' reasonable expectations are a life comp any's view of what its custo mers' expectations are. They will be formed and influenced over time by reference to:
Policyholders' participation rights in the company's articles of association from time to time.
Company's promotional and publicity material, as well as subsequent statements made as to the company's bonus philosophy and the entitlement of policyholders to a share in profits. This inc ludes any guarantees on market value reduction and bonus.
Company's with-profits guide.
History and past practice of the company.
Practice over time within the life insurance ind ustry generally.
So, policyholders' reasonable expectations are not def ined in a rigid framework but, rather, develop within the company in question. The definition can, therefore, vary from company to company.
For with-profits policyhol ders, expectations can include:
Anticipated level of fluctuation in annual/reversionary and terminal bonus rates from one year to another in normal investment conditions.
Anticipated level of fluctuation in surrender values and the relationship between surrender values and premiums paid, taking into account such matters as tax, investment performance, expenses and the cost of providing protection benefits such as life cover and critical-illness cover.
Fair treatment between different classes of policy and bet ween similar policies with different terms, premium sizes, and so on. In particular, allocation of expenses and investment returns should be fair.
Investment strategy for the with-profits fund and the comparison between risk level and returns, including such issues as equity proportion of the fund.
MVR policy including the likelihood of an MVR applying in different circumstances.
The general impact of the new regulations on life companies writing unitised with-profits contracts is that they will have to increase their res erves. This will reduce these companies' free-asset ratios, which are often used as a measure of financial stren gth. Alternatively, they will have to amend their product terms.
The extent to which individual companies are affected will depend on the following fac tors. The additional res erves required will be higher if:
The unitised with-profits business represents a significant proportion of the total business of the life company.
The level of annual/reversio nary bonus declared is high or there is any guaranteed bonus.
The level of MVR-free guarantee is high and/or there are liabilities such as guarantees of no MVR applying at certain times such as at the 10th policy anniversary.
The fund invests a high proportion in equities.
Where life offices have ado pted a responsible app roach to bonus declarations and MVR policy, the new regulations should not affect current policy values. Companies should not have to change their investment strategy, bonus philosophy or MVR policy due to the new regulations.
Where they have not ado pted a prudent approach, the impact may be less pleasant.