With-profits is a long-term business and so, it seems, is the FSA's with-profits review. This is by no means a bad thing. With-profits is an extremely important element of our savings heritage, without which the current savings gap could have been a lot bigger.
Some reactions to the review, including my own company's, have been broadly positive, welcoming the steps to strengthen and not kill off with-profits. Others have launched vitriolic attacks, claiming the FSA has failed to overhaul not just with-profits but every other aspect of those nasty life offices.
Those who are supportive of retaining with-profits, even in an improved form, are accused of having a vested interest. Do we really believe that those who criticise do not? Surely, the FSA is right to seek to remove the potential for bad practices and allow consumers continued access to the only proven cost-effective means of having equity exposure with protection against volatility?
I would like to summarise the FSA's key proposals and comment on each.
The governance of with-profits
Here, the aim is for greater transparency over the nature and extent of the board's discretion, to avoid any conflicts of interest between policyholder groups or between policyholders and shareholders.
Firms may have to publish a principles and practices of financial management document for their with-profits business, describing investment strategy, exposure of policyholders to business risk, bonus and smoothing policy, charges and expenses, surrender value bases and how any inherited estate is managed. A committee would then monitor compliance with the PPFM.
For some firms, these proposals simply formalise existing best practice. Making them compulsory will ensure this best practice is adopted by all.
The role of actuaries
The FSA has concerns over the conflicts that appointed actuaries can face if they hold dual roles and may ban them from certain positions such as chief executive officer, chairman or finance director. It also expresses concerns about how clearly boards understand that it is they, not the appointed actuary, who ultimately make decisions on exercising discretion.
The appointed actuary's role may be restricted to advising solely on the use of discretion, with a new actuarial function created to advise on other actuarial matters.
Ensuring that conflicts cannot arise and that boards can be in no doubt about their responsibilities must be a positive step. Well-run firms will feel little impact but others may have more to consider.
The first issue here is about showing clearly the ability of each with-profits fund to meet its guaranteed liabilities. Although there will be little new information provided, presentation will be clearer and at individual fund level.
Any reinsurance arrangements or other financial engineering will be shown clearly. Analysts who specialise in this area already have this information but the proposals will make it more generally available and understood.
The second proposal, regarding disclosure of realistic liabilities, will involve providing new information on the firm's ability to meet both guaranteed and discretionary benefits, including terminal bonus, at individual fund level. The FSA intends to make it easier for informed commentators, such as IFAs, to identify any build-up or depletion of free assets within a fund and to assess the actual investment returns being achieved compared with what is being credited through bonus additions. New indicators of life office financial strength that consumers can understand are also being considered.
At this stage, it is not clear how the detailed new requirements will emerge. Some of this information is already available to expert commentators. The FSA clearly has concerns over some providers misusing free assets or using policyholder funds for shareholder purposes and such practices will be more obvious in future.
We agree that some approaches to assessing financial strength, such as using free-asset ratios in isolation without reference to parent company strength, are flawed although trends can be meaningful. We await further detailed proposals with interest. Any changes here need to be considered alongside wider reforms of regulatory reporting, including those coming from Europe.
Disclosure to consumers
Scottish Equitable has followed the proposals on disclosure with interest. The FSA proposes developing simpler terminology for with-profits literature and documentation.
Information would be available in two tiers – core and supplementary. Pre-sale, the core information would include the policy features, risks, guarantees, a description of the smoothing concept and the consequences of surrender. In annual statements, core information would include the premiums paid, bonuses added, current value, surrender value and projected value .
This is very much in line with the Raising Standards initiative, which already uses plain English to describe all the above aspects of with-profits. The new with-profits summaries are particularly helpful in this regard. Providing information in tiers should provide a welcome reduction in the volume of material currently provided to all.
Attribution of inherited estate
The key proposal here is to appoint a policyholder advocate to obtain the best possible deal for policyholders whenever there is a debate about setting or changing the relative interests of policyholders and shareholders in future distributions of profit. This is only relevant to those providers seeking to make changes in this area and the benefit it will bring has to be assessed on a deal-by-deal basis.
Overall, Scottish Equitable views the FSA's proposals as a sensible and proportionate response to the issues surrounding with-profits. They will lead to significant change in the running of with-profits funds. Mere tinkering? I do not think so.
The anti-with-profits camp is now ensuring that Ron Sandler knows just how critical it will be if he does not answer its calls for life office (or is it actuaries'?) blood. Let us hope he does not take their bait.