The FSA with-profits review has hardly registered on the Richter scale of financial shockwaves.
Perhaps we have all been preoccupied by the other FSA review into the future of polarisation. Or perhaps we feel that the with-profits review needs fleshing out a bit before it is worth bothering about. But it could mean big changes are on the way for this popular form of investment.
Additional information may be made available to investors and their advisers which will allow them to be more analytical about their choice of with-profits provider. If you are an IFA who advises regularly on with-profits business, you will eventually find that your recommendations are going to have to be framed in the context of a much greater supply of comparative provider information.
For example, providers may have to define and disclose how the discretion they apply to the management of with-profits funds ensures policyholders are treated fairly. The publicly reported performance of with-profits could, for the first time, include the performance of the nominal funds which companies maintain to control the smoothing and equity of with-profits bonus announcements.
These are just two of the proposals included in the five issue papers published by the FSA in the last six months. But before we assume too much about the outcome, we need to be clear that issue papers are not consultation papers. They are the forerunners to consultation papers, where a range of likely possible solutions to address a particular issue are put out for debate. Many of the proposals in issue papers are virtually non-starters but are there for completeness.
Having said that, the two proposals described above have met with favourable responses from industry bodies, which is as good an indicator as any of the central ideas which will eventually appear in the consultation paper.
What do the issue papers say? The first one deals with inherited estates, which is that part of the with-profits fund not hypothecated as necessary to pay the benefits expected by policyholders. The paper examines the process of attributing the inherited estates to policyholders and shareholders and, perhaps more important, ensuring a fair outcome is achieved when circumstances give rise to a reattribution of that estate.
These events have no predetermined correct answer. There is a range of possible answers for both parties and it is really a matter of negotiation to find a single answer acceptable to both parties.
The problem (which was highlighted by an earlier Axa case) is who negotiates on behalf of the policyholders? In particular, should this negotiator be other than the independent actuary and the FSA, which are usually involved in these cases but have other responsibilities? The consensus seems to be that another player will have to be brought on to act for policyholders – not an easy process but one where the detail can be looked at in the next round of consultation.
The second issue paper deals with regulatory reporting. Here, the objective is to make with-profits funds more transparent by disclosing fund information aimed more at informed users than the average policyholder. This information could include more statistics about fund performance and financial strength.
It could include information on asset shares – a term used to describe each policy's theoretical share of the with-profits assets based on actual (unsmoothed) investment performance, expenses, share of tax and so on. With this information, advisers and commentators may be able to draw conclusions about whether a with-profits policy stands above or below its theoretical value which, in turn, will say something about its likely future direction.
If this information enters the public domain, IFAs will not be able to ignore it. They will be expected to take it into account in their with-profits recommendations but making sense of the figures may not be easy. But since nature and financial services both abhor a vacuum, there will be no shortage of analysts willing to take on this work on behalf of IFAs.
In the third paper, we move closer to the consumer end of the business, with an examination of what and how much information investors should be given to improve their understanding of with-profits. Based on consumer research, the FSA looks at descriptive information to be provided at point of sale, backed up by individual policy performance information provided regularly while the policy is in force.
Recognising the need to avoid information overload, it is suggested that both the preand post-sale information can be at two levels – core information which should be supplied to every policyholder and supplementary information which could be supplied on request. For example, on the use of market value reductions, it is suggested that every policyholder will receive at the point-of-sale information on the possible existence of MVRs and, on request, can obtain further information on their application and how they are calculated.
Altogether, the FSA lists as possible candidates for disclosure 36 pre-sale and 13 post-sale items of information. Once again, IFAs will be expected to pick the bones out of this information when advising their clients.
The fourth paper returns to the question of fairness but this time in the context of how management discretion is exercised in the operation of with-profits funds. The need to exercise this discretion is accepted, as is the principle that its application can involve making choices between different types or generations of with-profits policyholders. Nevertheless, the FSA feels that, in six areas, greater understanding is needed by policyholders of how that discretion can be applied. They should not receive any unpleasant surprises when its application produces a less favourable outcome for their policies.
The six areas are investment strategy, exposure to business risk, bonus policy, the application of MVRs, variations to existing policies and management of the inherited estate. Recognising that with-profits policies exist in a changing economic environment, the FSA proposes that there should be a set of principles for each of these areas which are unlikely to change over time and a set of practices which will reflect changing circumstances.
There are no performance numbers here, just statements about how things should be. New policyholders will be given information on the current relevant principles and practices when their plan commences. If practices change, they will be told. They will also be informed about compliance with the principles in, perhaps, an annual bonus statement.
The final issue paper is concerned with the governance of with-profits funds. The good news is that it will not give rise to any further disclosure. Instead, it looks at ways in which the interests of with-profits policyholders can be improved in the management of with-profits funds.
A number of options are examined and, from the responses, it looks as if the front runner is a with-profits sub-committee of the board populated mainly by non-executive directors. The inclusion of with-profits policyholders is not ruled out but the problem is getting one policyholder (or even a small group) which adequately represents the diverse views of all policyholders. A further part of this issue paper deals with the future role of the appointed actuary.
The five issue papers put forward many different options and have generated a range of different responses. The FSA must now distil that down to one consultation paper with a much narrower focus but not final proposals.
The FSA has said the consultation paper will be issued this spring but the final issue paper, which should have been out by the end of 2001, did not appear until March this year.Government bodies are famous for their liberal interpretation of the seasons. Spring may mean June, which would at least allow us to read the next stage of this review along with the Sandler announcement in that month.
For more information on the with-profits review, go to Gray Matter at www.scottish mutual.co.uk