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Regulator gets tough on with-profits loss-leaders

The FSA is looking to crack down on insurers writing loss-leading new business amid concerns that policyholders could suffer.

In a consultation paper published last week called Protecting With-profits Policyholders, the regulator outlines plans to force insurers to demonstrate that writing new with-profits business will not adversely affect policyholders’ interests. It proposes requiring companies to carry out or obtain analysis on the impact of the new business to support this conclusion and to provide that analysis to the firm’s with-profits committee.

The FSA says the current rules on new business may not pre- vent the erosion of value of a with-profits fund from companies making price promises they could struggle to keep.

The paper says: “A substantial minority of firms have been wri- ting new business into their with-profits funds that is loss-leading in itself – that is, it is priced in such a way as to make it attractive to advisers and/or customers but it will never break even – or not enough of it is being sold to cover the cost of acquiring it.

“In both cases, the consequence is that the new busin- ess being written erodes the value of the with-profits fund. This, in turn, means that, over time, there is less money avail- able to distribute to with-profits policyholders.

“We believe that, given these findings, the rule as it is currently framed does not nec- essarily achieve the intention of preventing erosion of the value of the with-profits fund.

“In other words, it gives scope for minor or immaterial detriment. Our concern is that, over time, even minor detri- ment, when aggregated, has the capability to become material detriment.”

The measures could also force insurers to discuss with the FSA what actions may be required if they have sustained and significant falls in the volume of new business, with firms mandated to draw up contingency plans if this occurs.

Hargreaves Lansdown pensions analyst Laith Khalaf says: “The FSA has its work cut out cleaning up the with-profits sector. Some providers are responsible enough to treat policyholders fairly but the FSA has highlighted some practices that are clearly unacceptable.

“The strengthened rule on loss-leading business goes hand in hand with ensuring with-profits committees are truly independent and are challenging the decisions made by the insurer.”

The consultation also proposes removing the ability of firms to apply market value reductions on the grounds of surrender volumes only. Under current rules, an MVR can be applied if there has been, or there is expected to be, a high volume of surrenders relative to the liquidity of the with-profits fund.

If the amendment comes into force, an MVR could only be applied where the face value of the policy is higher than the value of the underlying assets.

The regulator says: “We believe MVRs should only be applied where their use avoids potential detriment to the remaining policyholders that would arise if the payment was higher than the value of the assets underlying the policy.

“We do not accept that an MVR is justified solely by a high volume of surrenders unless the policies’ face values are more than the value of under- lying assets.”

The FSA is looking to expand guidance in its Cobs rules to address potential conflicts between with-profits and non-profits investors in the same fund, between with-profits policyholders and the members of mutually-owned firms, between with-profits policyholders and management, and between different classes of policyholders, such as those with and without guarantees.

In addition, the regulator rai- ses concerns over the use of with-profits assets to make “strategic investments” which may be illiquid and difficult to price. It proposes introducing a new rule requiring a firm’s governing body to be satisfied that the purchase or retention of strategic investments will not adversely effect policyholders.

Finally, the consultation suggests removing the ability of firms to reattribute excess surplus on a with-profits fund. A reattribution occurs when a provider buys out policyholders’ interests over and above the amount needed for the fund to meet its immediate liabilities. Under the current rules, providers can choose to reattribute or distribute excess surplus between policyholders.

The FSA says: “A reattribution brings about a change to the possible recipients in the event that the working capital in a with-profits fund ceases to be required

We now take the view that where an excess surplus is identified, it should be distributed in the required percentage to with-profits policyholders.”

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