Ron Sandler's report is well intentioned, well structured and, in some quarters, well received. The intention, it seems, is for the lowest-income groups to drive a Mondeo like the middle-income group. Unfortunately, what will happen if his recommendations on the “simplicity front” are carried through is that everyone will end up driving a Trabant with a trail of blue smoke adding to the current haze.
The report tells us we need to move to simplicity and create a new with-profit contracts that detaches itself from the workings of the underlying company. He describes it as being “akin to what people now call a managed fund”. Mr Sandler,it is not only akin to, it is,a managed fund.
Who are the designers of this innovation who brought it to Mr Sandler's research team? The Halifax bank. Well not quite. Clerical Medical Life, part of the Halifax banking group. Coincidentally Adrian Sanders, Clerical Medical's chief actuary was a speaker at a technical conference on with-profits in London recently and regaled the audience with his company 100:0 model for with profits funds as the answer to “simplification” as “fairness”.
The question is – if you take 100 per cent of policyholders' money and you separate (not deduct) the life insurance company “risk” premium and create a separate pool for reserves to allow smoothing plus the “management” costs, then you are, still left with 100 per cent, actuarially. Practically, I think you are left with a “con”.
Historically, over a 15-year term, with-profits funds have outperformed managed funds by some 2 per cent to 4 per cent a year, depending upon underlying market conditions.
Mr Sandler's report verifies this “distortion” by stating this is the effect of the “inherited estates” and “historically” the results of improved mortality.
The report also points out that life insurance funds have to maintain assets against long-term liabilities – a feature which does not pre-exist with managed funds.
The inherent safety of life insurance funds therefore and the true with-profits principle is that policyholders share in all of the ups, and as Equitable Life and others before it have also shown, the downs of a complete commercial entity. The managed fund merely reflects investment returns. Different recipe, different cake.
At paragraph 10.27 in the Sandler report for “stakeholder with-profits” simply read “managed fund”. In other words, Mr Sandler, in the interest of simplicity, would have all the safeguards and the solid base of what he calls “inherited estates” which transfers security generation to generation and supplant it with a vehicle that, like the Trabant, is far less trustworthy, produces a poorer result and has a much more suspect ride but is available through banks and investment houses.
A banking organisation only needs £9.50 per £100 of depositors' assets that it holds
The policyholder benefits from properly costed policies as well as investment expertise.
Although the Sandler report mentions security, guarantees and certainty in a with-profits contract context, it ignores them in its endeavours to bring what it calls simplicity to a complex marketplace.
The nomenclature “with profits” should be guarded by the FSA to follow the key characteristics listed in the report at 6.4 through to 6.7. With-profits funds, even with “proprietary offices” have to “feed” the shareholder as well as the policyholder, which is the driving force behind their success. Shareholders get 10 per cent of the profits made and the policyholders get 90 per cent of the profits made. How much more egalitarian can one get?
According to Mr Sandler's report at 6.11 and 6.12, it would improve the situation immeasurably for the shareholders by making sure they are looked after first and then leave the hapless investor to take whatever the investment manger can make for them. That cannot be right. Where is the incentive to perform?
The real conclusion of the with-profits arguments is highlighted in 6.46 of the report. This is the nub of the whole with-profits argument: “their (traditional with-profits funds) existence tends to act as a barrier to entry to new entrants”.
In other words the existence of true with-profits funds with the security of £100 of assets to £100 of liabilities, enhanced by 25 per cent in normal times as a safety measure, disenfranchises the banks who only need £9.50 for each £100 of money that they are custodians for, and investment houses whose assets against liabilities for the protection of their fundholders is nil.
If the FSA and the life insurance industry need to do anything with regard to with-profits funds, they need to protect the enduring formula that has produced superior long-term returns for the benefit of policyholders and stockholders alike, for 240 years.
The review concludes that the principle of with-profits is a benefit to those of modest means. Perhaps that is why those who complain most about the undoubted attributes of the concept of with-profits will use almost every trick to use the nomenclature but abandon the principal recipe that has created its success.
O'Halloran & Co.