Norwich Union's decision to charge for guarantees on its policies has met with little controversy, just as with Standard Life.
With Standard Life, at least, the tendency has been to say something like: “Well, it is in a mess after its disagreement with the FSA. Something had to be done. There was always a cost of providing these guarantees. All this does is make it more explicit. At least now everyone knows what those guarantees really cost. It is transparent, it is clear and the actuaries no longer have to bury it in the detail of their annual returns.”
Which is all true, of course, but is it the whole story? Is it possible, for example, that this practice of charging for guarantees should actually be much more controversial than it has proved until now? Could it even be open to legal challenge?
In case you missed it, Norwich Union is saying it will make an explicit charge, reducing the annual rate of return that policyholders can expect by 0.75 percentage points. This is to pay for guarantees which promise a minimum amount on maturity – sometimes known as guaranteed investment returns.
NU makes it clear that this was the outcome of a choice it was faced with because of the new financial reporting regime. Either it could treat those policyholders separately, charging them for something only those policyholders with guarantees could benefit from, or it could spread the cost over the whole with-profits fund, so every policyholder in the with-profits fund picked up the cost.
Every policyholder would pick up the cost in the sense that the fund would have to sell equities and buy gilts to cover the guarantees under the new reporting regime. As a result, every policyholder's potential return would be reduced (unfortunately, with Standard Life, both undesirable outcomes have been realised at once).
There is no doubt whatsoever that something had to be done to address these guarantees. The whole industry, including Equitable Life, Standard Life and NU, offered guarantees throughout the 1970s, 1980s and 1990s, which at the time seemed quite innocuous.
Few guessed that inflation and investment returns (or, for that matter, interest rates) would get so low and stay so low, with no prospect of a return to the double digits of the past. In other words, few guessed these guarantees would ever become a burden for a life office to provide.
In some cases, guarantees were introduced to lessen the difference between with-profits policies as a vehicle for retirement saving – a money-purchase vehicle – and occupational pensions, where you knew what benefits you would get because they were explicitly defined. In the new policies, you did not know what you were going to get but at least you would get a minimum.
In that respect, the guarantees were a crucial factor in making sure that not just the policyholders, not just the life offices but the Government and regulators too were happy that people invested in these policies. Even if policyholders were barely aware of the guarantees, the huge sums of money going into those policies were possible partly becuse of the guarantees.
In other words, the life office as a whole was able to attract funds partly because of the guarantees. The life office as a whole benefited from them.
Put it another way. When advisers sold policies with guarantees, when the customer signed up, the contract was between two entities – the customer and the life office. Given that NU was mutual when these policies were sold, just as Standard Life and Equitable Life were, its customers were effectively signing a contract with the society, that is, with all the other with-profits customers who owned Norwich Union Life and Pensions. The contract was between the new customer signing up and all the existing ones who had already done so.
The guarantees were promises made by all the customers already on board to the one who was just signing up. It was definitely not simply a contract between the customer signing up and that fraction of customers who also had guarantees.
Now, I am no lawyer, no actuary, only a journalist, so the following may be naive. But shouldn't that mean that the responsibility for covering the cost of those guarantees should lie with all policyholders? Naive arguments like this were dismissed by both the industry and regulators ahead of the famous House of Lords decision on Hyman versus Equitable Life Assurance Society. But the whole point of that decision, unless I am mistaken, was to make it clear that Equitable could not say on the one hand: “We have given you guarantees” and on the other: “If they ever turn out to be worth anything, we will make sure you see no financial benefit from them.”
To take it a stage further, Equitable could not say on the one hand: “All the policyholders of Equitable Life give you, the minority, guarantees” and on the other: “If they ever turn out to be worth anything, you, the minority, will have to pay the cost.”
In fact, the whole principle established by Hyman was that Equitable could not retrospectively treat those with guarantees as a separate class of policyholder, liable for different treatment from the rest.
Of course, Hyman was about guaranteed annuity returns. The charges made by NU and Standard Life have more to do with guaranteed investment returns. Would the courts regard that distinction as important? I am not sure that they would as the principles are largely the same.
I hope that NU, Standard Life and the FSA – which has, directly or indirectly, gone along with these charges – all have very good lawyers.
Andrew Verity is a personal finance reporter at the BBC