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June 2010

Reinventing with profits and life after Chrysalis: by MGM advantage

Chris Evans, CEO of mgmadvantage discusses his Society’s approach to the issues in the FSA’s October 2009 Dear CEO letter on Mutuals

When in 2007 our strategic review led us to focus MGM’s member value growth agenda on the retirement income market, it was clear that there would be a few jobs to do. Once we’d assembled the talent we’d need from within the firm and with some new faces, we’d have to run some deep primary research on the consumer needs, design a proposition that met the needs well and profitably, test what we produced and then execute the plan efficiently. Research – design – test – execute became the mantra for the transformation program as we launched our Enhanced Annuity product on the back of a gleaming new technology platform. And by the end of 2009 we’d been achieving all of our business plan objectives for sales, margins, expense reductions, IFA penetration, brand recognition and happy customers.

So everything going swimmingly then? Well, actually not exactly everything.

Like all of us we had to respond to the turmoil in the capital markets and needless to say that dominated much of our time. But (as has turned out to be the case across the insurance sector), our one-in-two-hundred-year risk event planning saw us through. It wasn’t the credit crunch that presented the strategic threat to the business plan. Instead the problem was specifically connected to our mutuality.

The membership model that enabled us to return tangible benefits for customers was paradoxically also the model that threatened to coral us into a dead end.

mgmadvantage is a With Profits mutual. Our only members are With Profits policyholders and our Articles of Association lay down that only those policyholders who participate in the profits of the Society shall be granted membership. In 2007 we knew that this meant that unless we could sell more participating products our membership would be in permanent decline. Yet With Profits products have become less popular today so how were we to respond?

Our analysis had shown that a run off was poor for members compared to delivering commercial success in a thriving business so we realised we had to either grow membership or design a new corporate structure model and ask members to sign up for that change.

At the same time as launching the (non-profit) Enhanced Annuity product we were already designing a membership-conferring product that met another under-served consumer demand: asset-backed retirement income.

The product under development was the Flexible Income Annuity (FIA) where the policyholder retained the investment exposure and return and shared the mortality profits but having the safety net of a Minimum Income Guarantee. Our assessment was that With Profits as we know it had become relatively out of vogue and this meant that we were keen that customers should be able to select from a range of world-class asset managers in a unit-linked investment. Yet we also wanted them to “participate in the profits of the Society” so that they could enjoy membership.

We therefore included a bonus element that enabled the policyholder to benefit from distributions from the miscellaneous surpluses of the Society.

Throughout this time we collaborated with fellow Mutuals on the “Chrysalis” project that was exploring and proposing the means by which the sector could achieve an appropriate and sustainable future in the face of the FSA’s stated opinion regarding Mutuals’ use of capital and the rights of different classes of members as they perceived them. But on 13th October 2009 the FSA wrote to CEOs of Mutuals to make clear their position and many of the principles held by firms in the sector regarding membership rights and the use of capital were not accepted by the criteria set out in this letter.

At mgmadvantage we sought Counsel’s opinion on FIA and gained confirmation that this was membership-conveying and that, although it was very different from any With Profits product in the market, FIA would indeed be deemed to be a With Profits product and therefore by definition membership-conveying under our Articles of Association.

After an extended period of intense and enormously rigorous assessment by the FSA, they confirmed that the product did indeed meet the criteria as laid out in the Dear CEO letter and would be designated by them as With Profits.

FIA: Unit-linked; no investment in the With Profits fund; no smoothing; no MVRs; no terminal bonuses, and yet still designated as With Profits, still participating in the profits of the Society through paying out miscellaneous surpluses in the form of bonus distributions.

FIA was launched in February 2010 and I’m delighted to say is achieving planned levels of sales, putting the Society on track for net growth in membership and profitability.

This new construct is, I believe, a genuine innovation. It works not only for consumers purely as a product solution but also for the Society in contributing to mgmadvantage’s continuum of membership. And although it most assuredly will not be a solution for all Mutuals’ “Chrysalis challenges” given that all Societies have different Articles of Association and structures, it is at least a model that has been tested and found strong.

Footnote:

I asked our Head of Compliance to explain what in his view led to this successful outcome for the Society and this is what he says:

“The key factors that the FSA were concerned with were that:

  • Any new generation of with-profits products should not have a material adverse effect on with-profits policyholders.
  • Participation in the profits of the Society should not be illusory or non-material.
  • Firms should be able to demonstrate that the costs of development are appropriate to be borne by with-profits policyholders compared to the scenario of running off the business.

In our dealings with the FSA we were able to demonstrate that the development of FIA met all of the criteria in the Dear CEO letter. In particular:

  • When considering the need for a new product our starting point was that any new product must deliver better returns to members than closing to new business and running off. Without adopting this assumption we consider it unlikely that we would have been unable to adequately demonstrate the viability of FIA.
  • As part of the product development process extensive research was conducted and we were able to demonstrate a consumer need for an innovative annuity.
  • We also engaged with the FSA very early in the process to ensure that they were comfortable with our conclusions.
  • The needs of our existing with-profits policyholders were actively considered at all times in the development of the product. In all documents submitted to our Board we were able to explicitly demonstrate the fair treatment of existing and new with-profit policyholders.
  • FIA policyholders are entitled to participate in the profits of the Society. Of particular relevance is the fact that this is a material benefit. In the Society’s PPFM we clearly document how profits will be shared out amongst existing and new with-profits policyholders.
  • The FIA product offers a guarantee to policyholders in the form of a minimum income guarantee. We were aware of the need to ensure that the guarantee would not be paid for by existing policyholders and an explicit charge is made within the product to cover the cost of the guarantee.
  • We were also able to demonstrate how quickly the costs of developing the product will be delivered back to policyholders. Crucially we were able to provide this information in a number of stressed scenarios and still demonstrate that it was an appropriate use of the Estate.”


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