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August 2010

With profits management - delivering fairness and transparency

In June, the FSA published its report on findings from its review of with-profits management. Disappointingly for both the FSA and firms, the FSA’s conclusion was that “the majority of firms did not satisfactorily demonstrate that their practices were consistent with well run with-profits businesses...potentially exposing a very significant number of with-profits policyholders to risk.” (FSA, With-Profits Regime Report, June 2010)

BDO’s involvement with firms shows that many firms have made good progress over recent years to improve fairness and transparency of with profits management. However, it is also clear that performance across the industry often fell short of FSA’s expectations.

AREAS OF WEAKNESS

The FSA’s primary concerns across the industry are in relation to governance and communication with customers. In addition to these sector-wide issues, weaknesses were also identified within individual firms in relation to: COBS Chapter 20; Principle 6, customer interests; Principle 7, communication with clients; and, Principle 8, conflicts of interest.

FSA’S DESIRED OUTCOMES

The FSA expects firms to support the following policy outcomes:

  • Governance: Policyholder interests are protected and taken into account in actions taken by the firm.
  • Communication: Current and potential policyholders are provided with comprehensive, timely, and clear information to allow them to take a view on the risk and reward balance of their policy.
  • Payouts: Payouts are fair and policy conditions such as MVRs are applied fairly and proportionately to ensure all classes of policyholder are treated fairly.
  • Expenses: Costs charged to policyholders only reflect the costs incurred in running the fund. Any additional overheads charged to the fund are proportionate to the size and impact of the fund within the firm.
  • Investments: Investments are appropriate to the fund and do not prevent policyholders from receiving fair payouts or bonus distributions.
  • New Business: The terms for writing new business do not make existing policyholders materially worse off.
  • Closed Funds: A coherent plans and risk management approach is in place to ensure a fair distribution of assets to all policyholders.
  • Reattribution: Conflicts of interest in ownership and distribution of surplus funds are managed fairly.

RISK OF ENFORCEMENT ACTION

Many of the concerns raised by the FSA are not new, and have been raised in previous communications to the sector. Therefore, immediate action will be expected by firms that are considered to be falling short of FSA expectations.

The FSA has outlined the action expected from firms, and has promised “strong action” with firms that do not meet these expectations promptly. Indeed, the FSA is already undertaking swift enforcement investigations with firms where risks to policyholders are high and they have failed to meet COBS 20 and principles requirements.

ACTION FOR FIRMS

In response to the FSA’s findings, management of all firms should review their answers to key questions including:

Governance

  • Are policyholders’ interests properly protected and taken into account in decisions and actions taken by the company? Is this properly recorded and documented?
  • Are the With-Profits Committee and With-Profits Actuary (or equivalent) sufficiently independent and challenging of the Executive Management and the Board, and do they influence and drive the agenda for management of the with-profits fund? If there is no With-Profits Committee, is this justified?
  • Do the With-Profits Committee and the company engage with policyholders to explain decisions?
  • Does the With-Profits Committee receive adequate management information?

Consumer Communication

  • Are current and prospective policyholders provided with comprehensive, timely, and clear information to allow them to take a view on the risk and reward balance of their policy?
  • Are the CFPPFM, Annual Report and other event driven communications (e.g. statements, benefit notices, surrender notices, pre-maturity information) useful and understandable for policyholders?
    • Are policyholders made aware of key items, including: investment risk, changes of investment mix, the apportionment of charges and expenses, strategic investments, the discretion given to management and how they use this, investment?
    • Are customers reminded of key benefits of their policy, particularly if they may be about to take action which would result in losing benefits?

With-Profits Fund Operations

  • Are target ranges for payouts and smoothing strategies being set and operated in a way that will deliver fair outcomes for all policyholders in all reasonable scenarios?
  • Have clear benchmarks been established to assess whether costs to manage the fund (or apportioned to it) are reasonable, and are there regular and timely reviews of these? Are there adequate break-clauses in long-term contracts for administration, fund management or other services?
  • Does either new business in aggregate, or individual product lines, have an adverse effect on the interests of existing policyholders?
  • Does investment strategy, particularly in relation to strategic investments, risk unfairly constraining payouts?
  • Is the company’s asset share methodology robust and accurate?

Closed Fund Specifics

  • Is there a coherent plan and financial and operational risk management approach in place to ensure a fair distribution of assets to all types and generation of policyholder? Are these plans and risks regularly reviewed and updated, and is there a clear strategy for when the business becomes sub-scale?
  • Is there sufficient communication to policyholders about progress of the run-off and implications for them?

Reattribution

  • Are the rules for re-attribution fully understood and are mechanisms in place to effectively manage conflicts of interest in ownership and distribution of surplus funds?
  • Do plans allow the reattribution to be completed within a reasonable timescale of announcement?
  • Are policyholders fully informed of their options in a timely and understandable manner?

In addition to all of the above, management must also consider whether there are implications from Project Chrysalis that will impact the ability to run the with-profits fund as expected by the FSA.

Previous effort across the industry does not seem to have satisfied the FSA, and the bar seems to be higher than many firms had anticipated. To avoid the risk regulatory action, we urge all firms to review their current performance and to be challenging in assessing their ability to evidence delivery of the FSA’s desired outcomes.

For further information, contact:

Tim Kirk

Partner, Head of Financial Services Advisory Practice, BDO

Tim.kirk@bdo.co.uk

Tim leads BDO’s Financial Services Advisory Practice and has been a close adviser to the FSA and firms on improving customer outcomes and treating customers fairly.

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