Out-Law Analysis 8 min. read
06 Jun 2022, 2:14 pm
Ireland’s regulatory regime makes little distinction between with-profits and other life insurance policies.
This is also a very different approach to that adopted in the UK where significant amounts of with-profits business have been written. The UK regulators have adopted a standalone with-profits regime which applies to with-profits business in addition to the general regulatory rules.
Although the books of domestic Irish with-profits business have largely been closed to new business for a significant period of time, large volumes of such business has been transferred onto balance sheets of Irish insurance companies in recent years as UK insurance groups restructured their operations to take account of Brexit. These transfers included open books of with-profits business. At the same time, a large proportion of the Irish with-profits funds are 100% reinsured to the main UK with-profits funds.
Against this backdrop, and the regulators’ recent focus on fair treatment of customers, Irish with-profits providers should be looking to the UK regime for examples of best practice for the treatment of this type of business.
A with-profits policy is a life insurance contract which provides benefits through eligibility to participate in discretionary distributions based on profits arising from the insurance company’s business or from a particular part of that business, the with-profits fund.
With-profits policies can be structured as whole of life, endowments or pension policies. They contrast with non-profit policies which provide for a fixed benefit. With-profits policies are designed to take account of participation in profit. A key characteristic of a with-profits policy is exposure to investment return.
In the past, with-profits policies were popular investments. However, well-publicised failures of insurers in the UK selling with-profits policies – including Equitable Life – and mis-selling issues contributed to a reduction in demand.
With-profits policies are complex products which by their nature provide for a significant amount of discretion being retained by the insurer with respect to issues such as ‘smoothing’, bonuses and guarantees, amongst others. They also fell out of favour compared to more modern investment vehicles which cater for multi-asset funds where the policyholder is able to select bespoke investments. Most with-profits policies are now held in “closed” funds, so they are in run-off. This can shine a light on historical business issues which arise from the selling mechanisms as many with-profits policies in Ireland would have been sold as industrial branch business through door-to-door sales and premium collection. Many of the “closed” funds also have significant levels of ‘gone away’ policyholders, with whom the provider has lost contact.
A typical with-profits policy will have a guaranteed minimum amount or “sum assured”. This is the minimum amount that the policy will pay out on maturity provided that premiums have been paid. Annual or regular bonuses are declared by the insurance company which will increase the guaranteed minimum amount. Final bonuses may also be added by the insurance company when the with-profits policy is claimed based on fund performance and distribution of the “inherited estate”. The inherited estate is the excess of assets over liabilities within a with-profits fund, and policyholders allocated to that fund are generally entitled to distributions form the inherited estate. The inherited estate is important as it provides security for policyholder guarantees against unexpected adverse conditions, support for smoothing procedures and investment flexibility and the finance needed to support the continued writing of new business in the funds.
The “asset share” or “policy value” of the with-profits policy is the policyholder’s proportion of the investment return of the fund less deductions for costs and charges.
Conventional or traditional with-profits policies operate on the basis that premiums purchase a sum assured, and bonuses are added to the sum assured.
In contrast, with unitised with-profits policies, the policyholder’s investment acquires units in the with-profits fund. The fund grows with premiums invested and guaranteed amounts are set by reference to those premiums rather than the sum assured. Bonuses are added to the premiums paid and the guarantees are built up on that basis. Unitised with-profits policies are easier to value than conventional with-profits policies and can be combined with other forms of unitised investment, such as unit-linked policies.
One of the main features of with-profits policies is ‘smoothing’. This refers to the addition of final bonuses to with-profits policies in such a way as to protect payouts from short-term variations in the markets. Smoothing involves holding back some of the investment gains in ‘good’ years to release them as bonuses when returns have been poorer. The aim is for smoothing to cancel itself out over the long term.
The primary source of UK with-profits regulation is COBS 20 of the Financial Conduct Authority (FCA) Handbook. It was introduced on 1 November 2007 and has been subject to numerous amendments since then. Compliance with the provisions of COBS 20 of the FCA Handbook is the responsibility of the FCA. There is also standalone prudential regulatory guidance for UK with-profits business which the Prudential Regulatory Authority (PRA) is responsible for regulating that is outside the scope of this article.
Insurance companies are required under COBS 20 to take reasonable care to ensure that all aspects of their operating practice are fair to the interests of its with-profits policyholders and do not lead to an undisclosed, or otherwise unfair, benefit to persons with an interest in the with-profits fund.
Under the UK rules, a firm must determine on an annual basis whether it has an “excess surplus” in its with-profits fund. If so, and if the firm cannot justify retaining this surplus, the excess should be distributed to policyholders (and shareholders, if it is a shareholder-owned firm). The effect of this rule is that the inherited estate should never become too large and should instead be distributed to policyholders as it builds up.
This is particularly relevant for closed funds where there will be a diminishing number of policyholders over time following closure of the fund and a ‘tontine’ can emerge. A tontine occurs where where the last policyholders in a with-profits fund are disproportionately benefitted by a large distribution of the inherited estate of the with-profits fund which had built up over time and not been previously distributed. An emerging tontine effect can be addressed by distributing the inherited estate over time through declaration of larger bonuses or through a one-off large distribution of the inherited estate through a scheme of arrangement or other similar structure.
An insurance company underwriting with-profits business which resolves to cease writing new insurance contracts into a with-profits fund must inform the FCA and its with-profits policyholders within 28 days and submit a run-off plan to the FCA within three months thereafter. The run-off plan submitted to the FCA must include an up-to-date plan to demonstrate how the firm will ensure a fair distribution of the closed with-profits fund and its inherited estate, and must have been approved by the board of directors of the insurance company.
A “reattribution” is the “process under which a firm which carries on with-profits business seeks to redefine the rights and interest that the with-profits policyholders have over the inherited estate”. This typically occurs in conjunction with a transactional process such as a transfer of a portfolio of insurance business or a scheme of arrangement. The provisions are designed to manage conflicts between with-profits policyholders and shareholders. Where there is a “redefinition” which triggers the reattribution provisions in COBS 20 this can add significantly to costs and complexity of a transaction as the provisions essentially require the involvement of an independent policyholder advocate to “negotiate” on the policyholder’s behalf.
Ireland does not have a standalone with-profits specific regulatory regime with one limited exception: the introduction by the Central Bank of Ireland (CBI) of a requirement for Irish authorised insurance undertakings underwriting with-profits business to adopt a set of with-profits operating principles (WPOP).
The requirement for Irish insurance undertakings to produce a set of WPOP was introduced in 2018 through CBI guidance: “Domestic Actuarial Regime and Related Governance Requirements under Solvency II” (21-page / 349KB PDF) (‘the 2018 Guidance’). The 2018 guidance was introduced at a time when a number of large books of with-profit business were being transferred to Irish insurance undertakings by UK insurance groups as part of their Brexit restructuring plans.
The WPOP is a publicly available document maintained by an insurance or reinsurance undertaking (together, ‘an insurer’) which details the principles which the insurer adopts in maintaining its with-profits portfolios. It is effectively the Irish equivalent of the UK requirement set out in 20.3 of COBS which requires UK with-profits underwriters to adopt a document called the Principles and Practices of Financial Management (PPFM) setting out the way the undertaking manages its with-profits funds. Indeed, as a number of the Irish with-profits funds are 100% reinsured to the main UK with-profits fund in the group, WPOPs are often drafted to be consistent and back-to-back with the PPFM of the main UK with-profits fund.
The 2018 guidance specifies certain principles which must be included in a WPOP as well as restrictions on amendments to the WPOP. The Head of Actuarial Function is also required to report to the board of directors of the Irish insurer at least once a year regarding the ongoing compliance of the with-profits fund with the principles detailed in the WPOP.
Under the guidance, the board of directors of an Irish insurer writing with-profits business is responsible for the content of the WPOP, ensuring the with-profits fund in question is operated in accordance with it and “ensuring the fair treatment of all with-profit fund members”. This is the clearest Irish regulatory expression of the obligation owed by Irish authorised insurance undertakings to their with-profits policyholders and, importantly, appears to confirm that this duty is owed to both Irish resident and non-Irish resident policyholders. However, the 2018 guidance does not provide any detail as to how the board of directors achieves fair treatment of all the members of the insurer’s with-profits funds.
Aside from the high-level requirements set out in the 2018 guidance, Irish insurers writing with-profits business are not subject to any other material Irish legislation or regulation which has been drafted specifically for with-profits business. As a result, the general principles of Irish insurance legislation apply to management of with-profits funds. The key principle is set out in the Consumer Protection Code 2012 (as amended) (CPC), which requires that an insurance undertaking “…acts honestly, fairly and professionally in the best interests of its customers…”. However, the provisions of the CPC do not apply to services provided by Irish insurers to customers outside Ireland.
Taken together, the 2018 guidance requires Irish insurers to ensure the fair treatment of all with-profit fund members, while the CPC requires them to act honestly, fairly and professionally in the best interests of its customers. To ensure full compliance with these requirements, Irish insurance undertakings may need to look to the UK regulatory obligations applicable to with-profits business set out in COBS 20 as best practice. This is due to the fact that the UK regulatory obligations deal with certain scenarios and circumstances which arise in with-profits business and which are not specifically catered for under Irish law.
An example of this would be in circumstances where a large inherited estate is accumulating in an Irish with-profits fund which is closed to new business so there is a risk of a tontine emerging. It may make sense for the Irish insurer to identify what the requirements under COBS 20 are with respect to distribution of that inherited estate in those circumstances, given there are no equivalent Irish provisions.
While the requirements of COBS 20 are those of a different jurisdiction, they constitute the regulatory standards of a jurisdiction with a much more developed with-profits regulatory regime from which a lot of the Irish with-profits business in Ireland was originally marketed. It is difficult to see how an Irish insurer carrying on with-profits business and adhering to the requirements of COBS 20 could be considered to have breached its obligations under the 2018 guidance or the CPC.