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FSA 'betrays' with-profits policyholders with compensation rule, says Which?

Life companies will no longer be able to use surpluses in with-profits funds to pay compensation for operational errors such as mis-selling from 31st July, the FSA has said. But the new rule will not apply if the misconduct happened before that date.

The Financial Services Authority's decision not to make the rule retrospective has been criticised by consumer body Which? as an "unbelievable betrayal" of consumers.

Chief executive, Peter Vicary-Smith said: “It appears the FSA is allowing the financial services industry to dictate policy once again. In the current environment it seems ludicrous that firms can raid with-profit funds to pay for their own regulatory failings. The FSA must stand up to this industry.”

The regulator anticipated the final rules would not meet everyone's approval.

"We recognise that consumers would like us to go further than the [consultation paper] has proposed, while some views from the industry consider the proposal to be unjustifiable and ill-founded," the FSA said in a policy statement published this month.

"We have had regard to all the views expressed to us in response to the consultation and have made a decision taking into account those views," it said.

Bruno Geiringer, a life insurance expert at Pinsent Masons, the law firm behind OUT-LAW, thought the regulator had fairly balanced the interests of shareholders and policyholders.

"The FSA's resistance to introducing rules retrospectively is to be welcomed. Moving the regulatory goalposts would only bring uncertainty to the industry, which would not benefit anyone," he said. "The rule change means that, in the future, shareholders not policyholders will foot the bill for costs arising from operational failures. 

"Life companies are liable for mis-selling only where they sold the policy directly to the customer," Geiringer added. "But the vast majority of with-profits policies are sold by independent financial advisers, who are and will remain responsible for any liability arising from their own mis-selling. The new rule will not change this".

Using the surplus

The surplus in a with-profits fund – known as the inherited estate – can be used by the life company to provide working capital, smooth out returns between good and bad years and fund future growth. Until now, it could also be used to fund compensation payments, for instance arising from cases of mis-selling.

At least once a year, the life company must consider whether to make a distribution from the surplus to policyholders and shareholders, usually on a ratio of 90:10.

Policyholders' concern is that the likelihood of any future distribution will be diminished if the inherited estate has been used to meet compensation costs.

Under the new rule, shareholder-owned life companies will be prevented from using the surplus to fund compensation or redress payments arising from events occurring after 31st July 2009. But for anything occurring before that date, the position is unchanged.

"The rules are not retrospective. They do not deem conduct to have had a different effect to that it had under the law in force at the time it occurred" the paper states.

Many consumers and consumer representatives responding to the consultation said the prohibition was too little, too late. Unless applied retrospectively to past events such as mis-selling, it would have only a very limited effect because so many with-profits funds have closed to new business and only a few new policies are currently being sold.

In response, the FSA points out that the rule is not limited to selling issues. It could apply to existing policies, for instance, if widespread mis-pricing or a major data loss occurred after 31st July.

And, although the regulator can require firms to justify their decision not to distribute the surplus in some circumstances, the FSA also reminds with-profits policyholders that they do not have an absolute right to receive a distribution, or even an expectation that they might do so.

The new rule will only affect shareholder-owned life companies. Mutually-owned life insurers have nowhere other than the with-profits fund to charge compensation costs and so will still be able to use inherited estates for this purpose, provided they are satisfied that the costs cannot be met out of any other assets in the with-profits fund.


In addition to compensation and redress, the prohibition will also apply to payments for inconvenience or distress that are made 'ex gratia' (without any admission of liability), but not to payments that merely correct a mistake, such as an overpayment of premium or underpayment of a policy value on maturity.

Life companies will still be able to meet compensation costs from assets in the with-profits fund that are attributable to shareholders – in other words, the portion of any declared distribution that has been earmarked for shareholders. And where a court-approved scheme allows for payments of compensation from with-profits funds, the scheme will continue to apply subject to its terms.

A wider review?

Many respondents said they would like to see a wider review of the with-profits rules to reconsider whether other costs, such as shareholder tax payments, should continue to be chargeable to the inherited estate.

The FSA says this was outside the scope of the current consultation, but that it is carrying out a review of how firms have implemented the rules governing the operation of with-profits funds. It expects to have the results of this work ready next year. It will then decide if any further changes need to be made.

In June 2008, a House of Commons Treasury Select Committee report called for a debate on the fundamental design of the with-profits regulatory system.

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