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FSA defends rules on life companies' use of with-profits surpluses

The FSA has resisted calls for a full-scale debate on the regulation of with-profits funds, but it has promised a major review of how effectively life companies are implementing its current rules.

The announcement formed part of the regulator's response to a Treasury Committee report which criticised the ways in which firms are allowed to use the surpluses that have built up over time in their with-profits funds.

The Committee found that the current regulatory framework fails adequately to protect policyholders' interests in such surpluses (known as the inherited estate), as against those of the company and its shareholders.

The report strongly criticised the use of the surplus to pay off shareholders' corporation tax bills following a distribution and the practice of 'phasing' distribution payments to policyholders over time, discouraging policyholders from leaving the with-profits fund.

It also highlighted the conflicts of interest inherent in the company using the inherited estate to fund its own future growth, particularly if it is already considering buying out policyholders' interests in the surplus (a process known as a reattribution).

"We would welcome a reopening of the debate about the fundamental design of the regulatory system for with-profit funds," the report concluded. 

But the FSA, which carried out a major overhaul of the with-profits regime only a few years ago, believes the real issue is not the regulations themselves, but how they are being put into practice.

In a response published last month, it defended its approach. On the issue of shareholder tax, for instance, it commented: "We do not think the position is as clear-cut as the Committee argues … We remain of the view that the decision to permit this specific practice to continue where it was disclosed to new and current policyholders was reasonable".

"More generally, we believe that our framework of rules already covers the range of activities that might take place in managing a with-profits fund and the ways in which firms might use their discretion in doing so," it said. "Therefore we do not currently believe that there is a need to specify more closely the uses to which a with-profits fund can and cannot be put, over and above those rules and guidance which we have already issued."

But, the regulator added: "The existing with-profits regime has been in place for three years.  While we supervise individual firms as issues arise, we have not yet carried out a systematic information-gathering exercise to determine conclusively how senior management in firms have implemented the rules, individually and collectively." 

"We believe now is the right time to do that," it said. "We will therefore be conducting a comprehensive review".

The FSA will also consider clarifying some aspects of the reattribution process, building on practical experience gained in recent transactions, such as the ongoing Norwich Union reattribution.

For instance, the FSA believes it would be helpful to publish more information on the roles and responsibilities of all parties to the process and to set out the factors it takes into account when forming a preliminary view on whether a company's proposals are fair.

Another suggestion is that firms should be required to seek the regulator's permission before announcing a reattribution to avoid the uncertainty that can be caused by premature publicity and enable the FSA to make sure that the company is ready to proceed to the next stage.

Commenting on the FSA's paper, Clare Spottiswoode, policyholder advocate in the Norwich Union reattribution said:

"This is a curate's egg of a response to a very clear report from the Treasury Committee. The FSA's fundamental policy stance has not changed and it remains difficult to see how the FSA can justify its support for the use of the estate to subsidise the capital cost of writing new business or for paying shareholder tax.

"These rules mean that shareholder interests are still favoured over policyholder interests," she said.

Bruno Geiringer, a partner specialising in life insurance at Pinsent Masons, the law firm behind OUT-LAW.COM, said: "The FSA's response makes it clear that life insurers must now focus their attention on compliance with the current rules and not become side-tracked by debates about potential rule changes."

"Since the new with-profits regime was introduced in 2005, the FSA has repeatedly warned senior management to take a greater interest in the fair treatment of policyholders. Over the coming months, many insurers will have a lot of work to do to improve the way they manage their with-profits funds, deal with conflicts of interests and communicate with their policyholders," he said.

The FSA plans to publish the results of its with-profits review by the end of 2009, when it will consider whether the current rules need any further amendment or clarification.

In the meantime, it is progressing with its proposal to prevent life companies using the inherited estate to fund compensation payments for mis-selling claims – a move welcomed by the Treasury Committee in its report. 

"We have received a substantial response to the consultation, representing a wide spectrum of strong views," the FSA said. "We are currently considering the responses and intend to issue a policy statement before the end of the year".

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