FSA accused of failing policyholders
The City watchdog was today criticised for failing to protect the interests of policyholders in with-profit funds.
The Treasury Select Committee said the Financial Services Authority (FSA) was not providing a robust enough framework to manage the conflicts of interest relating to so-called inherited estates.
The term inherited estate refers to money that has built up in with-profits funds over the years that is surplus to what is needed to meet the fund’s liabilities.
The money accumulates because insurers withhold a proportion of investment returns during good years to pay out in bad ones.
But companies’ use of inherited estates has been the subject of controversy in recent years, with consumer groups arguing that they should not be allowed to use the money to meet mis-selling claims, pay shareholders’ tax and subsidise new business.
They instead argue that the money should be returned to policyholders through a special distribution.
The Treasury Select Committee agreed that it was “inappropriate” for firms to pay compensation to people who were mis-sold products out of the inherited estate, arguing that these costs should be borne by shareholders.
Chairman of the Committee John McFall said: “I was astonished that the Prudential had taken £1.6 billion from their inherited estate to pay the costs of compensation arising from mis-selling.
“By reducing the size of the inherited estate in this way, the firm’s policyholders have a much lower chance of receiving a special distribution than they would have done otherwise.”
The FSA is currently looking at the issue, and launched a consultation last month with a view to ending the practice.
The Committee was also critical of firms for using surplus funds to pay shareholder tax and called on the FSA to consult on ending this by the end of 2008.
It claimed the practice was a “striking example” of how certain life firms were able to use their discretion to “further shareholders’ interests to the detriment of policyholders”.
It added that the FSA’s regulation of the issue was “barmy” as it allowed firms that had always charged tax to the inherited estate to continue doing so, while those that had not were barred from doing so.
The report also criticised firms for funding new business from inherited estates, while it called for With-Profits Committees, who are supposed to protect policyholders’ interests, to be given an explicit role in ensuring they are treated fairly in line with the FSA’s principles.
But the report said the use of inherited estates to smooth returns for policyholders between good years and bad ones was appropriate, although it called on the industry to make the process more transparent.
It criticised the fact that when firms did decide to return money to policyholders, they often phased payments over several years.
Norwich Union is currently returning £2.1 billion to certain of its with-profits policyholders, but it is making the payments over three years.
The Committee said this phasing meant many of the group’s longest standing policyholders would not receive all of the money when their policies matured, while those who decided to leave the fund would also miss out.
Overall, the report said the FSA had failed to develop clear principles for the regulation of inherited estates, instead becoming “embroiled in making judgments in the round” and “micro-regulating particular firms’ situations”.
Mr McFall said: “The approach taken by the FSA towards inherited estates seems a long way from the philosophy of ‘principles-based regulation’ to which it aspires.
“Policyholders need to have confidence that their interests are being protected, but the current oversight by the FSA gives no such assurance.
“Policyholders deserve a regulatory framework based on a clear set of principles and unambiguous guidance on how inherited estate can be used by life firms’ management.”