Regulator sets out new options on inherited estates

Inherited estates sometimes called orphan assets are usually taken to mean the excess of assets held within the long-term fund over and above the amount required to meet liabilities. The liabilities, for this purpose, include those that arise from the regulatory duty to treat customers fairly in setting discretionary benefits, such as terminal bonuses. The inherited estate acts as working capital of the business. It is used to support the business by, for example, providing investment flexibility and a cushion against adverse stock market conditions. If not required for such purposes, distributions can be made from the inherited estate and shared between policyholders and shareholders.

The paper draws a distinction between attribution, re-attribution and distribution of the estate, An attribution defines the way that any such future distribution from the inherited estate would be split between policyholders and shareholders. In the case of re-attributions, one group negotiates to buy-out the others interest in any future distributions. Only if the fund has excess working capital can it be distributed between policyholders and shareholders, in line with the attribution at the time.

The FSA issues paper covers the process by which each of these processes happens, rather than the technical details of valuation and the mechanism for attribution. It includes proposals for a framework to make the process more transparent without undermining legitimate commercial confidentiality. The paper also discusses options, within this framework, for the formal introduction into the negotiations of a policyholders representative.

In brief, the five options are:

a) Modified Status Quo: The present approach, with reports by the Appointed Actuary an independent actuary and/or an Independent Expert, and the ultimate no objection scrutiny by the FSA, but with the greater disclosure referred to above.

b) FSA as negotiator: The Authority would take on an explicit role to negotiate on behalf of policyholders, in addition to its role as regulatory scrutineer.

c) Actuary or Independent Expert as negotiator: An independent actuary and/or Independent Expert would be separately appointed with a specific mandate to ensure that the best possible deal in terms of policyholder benefits has been obtained in the attribution process.

d) Proxy negotiator: A suitably qualified third party (whether individual, group or organisation) would act as policyholder negotiator by proxy.

e) Policyholder consultation: The company consults policyholders in an open and public manner

Further details of each option, together with a discussion of factors to be considered in relation to each, are contained within the paper, which is the first of a series of issues papers to be published under the FSAs review of the With-Profits industry. This review was announced in February and will itself form an important part of the comprehensive review of insurance regulation that the FSA is already undertaking.

The purpose at this stage is to stimulate debate and seek views on a series of issues and responses are requested by 7 December 2001. The FSA will draw on the responses to this paper, and those to other issues papers to be published during the remainder of the year, in bringing together the conclusions of the With-Profits Review in Spring 2002.

Notes for editors

1. The full issues paper can be found on the FSA website www.fsa.gov.uk. Copies are also available from the FSA Publications Department, Tel: 020 7066 1000.

2. The FSAs with-profits review was announced in February and is looking at the prospects for change in four main areas:
   • the extent of discretion available to management over the operation of with-profits funds and how that discretion is exercised;
     
   • improvements in the transparency of the published information in consumer literature and in the regulatory returns about with-profit funds;
     
   • better information for policyholders about the progress of their investments, including improvements in the language used to describe returns, and greater clarity about investment strategies and the way in which terminal bonuses are determined; and
     
   • the principles which underpin the requirement for firms to have due regard to the interests of customers and to treat them fairly.

   In the first phase of the Review a number of activities were undertaken to gather information and seek input to the scope of the Review, including publication of an initial Discussion Paper, an Open Meeting held on 18 June, a programme of visits to interested external parties, and consumer research. The issues arising are being taken forward in a further series of Issues Papers covering the key themes under the Review: Procedures for Handling Inherited Estate; Use of Plain Language; Disclosure, Regulatory Reporting; Unfair Contract Terms; and Governance & Discretion. A final report will be prepared by Spring 2002.

3. The FSA regulates the financial services industry and has four objectives under the Financial Services and Markets Act 2000; maintaining market confidence; promoting public understanding of the financial system; the protection of consumers; and fighting financial crime.

4. The FSA aims to maintain efficient, orderly and clean financial markets and help retail consumers achieve a fair deal.