Speech by David Strachan, Insurance Sector Leader, FSA
IEA Conference: The Future of Life Assurance 2005
23 May 2005 

Introduction

  1. Good morning and thank you to the IEA for inviting me back to speak at your life insurance conference for 2005.

  2. Just over 12 months ago I addressed the 2004 conference and looked ahead to the implementation of the reform programme that we – the industry and the regulator – had painstakingly worked to develop.

  3. Since then, with most of our reforms having been delivered and the remainder due before the end of 2005, you might be forgiven for thinking that we at the FSA would sit back and marvel at our accomplishment, safe in the knowledge that all being well in the world of insurance we can train our sights on another deserved target. Not so. Having designed a new regulatory framework, we need to make sure that both we and the industry implement it and in so doing, deliver the intended outcome. In short, an industry that is soundly managed, adequately capitalised and, most pertinently to what I'm going to talk about today, that treats its customers fairly.

  4. As some of you in the audience may know, one of the questions that an FSA supervisor might ask the senior management of his or her supervisory charge is a very simple one: what keeps you awake at night? And so in my time with you this morning, I would like to share with you some of the issues that are at the forefront of my mind; issues that keep me awake at night – my five causes of regulatory insomnia.

One: The fair treatment of policyholders in closed funds

  1. The issues surrounding closed funds continue to be high on our agenda. Naturally, we want to ensure that all policyholders in all with-profits funds are treated fairly. There is no with-profits caste system; policyholders in closed funds are not some type of underclass – they are entitled to expect fair treatment from their product provider in the same way as policyholders in open funds.

  2. We are, however, particularly alive to fairness issues in closed funds due to the specific circumstances of these funds. I'm thinking here in particular of issues such as excessive charging and the distribution of surplus assets. Against this background, we are currently carrying out a targeted review of practices within a sample of these funds to probe some of these areas of concern and to surface examples of good and less good practice in the closed funds sector. We expect to communicate our findings on this work later in the year.

  3. In addition though, there is of course also the question of how to safeguard the fair treatment of policyholders in closed books of business that are changing ownership. Although consolidation is nothing new, the recent emergence of innovative third-party consolidators looking to buy significant tranches of closed fund business, has flung our "change of control" process into the spotlight. I have spoken in some detail on this subject recently and so will only make two, headline points today. First, the two statutory tests that must be met – that the acquirer is a fit and proper person to have control; and that the interests of consumers would not be threatened by the acquirer's control – provide us with a baseline to determine whether the new owners will appropriately manage the interests of policyholders. Second, we are also able to attach specific conditions to the change of control to protect policyholder interests – for example, stipulating the amount of capital that should be held and/or restricting the amounts and timing of dividend releases to shareholders.
  4. Amidst all of this, clear and digestible policyholder communication is paramount. And although good examples are to be unearthed, they are still too much of a rarity. Which brings me neatly to my second issue: consumer understanding of with-profits.

Two: Consumer understanding of with-profits

  1. Let's start with the plain facts. With-profits are not simple products to understand. Even though the concept of a smoothed investment product is relatively straightforward, how it operates in practice is still difficult for policyholders to comprehend. Our new regulatory requirements do indeed illuminate the practices of this sector. But the question still remains as to why it is that many investors in with profits funds have yet to engage properly with what their with-profits product means for them.

  2. What makes this issue all the more thorny is the fact that beyond the generic definition of the product, with-profits typically defy generalisations. As such, generalised advice offered on a one-size fits all basis to with-profits policyholders may, at worst, result in individual policyholders making the wrong choice given their particular circumstances. That said, it is essential that there is clear and helpful information to encourage policyholders (and their advisers) to ask the right questions for them.
  3. So what is to be done? To help inject some balance to the whole with-profits debate and to dislodge some of the more unhelpful inaccuracies that were beginning to take root, we first published a document in the autumn last year setting out our approach to the regulation of closed funds. This was followed up by some targeted consumer information – ten questions designed to help policyholders think about the types of issue they need to consider when making a decision on their with-profits investments. These are relevant regardless of whether policyholders are in open or closed funds. One particular point that we have sought to highlight is the problematic maxim: "Open funds: good; closed funds: bad". Data from our annual payout survey indicates that although some closed funds perform less well and reside at the bottom of the league tables, this is certainly not true of all. Being in a closed fund may well be a material factor in a policyholder's decision over whether to continue with their with-profits investment, but it certainly should not be the only one.

  4. Individually, I see and hear of very positive moves that some providers are taking to help ensure that their policyholders have the information they need to take responsible decisions about their investments. But more needs to be done. Much more. Examples of excellence in this area need to become the rule, not the exception. There is also, I think, a need for the advisory community to take some responsibility too. Here, the anecdotal evidence is not helpful to the cause. One financial adviser asking whether he is really expected to understand the with-profits policies he has been advising on for ten years; another recommending that a policyholder stay put in his closed with-profits fund based on the rationale that as a closed fund, the provider firm would not be liable to any mis-selling compensation costs!

  5. I appreciate that some will accuse me of lingering on a couple of particularly pernicious examples, and thereby unfairly casting aspersions on an otherwise much better informed sector. In response I would say this: ask yourselves which of the following has the greatest impact on the industry's reputation: the shockingly bad experiences of the few or the uneventful experiences of the many? While the future of with-profits as we know it may be uncertain, what is clear is that the reputational damage that you suffer today will not be forgotten tomorrow.

Three: Intermediary engagement with the new world

  1. The third issue which I want to share with you relates again to the intermediary community – and in particular their engagement with and level of awareness of the new regulatory regime for life insurers.

  2. It is becoming starkly apparent that beyond depolarisation, some significant changes that have been made to the way in which insurance firms are regulated have largely slipped by unnoticed beyond the sector itself. Work we have carried out to determine industry use of the new realistic data indicated that financial advisers in particular had scant appreciation of the changes that had been implemented, let alone any views on how this new source of data might help inform their advice process. I also read the other day that just under 50 per cent of intermediaries polled had any recognition of our Treating Customers Fairly work And while I don't normally set great store by the results of opinion polls, their success in predicting the outcome of the General Election earlier this month has gone some way to restore my confidence. But even absent the percentage point movement of a swingometer, it is the flat-lining recognition of PPFMs amongst the advisory community that is my greatest cause for concern.

  3. PPFMs were designed to fulfil two functions. First, as a governance discipline, to set out clearly and comprehensively the way in which a firm manages its with-profits book of business. Second, to help intermediaries and other knowledgeable commentators compare and contrast different with-profits funds. While the first of these is clearly being met, the second is still a long way off. At the time of their introduction, we were quite explicit that we expected the PPFMs to evolve in terms of quality and consistency. And granted, some providers still have some way to go on this front. But, from the evidence we have seen to date, financial advisers are simply not engaging with these documents. To use the jargon: there is no cut-through. To be fair that is a sweeping generalisation – some, it is true, are indeed methodically working their way through the PPFMs for the funds they advise on. Others, it would appear, have yet to decipher what the acronym even stands for.

  4. One year ago, I made it absolutely clear that intermediaries should not think it acceptable simply to build up a library of PPFMs that gathered dust on the shelf. Today it would seem that I may have been overly optimistic.

  5. Quite simply, when only a fifth of advisers surveyed confirmed they are actively using these documents in the advice process this is an untenable situation. All the more so, when it is clear that if the PPFM had indicated that the product would be unsuitable for the consumer in some way, then a financial adviser could be in breach of our conduct of business rules if he or she had failed to read this document before going ahead with the recommendation. I am of course painting a stark picture for you. But I hope it is a picture in which the commercial imperative of reading and assimilating the information in these documents is abundantly clear. For our part, we are engaging with AIFA to explore ways in which to ramp up IFA engagement, but you as product providers also need to ask yourselves whether you are doing enough in terms of the accessibility of your PPFMs.

Four: Preparations for A-Day

  1. The fourth issue that I would like to draw your attention to relates to pensions reform and A-Day. On the provider side of the market, we are now gearing up to examine firms' preparations in terms of systems and controls in the light of the reforms, and in particular the issues surrounding the myriad of legacy systems.

  2. An attendant issue that has been surfaced as part of our own preparatory work for A-Day relates to the Open Market Option that consumers are invited to exercise when purchasing an annuity. It is early days, but one concern that appears to be emerging here relates to the amount of time it takes for a product provider to respond to a policyholder's request to transfer monies from their pension pot to another annuity provider.

  3. This is an area that we need to explore in more detail but the evidence we have to date suggests a wide divergence of performance amongst the providers on this front, with some responding to the OMO extremely promptly, whereas other lag quite some way behind. If we discover that administration delays are in effect negating the open market option that consumers have then we may need to consider what further action is required. We will of course be exploring this is more detail with both the ABI and AIFA, and should it be required, would be receptive to a market-led solution, such as industry-wide service standards, for instance. Which leads me on to my fifth point: Treating Customers Fairly, and in particular, the boundary of responsibility between product provider and distributor.

Five: Treating Customers Fairly – the boundary of responsibility

  1. First, I want to acknowledge the engagement and efforts of the ABI in particular, their 5-point action plan for restoring consumer confidence. I for one, look forward to continued constructive engagement on this front in the coming months.

  2. It won't surprise you to hear that as part of our TCF work, we have been exploring the interface between provider and intermediary. In broad terms, here we have found that firms are pretty clear about the split of responsibilities within the distribution chain – responsibility for the actual product lies with the provider while responsibility for the advice/suitability of the product rests with the adviser. And while this is absolutely right and proper, there remains a question in my mind - and hopefully your's – as to whether the end-customer would share this view. In a black and white world, the baton of responsibility is passed from product provider to adviser. But given brand recognition of the providers, the lion's share of any opprobrium, should anything go wrong, could well attach itself to the provider.

  3. More detailed findings of our work on this interface will be published along with other topics explored in a detailed report sometime next month. One closely related area that we have already published our findings on is that of product design. Here, although many firms recognise that TCF applies to product design, the simple fact is that many are not doing enough. Specifically, while some product providers have taken a close look at their role to help ensure fairness at the point of sale, others are taking a less proactive role in protecting consumers from what may turn out to be inappropriate risk. Encouraging practices such as provider road shows and face-to-face adviser training and testing for new product launches; the use of complaint information and persistency data to identify particular problems in the advice chain; and manufacturers' ongoing monitoring of products through their lifetimes, are all to be applauded. To my mind, these types of action truly comply with the spirit as well as the letter of TCF. Less positively though, there were also examples of firms providing limited information to intermediaries on the assumption that they will know what they are talking about as well as a number of firms where training or resourcing of service staff to provide technical support was clearly wanting.

  4. The emergence of new ways of packaging products, particularly where different components may be supplied by different providers with multiple sub-contracting, perhaps using so-called wrap platforms, has the potential for sowing the seeds of further confusion in customers' minds as to who is responsible for what. I view it somewhat differently. Put quite simply, these new style products do not have the history that has dogged others in the long-term savings market. Get TCF right now at the outset and to my mind the prospect of consumer detriment, disappointment, and ultimately disengagement further down the track diminishes significantly. This uplifting outcome is well within the industry’s grasp. But only you, working collectively, can capitalise on it.

Conclusion

  1. I've presented these five issues as things that currently preoccupy me. Quite justifiably, it may be of little concern to you that these issues keep me awake at night. When we look back over the past 12 months, we see a year of progress. As we look forward we see opportunities, as well as challenges. Are they the stuff of nightmares? They needn't be if we keep our focus, seize the opportunities and deal with the challenges. You've already proved you can do it. The recipe for a good night's sleep – not just for me, but more importantly, for your customers as well – is to keep doing it.

  2. I'd be delighted to take any questions.

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