A regulatory update on closed with-profits funds
Speech by David Strachan, Insurance Sector Leader, FSA
Cazalet Consulting Conference,
29 November 2005
Introduction
Good morning. I would like to thank Ned for inviting me to speak today on a subject that is very high on the FSA’s agenda: closed with-profits funds. Just over a year ago, when I spoke on this topic at last year's conference, this now very significant sector was very much in the spotlight. For our part, we were making the critical transition from policy development to implementation and delivery of the new regulatory regime. Having seen the publication of PPFMs six months earlier, we were looking ahead to the introduction of the new capital regime and with it the birth of a new acronym – ICAS. And although it seems hard to believe it was only just over one year ago, we were of course still consulting on a number of new rules on what it means to treat policyholders fairly. In addition, there was much chatter and curiosity about the debut of the new closed fund consolidators. Overlaid on top of all of this, media, policyholder and political interest in closed funds sector was understandably intense.
All in all, these were as they say, "interesting times". To help quell some of the anxieties and address the uncertainties, in September 2004 we published our first Insurance Sector Briefing on the subject. Some 14 months later, the world for closed funds, their senior management and their policyholders has moved on. Bar a handful of some important outstanding rules on the fair treatment of policyholders - due to take effect at the end of the year - the new regulatory regime is now in place and part and parcel of day to day operations for life insurers. The commercial environment has of course also continued to evolve. Third party acquirers are now part of the closed funds landscape with six major transactions involving closed funds changing hands having taken place since 2004.
In recognition of these developments - and, I would argue, greater maturity in the sector - we felt it would be appropriate to give an update on our thinking. So, today I am pleased to announce that we are publishing a sequel to last year's Sector Briefing, focusing on recent changes and exploring the implications as we see them for firms and policyholders alike. In publishing this document, we are, I hope, making clear that closed with-profits funds remain a priority: in helping ensure consumers have a sufficient understanding of their policies; in helping ensuring consumers are appropriately protected; and lastly, in maintaining market confidence
As with all of our previous Sector Briefings – and they now number five - today's publication points to our commitment to continue engaging constructively and meaningfully with the industry - and with our wider stakeholders. I cannot emphasise enough how critical this is. As with any new regime, in the early days there is bound to be a period of readjustment – both for firms and the FSA. Feedback during these formative months is essential – and that means engagement by both sides involving a genuine exchange of experiences so that we can both learn and improve. Earlier in the month, we gave our views on the new ICAS regime and prior to that we published a similar stocktake on PPFMs. I hope this latest addition is another useful contribution to that ongoing debate.
In my time with you this morning, I'd like to point up some of the key issues included in the document, first in relation to implications for firms, and second to explore what all of this means for policyholders. In respect of this second aspect, I will also make some brief remarks on the very specific question of availability and quality of financial advice for with-profits policyholders.
Implications for firms
At the risk of standing accused of stating the obvious, I think it is worth stressing up front that there are no derogations from our new regime for closed with-profits funds. Designed to deliver an industry that is adequately capitalised, soundly managed and to help ensure that policyholders are treated fairly, the various strands of these reforms have now been woven into the fabric of the regulatory regime. I will not rehearse the details of these reforms now; suffice it to say that we think we have introduced a regime that, in time, will move us towards our goal of a healthier and more robust industry that treats its policyholders fairly.
Over the last year or so - and particularly in light of the various components of the new regime beginning to make themselves felt - we have identified a number of specific 'pinch points' for life insurers that are closed to new with-profits business. Typically, these issues tend to coalesce around Treating Customers Fairly - from which I hasten to add, there is no carve out for closed with-profits funds. Indeed, in recognition of some of the specific issues that come to the forefront with closed funds in a TCF context, we have published a case study on our website to help firms consider how they might deliver on TCF with in such funds. In the Sector Briefing we explore some of the more challenging issues relevant to closed with-profits funds including: policyholder communication; investment strategy; management of inherited estate; charging; outsourcing; management information; and finally legacy knowledge and information. You can of course read the detail of our observations on each of these in the document itself, but for this morning's session, I will focus my remarks on the first two: policyholder communication and firms' investment strategies.
First though, an important health warning. Our rules require that on closure a firm is required to take certain actions, namely: alerting policyholders and setting out the options open to them; and submitting a run-off plan to us. However, it is quite clear that there is a fairly distinct glide path towards closure. Where this is the case - in other words, where a fund is 'nearing closure' - a number of these 'pinch points' are of equal relevance to the management of these funds. And so, while there are 51 life insurers who have at least one with-profits fund that is closed to new business, I would expect the readership of the Sector Briefing to be somewhat broader.
On policyholder communication, the first point I would like to stress is that clear and timely policyholder information is non-negotiable in a Treating Customers Fairly context. Indeed, in the absence of this, it is difficult to see how firms satisfy themselves that they are complying with this obligation. Consumer-friendly PPFMs will, of course, be publicly available from the end of this year and we expect these to be written in clear and plain language that can be easily understood by most policyholders. As I mentioned earlier, we have already published feedback to firms giving our views on the standard of PPFMs and in the first half of 2006 we will evaluate the impact that the consumer-friendly versions are having.
Beyond this, though, there is the wider and thornier question of how product providers communicate with their policyholders more generally. Earlier in the year, we carried out a limited desk-based review of annual statements to get a flavour of the type and quality of post-sale information that a policyholder might typically receive. This litmus test appeared to confirm concerns here that more could be done to help policyholders.
I should of course say here that we do not mandate the provision of an annual statement; it is however a key tenet of the ABI's current Raising Standards Accreditation Scheme. We very much welcome industry led initiatives to ratchet up industry standards to deliver a fair deal for their policyholders. We look forward to seeing the outcome of the ABI's current consultation to reform the Scheme and in turn, the impact this has on industry practices. Our clear preference is to streamline our rulebook, not add to it, so I can confirm that we will take account of progress with this initiative when considering whether post-sale regulatory disclosure requirements are necessary in the with-profits sector.
The second issue that I'd like to spend a few moments on relates to a fund's investment strategy. A lot has been said on this subject and I think it is important to be absolutely clear that the FSA does not dictate what investment strategy a firm should follow. We have no locus to do so. Rightly though, our supervisors will challenge an investment strategy if it impedes the firm's ability to treat its customers fairly given the particular circumstances at the time. This last point is absolutely critical here. When equity markets fell during the early part of this decade, many with-profits insurers (both open and closed) reduced their equity exposures substantially in order to protect the stability of the fund. What is important to bear in mind here is that our non-objection to these actions depended largely on the circumstances that each fund faced at the time including what they had communicated to policyholders. But the corollary of this is that firms should consider whether maintaining this reduced level of equity exposure is still appropriate where, as is the case for a number of firms now, their financial position is stronger than it was a few years ago. We have seen cases where closed funds have increased their EBRs. Going forward we will be having similarly robust conversations with firms where there may be scope for them to reconsider investment their mix consistent with their overall approach to treating customers fairly. Clearly we are not in the market for dictating investment strategy; this is not the regulator's role. But we should challenge where circumstances have changed.
Implications for consumers
Much of what I have talked about so far this morning relates primarily to our interaction with life insurers with closed funds – or indeed those that are 'nearing' closure. But clearly, the driver behind this challenge agenda is to ensure that policyholders' interests are appropriately protected. In addition though, the FSA also has a statutory objective relating to consumer understanding of the financial services industry.
We think that consumers will benefit from the enhanced transparency and disclosure requirements which underpin the new rules on fair treatment of with-profits policyholders. And, as with any long term financial investment, consumers should consider whether their with-profits policy continues to meet their needs at regular intervals; this applies regardless of whether the fund is open or closed to new business. However, we recognise that despite the improvements we have made, with-profits, with all their intricacies, are still complex propositions for most.
To help consumers identify the issues they need to consider when thinking about their with-profits investments, earlier this year we published a list of questions on our consumer website, together with some of the considerations that they should take into account. One of the reasons for doing this was to help move the debate on from the blanket assertion that closed funds are bad and open funds are good. What is clear from the detailed work that we have done on these funds – open and closed – is that this broad brush generalisation is of little practical assistance to policyholders. What actually matters is a combination at any particular point in time of: the management of the fund itself (regardless of whether it is still open to new business); the terms of the policy; the policyholder’s needs; and the relative risks and rewards of potentially suitable alternative investments. Given the vast number of combinations of these factors, it becomes clear that appropriate generic advice is near on impossible and could at worst lead to some wrong decisions.
That said, we do think that policyholders have a right to know whether their policy is invested in a closed fund. This remains a material fact, albeit just one of many. This is why we introduced our new rules requiring firms to inform their policyholders when they close to new business. Of course, this will only help policyholders in funds that close to new business from now on and in fact since our new rules took effect there have been no new closures. So to help those in funds that are already closed, where firms have given us their permission, we have included in the Sector Briefing a list of insurance companies that write with-profits business, indicating whether their funds are open or closed. This list should be used in conjunction with the questions provided on our consumer website so that any decisions relating to the policy do not rest solely on whether the fund is open or closed to new business. We think that these two sources of information should lead to policyholders taking more informed decisions about their investments, but wherever possible, they should seek financial advice.
Before closing, it is the two words "wherever possible" that I would like to pause on, briefly. Clearly, the decision on whether to advise on new sales is a commercial one. What I want to focus on here is the issue of ongoing advice. Anecdotally, we hear that few financial advisers are proactively engaging with their customers to review any existing with-profits investments. Word reaches me that the reasons cited for this include: fear that the FSA will take action on ground of 'churning' and/or – more alarmingly if true – plain inability to give advice.
Taking these in turn, if an adviser recommends to a client that they switch out of their with-profits policy (be that in an open or closed fund) – either to another fund or indeed to another investment vehicle, and if the suitability requirements have been satisfied (including a clear demonstration that a policyholder's needs are better met by switching) then the likelihood that we would view this as a 'churned' sale is small. What I do think is worth reflecting on though is the question of capacity. Now, as I have said, to date our evidence is largely unstructured, so to help give us a clearer picture of what level and what quality of advice is actually available to with-profits policyholders, we will in the coming months be carrying out some research to give us some hard facts. In the meantime though, I offer you the following observations.
First, our latest data taken from the realistic balance sheets shows that there are £385bn of assets in the with-profits sector, £85bn of which are in closed funds. Even though the flow of new with profits business is more a trickle than a torrent, £385bn nevertheless amounts to a very significant stock of existing business. At a time when there is great public debate on long-terms savings and provision for retirement, the need for policyholders to have access to advice on their options is plain for all to see.
Second, given the number of policyholders affected and the potential for consumer detriment through lost opportunity to arise if advice is not available, it is important to consider how capacity could be increased. If one of the causes of this supply side failure is the adviser's difficulty in understanding the policyholder's position and translating this into considered and meaningful advice, then one possible solution would be to improve understanding, including through professional standards. As ever, our preference is for market led solutions, and the industry may want to consider exploring the option of some type of with-profits accreditation. First, so that advisers can be more confident that they are able to give good quality advice on these products; and second, so that consumers know that appropriately qualified help is available should they need it.
I stress though that these comments are merely food for thought – at least for now. Much will depend on the outcome of our research. What is clear though is that there is no silver bullet. We all have an interest here and I suspect that in order to resolve this collective action of some type may well be necessary.
Conclusion
I hope you have found this a useful précis of some of the issues included in the Sector Briefing. Closed funds have for some time been portrayed as the outcast of the long term savings industry. Closed funds. Zombie funds. Forgotten funds. You name it: you don't have to be an expert in linguistics to know that these are not terms of endearment. And yet when I look around me, what I see is a sector that is anything but dormant. The new regulatory environment has set out quite clearly what is - and importantly what is not - acceptable in the management of these funds and the treatment of their policyholders. Commercially, the sector feels more vibrant than it did, with signs of the potential for innovation being realised. Yes, there are still concerns over how much policyholders really understand about their position and whether they can in fact access sufficiently knowledgeable financial advice when it is needed. But to my mind these issues have been recognised and, although the solutions may not all be there yet, there is progress.
I'd be delighted to take questions.