Memorandum from The Association of British
1. The Association of British Insurers (ABI)
is the trade association, which represents the views of the UK
insurance industry to the Government and to regulatory and other
agencies. The ABI represents over 400 insurance companies, which
between them account for over 96 per cent of UK insurance business.
2. As a trade association we represent the
interests of insurance companies collectively. It is not part
of our role to comment upon or investigate individual companies
or cases. Accordingly this memorandum addresses generic issues.
3. We do not believe that the unique circumstances
at Equitable Life reflect generic weaknesses in the industry as
a whole. As we understand it, the problems at Equitable Life derive
essentially from a business decision relating to future interest
rates and appropriate levels of capital, not from the nature of
insurance-linked savings vehicles.
4. Nevertheless the Equitable situation
has given rise to a number of possible misconceptions about the
industry, the value of saving, the security of investment and
the "with profits" investment vehicle. This memorandum
aims to address these issues in a summary form.
5. Our ageing and increasingly healthy population
means that increased financial provision for retirement is essential.
The state cannot do this alone, given the costs. A mix of state
and private provision must therefore be the way forward. The Government
has recognised this in, for example, their proposal to introduce
a new pension credit from 2003; and the launch of stakeholder
pensions later in 2001. More broadly, the Government is keen to
increase the general level of saving in the UK and there is widespread
recognition that many people are not saving enough.
6. The only way of ensuring that money being
saved for the future is not eroded by inflation, and more importantly,
actually grows in value in real terms, is to invest it in the
financial markets. There it can be put to work in the economy
and so generate economic growth and earn a return for the lender.
Historically, returns from investment in stocks and shares have
been significantly higher than from corporate or Government debt.
7. The total amount of money invested by
the insurance industry in the economy is currently running at
just over £1,000 billion. For example, in 1998, the latest
year for which figures are available, £275 billion and £140
billion were currently invested in insurance company administered
personal and occupational pensions, respectively. This move towards
funded pensions in the UK has helped avoid the "pensions
time-bomb" facing some other developed countries.
8. Against this background it is important
confidence is maintained in the financial
system through an effective regulatory system;
there is an appropriate degree of
protection for consumers where, exceptionally, a company faces
savers are able to choose from a
range of investment products so that they can achieve a risk/reward
balance with which they are comfortable; and
relevant and clear information is
made available to potential savers/investors so that their choice
is well informed.
9. The primary responsibility for protecting
policyholders rests of course with the relevant insurance company/other
financial service providers. But this is reinforced by several
the regulator (Financial Services
Authority) responsible both for the prudential regulation of companies
and for the regulation of conduct of business;
the Financial Ombudsman service which
deals with complaints in individual cases that cannot be resolved
between the policyholder and the company; and
the Policyholder Protection arrangements
as currently set out in the Policyholders Protection Act 1975.
These provide for action in the event of an insolvency including
arrangements for compensating policyholders in such circumstances.
These arrangements have recently been considered
by Parliament during the passage of the Financial Services and
Markets Act 2000. The ABI supports the statutory responsibilities
given to the FSA in this legislation and supports the broad approach
the FSA has set out in its document "A new regulator for
the new millennium". It welcomes the inquiry which is now
being conducted by the FSA's Head of Audit to see whether there
are lessons to be learned from the events surrounding Equitable
10. There are many ways of investing in
the markets. At one end of the spectrum, there are various kinds
of deposit account, where the risks are lower than in other kinds
of investment, withdrawal relatively easy, and the returns commensurately
low: typically 5 per cent per annum net of tax in the last 10
years. At the other end of the spectrum is direct investment in
individual equities and other traded instruments. Next along the
spectrum are collective investments into broad-based funds which
spread the risk but nevertheless leave a direct exposure to market
movements. These include unit trusts and products linked to life
insurance (often an important additional benefit for the saver
and his or her family) such as unit-linked bonds and endowments.
Such investments have typically yielded 12 per cent per annum
in the last 10 years. These higher returns are balanced against
the need to be able to keep the money invested for longer periods,
and against the higher risksfor example the recent drop
in the stockmarket.
11. Towards the middle end of the spectrum
lie with profits policies. Like some of the higher-risk vehicles,
these can give investors and their families the security of life
insurance. But they also remove some of the risks of direct investment
in stocks while allowing savers to benefit from higher returns
than deposits. Typically, they have yielded 11 per cent per annum
in the last 10 years, comparing well with unit linked products.
12. With profits allows the company to smooth
the returns on market investments so that the saver continues
to receive a return even in "bad" years. The policyholder
gets a so-called "reversionary" bonus regularly (often
yearly) during the life of the policy. Once awarded these bonuses
are guaranteed on maturity and cannot be removed even if the value
of the underlying investments falls. Additionally, savers who
keep their money with the fund right through to the maturity date
of the policy (or if there is a death claim) get a "terminal"
bonus. These are not usually guaranteed (any more than is a straight
unit-linked investment), but reflect the value of the investments
at the end of the policy.
13. This two-bonus approach allows the policyholders
to get a combination of guaranteed returns, a lower risk of exposure
to stockmarket downturns, and the potential of higher returns
at maturity. It also means that although it is not possible to
be completely certain of the final value of a policy until it
matures, or is surrendered, the value will be less volatile than
that of the equivalent unit trust or unit linked plan. Nonetheless,
the track-record is good, as indicated above. And with profits
are a popular form of investment representing around 40 per cent
of both existing and new life and pensions business.
14. Despite this, with profits has attracted
criticisms. Some of thesefor example about the performance
over the long termare unjustified, as explained above.
Otherssuch as calls for greater transparencyare
justified. The industry has already begun to address these criticisms.
A key step in doing so is the ABI's Raising Standards Quality
Mark Scheme launched last autumn. The scheme will set new standards
for accredited brands, thereby ensuring that consumers (of all
types of investment/protection products) receive plain English
literature, regular annual updates, consolidated and clear information
about charges andfor with profits investorsa special
new "with profits" summary to explain the operating
principles clearly and openly.
15. But the industry recognises that it
needs to do more with regard to "with profits". The
Faculty and Institute of Actuaries set up a working party in late
1999 to consider how the transparency of "with profits"
might be further improved. Its report is expected shortly andin
the light of itthe industry will do whatever more it sensibly
16. Even so, it is important to recognise
that the essence of with profitssmoothing investment returns
over time when the future is unknownmeans that some discretion
must be retained by the company. The aim should be for increased
openness about the investment and smoothing policies being followed
whilst retaining the degree of discretion needed to allow smoothing
to work for policyholders as a whole.
17. Finally, although the Equitable situation
has prompted some public and media focus on the with profits concept
it is important to emphasise that the problems at Equitable have
a very specific cause which is not in any way intrinsic to the
nature of with profits. With profits remains a valuable and popular
investment vehicle and the aim should be to strengthen it further
through greater clarity and transparency.
26 January 2001