Oral evidence

Taken before the Treasury Committee on Tuesday 11 November 2003

Members present:

Mr John McFall, in the Chair
Mr Nigel Beard
Mr Jim Cousins
Angela Eagle
Norman Lamb
Mr James Plaskitt
Mr David Ruffley


Memoranda submitted by Cazalet Consulting, The Association of British Insurers

and Ms Mary Francis

Examination of Witnesses

Witnesses: MR NED CAZALET, Cazalet Consulting, PROFESSOR PHILIP DAVIS, Brunel University, MS MARY FRANCIS, The Association of British Insurers, and MR CHRISTOPHER O'BRIEN, Nottingham University Business School, examined.

Q  Chairman: May I open this morning by welcoming yourselves along. Thank you for coming and for being the first witnesses in our session entitled "Restoring Confidence in Long-Term Savings." For the sake of the shorthand writer, could I ask you to introduce yourselves.

Professor Davis: Professor Philip Davis, Brunel University.

Ms Francis: Mary Francis, director-general of the Association of British Insurers.

Mr O'Brien: Chris O'Brien from Nottingham University Business School.

Mr Cazalet: Ned Cazalet from Cazalet Consulting.

Q  Chairman: Thank you very much. We will be observing a two-minutes' silence at 11 o'clock, just so that everyone knows. It will come up on the screen just before that. Maybe I can start with the ABI, Ms Francis. The survey evidence consistently points to a very high level of consumer mistrust in the financial services industry. Do you find it remarkable that even the ABI's own latest survey showed that 38% of personal pension investors distrusted their personal pension provider when these providers are supposed to be some of our most prestigious financial institutions?

Ms Francis: Actually, Chairman, I would put it the other way round. We recently commissioned the survey to which you have referred, which was a very thorough poll conducted by U-Gov. The results, I felt, were not surprising at a time when stock-market returns generally have fallen: they showed that very few people had confidence that they are saving enough to provide themselves with a decent income in retirement. Only 4% of people were very confident that they were going to have enough to live on in retirement, and I think that highlighted the vital role that my industry is going to have, in helping to provide more for savings, going forward. We did, as you say, then ask who people had most confidence in, in delivering their pension savings. One of the lowest groups which people had confidence in was in fact the Government: the survey showed that only 15% believed that the Government would deliver on pensions; around 60% of people saving have confidence in pension providers; and slightly more have confidence in their employers. So there is a lot of lack of confidence around generally.

Q  Chairman: We are interested in the long-term savings industry here.

Ms Francis: But it seemed to me that the figure of 60% plus of confidence in pension providers was very high when juxtaposed against the 15% who had confidence in the Government.

Q  Chairman: Do you think consumer mistrust of our institutions has now risen to the point where it is significantly deterring long-term savings?

Professor Davis: One can point to some factors at least that might have caused that: the continuing fall-out of the mis-selling, for example; the pension deficits; the difficulties with closure of schemes, Equitable Life, et cetera, so I think one can definitely point in that direction, yes.

Mr O'Brien: There are a number of factors, as Philip has said. The bear market in equities over the last three years has clearly been a contributory factor which has affected not just life insurance companies but other providers of savings as well. I think that one would also, in due course, in terms of restoring confidence, think about the financial education of consumers and their understanding of the risks involved in long-term savings so that they have a better appreciation of the risks and rewards.

Mr Cazalet: The word "confidence" I think is quite interesting. What is that confidence or lack of confidence? Is it in the life insurance companies themselves or is it in the products and the surrounding regime? We have had a ludicrous debate in the industry recently about opting in or out of SERPS: it has occupied many newspaper column and taken up a great amount of brain power trying to work this out. I think that, perhaps, more fundamentally, consumers need confidence in the overarching structures, whether they be tax structures, benefit structures, that will remain constant, so they can plan with some degree of security as well. I think you need probably to take those together rather than just say it is the insurance companies. I think you need to look at the environment in which they operate.

Q  Chairman: Is there a notion maybe that people can beat the market, when you cannot beat the market at the end of the day?

Mr Cazalet: I think this is something else. I think it is getting more and more difficult. If you look at the behaviour of asset classes of shares and bonds, it was probably the case in the 1980s, and in fact it was the case in the 1990s, that the stock market did go up by large amounts most years - by 10, 15, 20% - and that probably made a lot of sense, compared to sticking your money on deposit or even sticking your money into gilts. What we have seen happen, first of all, is that the stock market has fallen very sharply. But what we see, going forward, is that there is not going to be a significant difference in the prospective returns available on equities as compared to what you might be able to get on gilts and that is something that is new. Therefore, if the insurance industry, in particular, is going to try to package up equities and charge for explaining this, and the packaging, manufacturing, distribution and administration, the margin between equities and bonds is now much narrower than it has been and therefore that is going to eat into that margin further. So there is a question, fundamental question, for the industry - and it is not to beat up the industry but it is a question the industry has to address - whether its products actually make any sense, to say to the consumer, "Come along and invest in this product. It is perhaps with profits, it is quite complicated. We are going to put the money in equities and we are going to do all of these things and at the end of the day you might just do slightly better, if you are lucky, than a cash ISA." That is something that is new, that new environment of how asset classes are behaving.

Q  Angela Eagle: Could I just ask Ms Francis, do you not think your answer abut the insurance industry being more trusted than politics is enormously complacent, given the mis-selling standards that we have seen, the fact that people who are taking out products have very good cause to be wary of your industry? Do you not think you would be better spending your time thinking of how to improve confidence in your industry by its performance and cutting out things like mis-selling of pensions and endowment mortgages, precipice bonds and the rest of it, so that people can have confidence? It is not really an answer to come here and say, "We are more popular than politicians."

Ms Francis: I was answering a factual question about what the survey that we had conducted showed. The factual answer is that those were the results, that people had least confidence in government, that they had a good deal more confidence in their pension providers, and they had somewhat more confidence still in their employers. Those are the facts of what came out of the survey. I could not agree with you more, that the industry needs to work very hard indeed, and the ABI is working extremely hard on its behalf, to look at ways of improving consumers' confidence in the industry, improving standards in the industry, and improving consumer education and information. My association is doing an enormous amount in those areas. We have a voluntary quality mark scheme that sets very high standards of plain English and disclosure which an increasing proportion of the industry is gaining accreditation to, but it is not easy to do so. I would not like to leave you with the impression that this is not the Number One issue for us about how, after a period of very low equity returns and after episodes that have led to a decline in consumer confidence, it is important to regain it. I think, as Ned Cazlet said, the actions do not only lie with the industry but they certainly lie a good deal with the industry. But other things like the regulatory climate and, indeed, actually just what happens to markets, in terms of whether returns do recover or not, will be very important in whether consumers do or do not have confidence in saving through equity-based products - and, indeed, bond-based products, because I should just explain that our industry packages investments generally.

Chairman: If we may move on. Your own submission states: "With trust and understanding at extremely low levels, many people are putting their faith in property." Given that you have identified a 27 billion savings gap, that is a big issue and we want to explore that.

Q  Mr Plaskitt: There is this concept out there of a savings gap. Very succinctly, how would you define it?

Professor Davis: I suppose it is calculated according to projections of asset returns and projections of earnings. One can calculate what would give one two-thirds of final salary, say, at retirement, and then calculate what people will actually get according to those projections and according to current levels of saving. That is my understanding, but the numbers were not produced by me.

Q  Mr Plaskitt: The ABI is suggesting that the gap, however defined, is 27 billion. Do you think it is possible to measure a concept such as the savings gap with such precision?

Professor Davis: I think one always has to produce some numbers, but one would want a sizeable confidence interval around it, definitely. We do not know what is going to happen to asset returns. There may be some other aspects that could help; for example - and this is something you may want to talk about later - whether the housing assets that people have built up could be liquefied for retirement much better than they are now. It does not revolt me, if you like, the number 27 billion. It sounds reasonable.

Q  Mr Plaskitt: I take it from what you are saying that we would probably be misguiding ourselves if we tried to come up with the number for the savings gap.

Professor Davis: Yes.

Q  Mr Plaskitt: It probably is not quantifiable to that precise degree, is it?

Professor Davis: No, but I think, nonetheless what it points to is the issue that, on reasonable projections of asset returns and average earnings a lot of people are going to have rather low retirement incomes, and that that will be an issue of concern.

Q  Mr Plaskitt: When those calculations were made, which assets are taken into account and measured?

Professor Davis: I am not privy to that information. The ABI, who produced some of the estimates, would no doubt have more to say than me, but I would assume it is some sensible combination of equities and bonds.

Q  Mr Plaskitt: Does anyone know which assets are measured when we are making this calculation?

Ms Francis: Perhaps I can help. The calculation of around a 27 billion savings gap was reached by the consultants Oliver Wyman whom we asked to look at the issue. They looked at a broad range of returns on assets.

Q  Mr Plaskitt: Which assets did they look at?

Ms Francis: I could certainly write to let you know the exact combination, but one of the factors that was taken into account in reaching the figure was that people who had property assets would choose to use a certain proportion of the assets towards their retirement income. So one of the grounds on which that figure has been criticised, that it did not take into account people's ability to release money from their property, actually is not the case.

Q  Mr Plaskitt: It is impossible to know with any precision, is it not, the extent to which people in general are going to liquefy their profit assets? It is pure guesswork.

Ms Francis: Yes. Any forecasting of any kind has to make assumptions which may not always prove to be completely accurate. I think probably what is more important is that, whether you take the ABI's figure or the Department of Work and Pensions figure of up to 13 million people not saving or not saving enough, what comes through is that there is a very substantial gap between what we are saving and what we need to save.

Q  Mr Plaskitt: Should we be paying any attention to the saving ratio? Does it mean anything nowadays?

Professor Davis: We have to remember that the saving ratio is a combination of different components. I would suggest the three most important are: contractual saving (which is what we are mainly talking about here: saving in pensions and life insurance); discretionary saving (what one may put or not into bank deposits, ISAs, et cetera); and then the deduction of the increase in liabilities. In a sense, the tail has been very much wagging the dog, it seems to me, in recent years: we have had a huge growth in the flow of liabilities into mortgage debt, and that has reduced the saving ratio, but that is not telling us the sub-component of more relevance here, which is how much people are putting into their pension funds or life insurance. I think the other aspect of the saving ratio that one has to be careful about is that it is obviously a macroeconomic aggregate, so the distributional aspect can also be relevant if a certain segment of the income distribution is not saving at all or may be doing something rather different. That may be a concern independently of the aggregate data.

Q  Mr Plaskitt: People sometimes point to the saving ratio and say, "It is down at 5%" and declare that as a reason for concern. Should it be?

Professor Davis: As I say, it depends what one thinks about these sub-components. I think there could be a concern because people may be borrowing too much and they may end up with liabilities that they cannot repay. That is not the issue for you today, but that is where I would focus my concern. But it is important, of course, to say what is happening to contractual saving. We know that there are some issues there - for example, lower contributions to defined contribution plans and defined benefit - that may be a part of it too.

Q  Mr Plaskitt: I am trying to establish whether this Committee in this Inquiry should spend much time on concerns about the savings ratio, and how informative an instrument is it in terms of telling us the reality of what is going on in the economy today in respect of long-term savings.

Professor Davis: Let's just say it is a starting point but it is not where you should end up. You need to get into the sub-components and the distributional aspects.

Mr O'Brien: There are different measures for savings ratios and some are more helpful than others. For example, if you have people in retirement who are not earning but they are running down their assets, then that is dis-saving. There is nothing wrong with that, that is fine, that is what we would expect, but of course that is a negative effect on the saving ratio. That is why I think one does need to get to the sub-components actually to understand what is going on. If one wants to focus on what is the amount of long-term saving that people are doing for their retirement, then that is the component to focus on. Whilst I do not know the details of the 27 billion figure, clearly it is focused on some assumptions about: If the target retirement income for people was (whatever proportion) of their final salary, then this is the regular saving that there would need to be. What saving is currently taking place? And then: What is that gap? If one has a proper understanding of what that target assumed to be is, together with the other assumptions going on about future asset returns, then that can be quite a helpful concept.

Q  Mr Plaskitt: There has been a change in relationship over the last 40 years between the savings ratio and inflation. All the way from 1960 to 1990 the savings ratio mostly lagged behind inflation. Since then, it has run considerably ahead of it, over almost all of the last decade. Should we read anything into that of significance?

Professor Davis: Can you explain, sorry, what you mean by lagging behind inflation or running ahead of it?

Q  Mr Plaskitt: If you plot the two indices against each other, since 1990 the savings ratio as a percentage figure has been running higher than inflation, which it had not done for most of the previous years. Should we read anything into that in terms of the way savings have changed?

Professor Davis: I can say a few words about that, if you like. I think that an important influence of inflation on saving used to be present, particularly in the seventies and eighties, because people held a large proportion of net liquid assets, and those net liquid assets made losses when we had inflation if the interest rate did not rise sufficiently. When I was at the Bank of England in the eighties and we were estimating consumption functions, that was an important component of it. We also in those days had more credit constraints - you will remember this was before financial liberalisation. More recent research which I have done with colleagues at the National Institute suggests that we have switched into what one might call more of a life-cycle saving model. Therefore, what tends to drive consumption and saving may be more the long-term assets' wealth effects - the pension, life insurance, equity, et cetera - rather than these narrower inflation effects on liquid assets and the sort of monetary type variables. Obviously also we have this factor of the mortgage borrowing as well. I think that is a bit of an explanation. What we saw in the eighties was something of a decline in savings, which was natural because we saw the wealth effect driving up consumption: people were earning a lot on their equities, et cetera. What we have not seen yet but one would expect in due course, is a rise in saving because the wealth effect has gone the other way.

Q  Mr Plaskitt: We now have very low inflation, low interest rates, so nominal returns do not look that attractive. We have had plenty of years of very lenient stock markets. It is not surprising that the savings behaviour of people will change. Money is going into instruments that it did not before. Do the ways in which we measure this reflect the changes in people's behaviour, given those very substantial changes in the certain key realities of the economy at the moment?

Mr O'Brien: An aggregate savings ratio hides all sorts of things that are going on, and I think we need to look into what we are really interested in and focus on measuring that. That can include aspects such as what amount of saving is taking place; what might it expect to build up to; and, if there is a target of pension that we might expect people to wish to have, then what is that difference. There is further work to be done on getting to the figures of what we are really interested in.

Professor Davis: Briefly, adding to what I said before, whereas we have seen the wealth effect in principle boosting savings by telling financial asset prices, the real asset effect has gone the other way with house prices going up. So people may be lulled into thinking they do not need to save because of the value of their houses, in other words, and the balance between the financial asset and the real asset wealth effect is an interesting one.

Q  Mr Plaskitt: Are they lulled into it or is it deliberate strategy? ABI's paper tells us that 32% of people plan to use money from their property to fund retirement. If one-third of people are now strategically putting money into property for retirement, do our provisional measures of savings reflect that or is it a fact that we miss?

Professor Davis: We need to look at the balance sheet as well as the flow, definitely.

Ms Francis: May I comment briefly on that. I am sure that, looking forward, more people are hoping to use their property to provide some retirement income. I think a question I would ask is whether people have been over-influenced by the increasing value of property over recent years into assuming that in the long run property will always outpace everything else. That is not what figures to date indicate. We were quite worried that the survey that we conducted recently showed people having a very, very heavy confidence or trust in ultimately being able to release some money from their houses if all else failed. I would question whether that might be a rather over-optimistic view. I would not believe that property will not have a role to play, but I think there is a danger of people putting too much trust in it.

Q  Mr Plaskitt: Is it any different from over-optimism in equities in the eighties?

Ms Francis: The long-run expectations about equity growth tend to be rather more stable than those about property. But I would not disagree that property has a role to play; I think there is a danger of people putting overmuch reliance in it is all I would say.

Mr Cazalet: The 27 billion figure fascinates me for a number of reasons. Firstly, because I discovered that it was the total amount we spent two years ago in this country on booze and tobacco, so it is a big chunk out of people's expenditure. Looking at it another way, it is equivalent, roughly, to about nine or ten pence on the basic rate of income tax. I guess I am saying that when people talk about reasonable projections for what people ought to save - and we can fine tune this as to whether they are going to release money from property or whatever they are going to do - looking at this, you say: Do you really want to wish for this? Do you really want a situation which is probably equivalent to that which we have had in Japan in recent years, where people save, if you like, too much? Because you have talked about inflation and interest rates, but, if people save too much, that will suck life out of the economy, so we could end up with mild or rather serious disinflation and deflation. Therefore, if you are offering a 0% interest rate or a 0.1% interest rate on a bank account, virtually inflation is -2%, and all of a sudden the gear stick has come off your motor car. It is all very well to talk about targeting this and "If everybody saved this amount of money" but does this make a lot of sense? Therefore, if this was negative to the economy - and let's say that it is - would it be worthwhile for people to save in dressed-up, packaged equities if we are going to be in a Japan situation? That is what worries me about the broad number. It may well be that actually we should be saying: What are the other levers we need to pull in terms of ensuring a satisfactory retirement income? Is perhaps the more fundamental question: Should we be retiring at 60 or 65? A man who gets to 60 will live probably to 78/79; a woman who gets to 60, probably into her eighties. Is it reasonable for us to talk about saving 27 billion a year so that when we get to 60 we can loaf about for 20 years? Those are things which need to be put in the balance, otherwise talking about 27 billion is meaningless. We will never, as a country, save 27 billion a year. People just will not do that. They do not have the money. It is equivalent, probably, if we say there are broadly 27 million people in work, to about 1,000 a head. For someone who is taking home not much more than 1,000 a month, that is a lot. People talk about the interest rate rise last week, a few pounds a month: Shock! Horror! We are talking here about 100 a month or 150 a month. I just want to introduce that broader issue, to say that I think we need to talk about this, rather than saying that theoretically the number is this, multiply it by this and we are all safe and happy. I do not think it is that simple at all.

Q  Chairman: I want to look at the issue of returns to savers - the issue of with-profits policies and smoothing. Smoothing has got me beat, so I am looking for some answers as to what this means. I read in the Financial Times that John Turton of Bestinvest says, "Unless it is contractual and written down in black and white, I don't believe it. Buying a with-profits policy is making a leap of faith, because you can't identify how fair they will or won't be." And Sandler states that "most providers of with-profits policies do not disclose their underlying investment performance at all." Is it acceptable that savers are given no information of their underlying investment on a with-profits policy, when we consider that there are performance records and league tables for unit trusts and savings deposits in most of the weekend broadsheets but we do not see anything on with-profits?

Mr Cazalet: The disclosure regime is changing. It has only been changed because a sharp stick has been pointed at the soft exterior of the industry, it has to be said, but the Regulator is introducing and has been introducing a whole set of requirements on insurance companies. There is a new regime called Principles of Financial Management, so if you have a with-profits policy or you are going to take one out, the insurance company will be obliged to set out in some rational format what its objectives are, how much money it is going to have in which sort of asset classes, how much the fund has returned and other useful information. The problem is that this has happened, I think, principally because the Regulator has said, "Guys, enough is enough." I think there is an issue for the industry. Even a year or so ago - and I know John Turton and I know Ron Sandler - we were hearing life companies say it would not be in policyholders' interests to be told what the underlying rate of investment return was. Even this year, last year, we were encountering life insurance companies that were very reluctant indeed to talk about how they had invested the assets, how much was in bonds and how much was in property. We have had insurance companies on the record, in newspapers, saying that it would not be in policyholders' interests to be told what the surrender charges were on aggregate. One company said it would be unhelpful.

Q  Angela Eagle: For whom is the question.

Mr Cazalet: That is the matter. So I think the regime we will have soon is going to be a good regime. I think the industry should take very little credit for the coming about of the regime. There has been this extraordinary reluctance to open the door, on the grounds, perhaps, that if people knew they would make rational decisions and vote with their money - which does not say a lot for it, I am afraid. But the regime is changing, and I think for the better.

Q  Chairman: Are there any other comments?

Mr O'Brien: There is a survey of the returns on with-profit endowments that matured earlier in this year. If you look at 10-, 15-, 20-, 25-year endowments, then that survey says that with-profit endowments have actually done pretty well. They have provided higher returns than unit-linked policies and they have by-and-large provided higher returns than you can get on a 90-day notice account, and so on. That survey says that there is some good news and there are some companies which have produced good returns in those circumstances. The surveys typically do not include some companies that decline to participate in those surveys. I think it is good news that the FSA is changing its regulatory returns so that people will be able to see more clearly what the returns have been from all companies, and that will be available to analysts to do that. Of course the survey does not actually talk about the people who have surrendered their policies and who have had a very poor return.

Q  Norman Lamb: So it is wholly misleading.

Mr O'Brien: It says that in some circumstances it is fine; in many other circumstances it is not fine. The other aspect is that that survey was done at the beginning of this year. Companies have been smoothing their payouts so that the payout compares with the underlying asset share (in other words, what the premiums have actually bought), and at the beginning of this year, I would guess, even though the payouts have reduced more than the normal amount over the last couple of years, companies would often have a rule that says, "We don't intend to reduce the payout by more than 10% in any one year," and the circumstances have led companies to reduce payouts by, say, 20%rather than 10%. My guess is that for some companies that reduction in payouts is still leaving them paying more than the underlying asset share. That means that, even though equity markets may be improving, there is still some catching up to do, and the industry will still be wanting to reduce payouts further because it has actually been overpaying at the beginning of this year.

Q  Norman Lamb: It is all entirely opaque.

Mr O'Brien: Well, you are lost for words on that. Ned is right, the principles of financial management that companies will be issuing earlier next year will help, but even so my view is that with-profits will still be an act of faith and that you are not going to be able to understand exactly what has gone on.

Ms Francis: May I add to that. I think it is worth pointing out that the amount of with-profits business that insurance companies are selling now is considerably reduced. In fact, it is about a proportion of 60:40 that is now unit-linked business. So, if you are conducting an inquiry into the insurance business, it certainly should not be focused only on with-profits business. Insurance companies sell, for instance ----

Q  Chairman: We will decide that, Ms Francis, if you do not mind.

Ms Francis: It is just to say that any view of the insurance industry needs to cover the whole range of what it does.

Q  Chairman: We will convene after the evidence today and then decide exactly where we are going.

Ms Francis: Yes.

Q  Chairman: We have had Mr Tiner and Mr McCarthy in front of us and they have expressed confidence - indeed, absolute confidence - that this package of reforms in the industry would at last make it possible for the consumer to distinguish between good life insurance companies and bad life insurance companies. I would like you to address that question. Do these proposals in CP167 issued by the FSA adequately address the problems widely identified in this industry? Lastly, on that point, I am aware that the proposals of the FSA fall short of requiring companies to publish regularly and explicitly their investment performance records. Without this information, do you think it is possible for consumers to take a fully informed view of the performance of the companies managing their savings?

Mr Cazalet: That is one heck of a claim, that consumers will distinguish between good and bad insurance companies. I run a business that makes quite a good living out of trying to distinguish between these and our clients include consulting actuary practices, reinsurers, investment banks and so forth. Our clients include big firms of actuaries. We are very train-spotterish in what we do: we do not get out very much. I think the idea that the consumer - and this is not to be patronising - is actually going to get a real handle on this, and say, "D'you know what? The Norwich Union, I rate them below Prudential," as if they were discussing football teams on a Saturday .... I think it is very complex. It goes back to this confidence thing. If with-profits is going to survive, then it needs to be seen - so this disclosure stuff, the fact that the stuff is in the shop window. The consumer may not be able to put it altogether, but I think the industry needs as a first step to say, "Actually, here is the information, if you can be bothered to look at it." Even people like John Turton, well-known IFAs, struggle, and we have come across financial advisor firms, large names, who struggle, to get meaningful information from insurance companies. The idea that we can make a big leap, from this being totally impenetrable, to the average man or woman on a Clapham omnibus saying, "Yes, I understand all this," I think is not going to happen and is not real. But I do think those disclosure elements, first off, will allow informed debate. The more information there is, the more people can form opinions. They may form the wrong opinion, just as you might have reams of analysis of a stock-market listed company and have ten analysts say it is a buy and then it falls over and goes bust, but at least, I think, from that point of view the availability of information is a starting point. As for the consumer, on with-profits, at any rate, distinguishing between good and bad, I think that is very difficult. People were led to believe that Equitable Life was the bees knees 15 years ago - it was written up in the newspapers as being such and so forth, and they were actually the most open company with their numbers - and look what happened to that; and some other companies which have been very obscure have actually performed rather well. But I do think openness and accountability and a better regulatory regime, where the regulators themselves have some idea of what they are looking at, will also help. If you look at some of the companies that have not gone bust but disappointed, where returns have been far below that which people thought they were going to get, and genuinely far below reasonable expectations, what was the Regulator doing? What was the overarching regulatory environment? At which point were people called in to explain their actions? I think the idea that you can write a CP167 and put it into print and the consumers will be wholly on top of this, is not going to happen; I think it is going to be much more incremental progress towards that aim.

Professor Davis: I agree with the points made. In a sense, consumers are just so far behind that, again, they do not understand the products themselves so how are they going to evaluate the life insurance companies? What that points to is a need for long-term consumer education. We need lessons in school on all this stuff. Nevertheless, one would hope that some sort of Morning Star type rating, which is something that happens in the US for mutual funds might help improve consumer information. Whether that sort of thing could develop in this country is unclear to me. I do not know if your firm is working towards that.

Mr Cazalet: We have already, sir, but ....

Professor Davis: No consumer takes any notice of it.

Mr Cazalet: We sell them to other professional bodies. But, yes, it is very difficult.

Ms Francis: Chairman, I very much agree with what has been said. I think the role of the Regulator here is terribly important. The point of having a powerful and expensive regulator in the form of the Financial Services Authority is to be able to examine the precise financial details and financial strengths of individual companies in a way that the individual consumer cannot do. I think it has to be said that the business of long-term saving is an inherently complicated one. If you are saving for a pension for 30 years and you are wanting to link that pension to growth in the equity markets and other asset markets, then the business of matching what is the expectation at the end to what to invest in is a difficult one. It does seem to me that the Regulator has a crucial role here in monitoring companies' strengths.

Q  Chairman: I have spoken to the Regulator. He says he is dragging the industry along on issues such as realistic reporting.

Ms Francis: On the question of disclosure, the ABI two years ago, three years ago was working very hard indeed on proposals for greater clarity in with-profits, many of which were actually adopted by the FSA in its own decisions and new regime.

Mr O'Brien: I think one organisation which it is worth taking note of is the International Association of Insurance Supervisors (IAIS), which FSA is a member of, along with the other insurance regulators throughout the world. IAIS has issued a document about market disclosure, which talks about the information that should be disclosed by insurance companies so that people participating in the market, be they customers, be they shareholders, should understand the financial position of the insurer and the risks to which it is exposed. With-profits in its true sense means - and there may be variations of with-profits that are now being developed - that the policyholder is actually participating in the profits or losses of the enterprise, therefore it does need an understanding of the financial position of that enterprise and the risks to which it is subject. That is particularly important, moving forward. In the past, for example, companies that have had compensation payments for pensions mis-selling, with-profits companies, have been able to make those payments out of their surplus assets, so that policyholders' asset shares and returns that they get are not affected by that. However, in current times, the surplus assets of with-profits companies are significantly lower than they used to be. The concern I have is that if there are further risks to the operation of the insurance company as an enterprise, then, if we are not careful, it will impact on the returns to savers because there is not that cushion there to absorb it, and that means savers do need to understand the risks to which the enterprise is exposed. And whether or not that is actually the savings element that they want, I think is an important question.

Q  Mr Cousins: May I just ask Mr Cazalet a rather more simple question. Is the basic structure of with-profits (that is, embedding returns, smoothing, and big terminal bonuses supported by big reserves), a valid structure any more?

Mr Cazalet: I think the key words there for me are "any more". And I speak in aggregate here - there are still companies that are very robust, so I do not want to tar them all with the same brush. I think the history of with-profits was a bit of an accident, with companies perhaps being a bit too prudent and accumulating surplus, excess capital, and saying, "What do we do with it?" and "Let's use that to smooth." The impact on the industry over the last three calendar years, as we have measured it ... We have tried to say, "How big is the industry?" We can do that very precisely. Then we want to look at how it has been affected by poor investment returns. Bear in mind that life insurance companies are companies, they have balance sheets, it is not just about the investment return, so, on the assets side, what has happened there? The assets have gone down and down. On the liabilities side, what has happened there? They have gone up in value. Some of that is just normal liabilities, but some is just things like companies that have offered guarantees and options to their policyholders did not properly reserve for them because the rules said they did not. The Regulator says, "Hang on a minute, here. This does not stack up. Tighten your reserving." So what you have is a squeeze, with the assets going down and the liabilities going up and the amount of money squeezed out of the middle is in excess of 100 billion when you take everything together. Bear in mind that the with-profit industry three years ago was 340 billion in size, something has happened. The people who have paid for this effectively are the policy holders because the amount of excess capital basically has fallen off a cliff and therefore the ability of these life insurance companies, first of all, to mismatch by saying, "We will give you guarantees that we can play in the stock market," that has been shot to pieces. Then to smooth returns - as Chris was talking about, the idea that you can smooth that out - well, you need something to smooth it with. What we have seen is that in past years the amount of change between policy values from one year to the other would have been quite gradual. It is now, for some companies, quite steep and quite alarming, so that somebody who has been saving for 24 years on a 25-year policy might be getting a statement saying, "When your policy matures next year it might be worth 50,000." "Oh, goody, I'll pay my last 12 months premiums" and then you find at the end of the 25th year it is actually worth a much lower amount than it was before.

Q  Mr Cousins: Exactly so. My question is: Are the basic design features of with-profits - embedding returns, smoothing, big terminal bonuses - now obsolete?

Mr Cazalet: I think for many companies they have become obsolete because the markets and their own liability issues have blown away the spare capital. I have to be careful on this. There are some companies that can still operate with-profits as we have known it and not give people nasty surprises, but for many companies - and you only need to read the newspapers from one day to the other - it is: Shock! Horror! This that and the other. Bonuses slashed! Closure to new business. Et cetera. The reason why that is happening is because that excess capital has been blown away. Why companies are closing to new business is because they do not have the financial wherewithal to write this business any more. I do not know if that answers your question.

Q  Mr Cousins: The implication of that is that we should not be thinking about cleaning up with-profits, we should be thinking of closing it down.

Mr Cazalet: I think closing us down is a bit radical. The with-profits industry is over 300 million in size, so what do you mean by closed? Quite a big chunk of it already is closed, in terms of closed to new business. As Mary Francis pointed out, life insurance companies are increasingly not writing with-profits but are focusing on something else. But the idea of saying to the Prudential or Norwich Union, "We are somehow going to close you down," I am not quite sure what that means. I mean, they have policyholders, the policyholders have contracts. I think that over a fairly lengthy period of time these things will run off and the size of the with-profits sector would go down and down and down, that is for sure.

Q  Mr Cousins: Does that not only work if you can find more saps to put their money into it?

Mr Cazalet: I would not put it quite that way. I think that when companies run out of capital, the idea that you can keep your life company going and have people coming in the front door and sign them up and mug them as they go out the back door is not a tenable business proposition. I do not really see that as a way forward, which is why we have seen so many companies close. The idea that you can just basically hit a bunch of people and make monkeys out of them, in that sense, is not what is happening.

Professor Davis: I think, in a sense, we can see the with-profits policies as aiding consumer choice. In a sense, one could have at one extreme a kind of unit trust, mutual fund, where all the risk is transferred to the consumer; on the other hand, you can have continental European-style life insurance where the promise is very close to the amount one expects, so there is no scope there for taking the higher returns from equities; and we can see that as a kind of intermediate point between those two extremes that adds to consumer choice. In a sense, though, the current situation really makes it difficult and I thoroughly agree with what was said just now.

Q  Mr Cousins: Does that justify building an enormously expensive industry on the back of something that could be run like a Post Office savings account?

Professor Davis: One has to say - this is relevant but slightly tangential - that it was partly driven, I think, originally by taxation as well, and taxation has often driven the complexity of savings products.

Ms Francis: May I just comment on what is the with-profits proposition. Smoothing is still working for people in this current year. A 10-year with-profit bond which is maturing today is yielding, on average, about 4%. It is still yielding a positive return. The talk of slashing bonuses is only that returns are lower - as you would have expected at a time of falling markets - than they have been in the past. The average unit trust is yielding only just over 0% and many people are seeing very, very heavy losses on more direct investment in shares through things like unit trusts. With-profits are still yielding a positive return and you could say that smoothing is working. The fact that returns may be quite modest, looking forward, for a while is again with-profits operating on the smoothing function. Perhaps, just to throw in one other illustration of the balance between with-profits and other business: my industry invests nearly 1,000 billion on behalf of savers and pensioners, and about 300 to 400 of that is with-profits. I think it is important to keep this in proportion.

Mr O'Brien: I think some of the benefits of with-profits can now be met by different means to avoid the situation where we have lots of discretion and lack of transparency, so I think there are now products in the financial markets that firms can invest in that can actually deliver smoothing on a more mechanical basis than we currently have with with-profits. So instead of having discretion as regards to the figure that we smooth the payout to, fund managers can actually buy financial instruments that do that smoothing and it is defined so that the customer would know what kind of return they are going to get. Similarly, with life-styling on pensions products you can buy unit-linked pension products that move people into more secure investments the nearer they get to retirement, so that their pension pot is not subject to a wild fluctuation. Those developments, I think, we did not have when with-profits was invented, and I think the industry can look and should look to these more mechanical ways of delivering the benefits of with-profits without the need for discretion, and it would do it in a much more transparent way.

Chairman: Okay. Nigel, asset allocation.

Q  Mr Beard: In the allocation of assets in the investment process, the United Kingdom insurance industry has had a very heavy emphasis on equities, whereas insurance companies overseas have put much more emphasis on investment bonds. Why is that?

Ms Francis: I think it is because, in the UK, the way the industry developed was that it invested the premiums of people who were initially buying life insurance, during quite a long period of time while the money was not needed, in assets which gave good returns. The equity markets are very deep and well developed in the UK and that was one very natural place to put the money. Over time, equities have yielded extremely good returns for British savers, and increasingly those funds became linked to savings policies as well as just straight term life insurance. As I say, they have yielded a very good share in the growth of national industry and the economy for ordinary people in the UK. In the last few years, as the value of equities has fallen, so insurance companies have scaled back their investment in equities - quite sensibly - and more into fixed interest things, like bonds,. In some continental European countries, like Germany, we have seen that insurers have gone the other way and leapt onto the equities bandwagon, just at the time when the growth went out. So in the UK, I think, we have seen a fairly expected path from equities moving back into more fixed interest securities as equity markets have fallen.

Q  Mr Beard: I understand the virtue of putting money into equities, but why did America, for instance, not follow the same route?

Professor Davis: I think in many countries, other than the UK, the regulation has driven the life insurers - and others may comment on this - towards a structure of policies where the guarantee element is very large, and therefore the scope for investing in volatile assets, such as equities, is rather low. In a sense, the reason we can invest endowment, et cetera, policies in equities is because the implicit promise is about three times the amount of what is actually guaranteed, so the life insurer is not taking risks with its solvency; whereas in other countries - and I think this does include the US, as well as continental Europe, Japan, et cetera - the margin between what is expected to be obtained and what is actually guaranteed, and therefore a matter for solvency, is rather small. The other aspect to which I think you alluded is that UK life insurers do run a lot of pension business and pension business is naturally in equities; US life insurers do not tend to do that.

Mr O'Brien: The regulators in the continent have put quantitative restrictions on the life insurers' investment in equities. So Germany has had rules - and I am not sure of the figures, but it is about 30 or 40% maximum in equities.

Professor Davis: It used to be a lot lower as well.

Q  Mr Beard: In the nineties, dividends were more taxed than they had been and the dangers of this bubble in equities was warned against by central bankers as "irrational exuberance". Why did the industry persist in this policy? Was that not, to a degree, reckless incompetence?

Mr Cazalet: Because that is what had worked for them in the past. We have looked quite a lot at what people were doing and I think the people that were perhaps, let us say, in their forties and in the life insurance industry, all they had ever known really, going back to the mid-seventies, when we had that dreadful crash, was stock markets actually performing jolly well and people really hooked into the mantra that equities were good and bonds were bad. And, to be fair, looking backwards over those 10 or 15 years, in most people's work experience in the industry it had been the thing to do. I guess people were very reluctant, because we have had some discussions - some of which might be recategorised as furious rows - some insurance companies saying, "Why on earth do you have 80% of your fund in equities? Is the fund not getting riskier and riskier?" And it was quite staggering, a year ago/two years ago, people would say to us, "You don't understand equities, stock markets are going to go up," and they would give you 50 reasons why the stock market could not fall. But I think the thing that was driving that was that in the past it had worked and they believed that the past was going to replicate itself in the future. When we warned people about the risk to their liabilities and how quickly that could flip over, and you could go from being a fund of 80% in equities and financially strong, to actually a fund ... We have seen some dramatic movements. Just broadly, across the with-profit sector, going back two years ago, the typical weighting in equities was 65%; it is now about 30%, and within that we have seen companies go from 80% in equities down to 20, and 65% in equities down to zero, and 50% in equities down to nil. I will leave you to work out which companies those are. But one of the pressures was that of past performance: "If we move out of equities now, people will take that as a sign of weakness; only weak companies do not have 60, 70, 80% in equities." The whole marketing story around this was built up on the past. I think it was very difficult for people running companies to have impertinent people such as ourselves, say, "Hang on a minute here, maybe the future is not going to replicate itself." I think there was a risk in the minds of people running companies that if they did make a move they would suffer for it. People would say, "You are doing this out of weakness, not out of prudence." That sort of group psychology, I think, is a fascinating thing to observe and a lot of people got burnt because they stayed in equities too late.

Q  Mr Beard: So this belief that the bull market would continue forever, really, was a collective recklessness?

Mr Cazalet: One company told me rather forcefully when the FTSE was 5,200 about 18 months ago, that the market was at a major low, but the market then fell to 3,300, and they bet the firm on this. They were fairly violently abusive about their commitment to equities. It was the idea that what we are about is packaging equities. Also, the intermediaries in the market, the IFAs, were choosing companies that had bought into this idea that if the fund had 75-85% in equities that was going to be good because that would deliver the big returns going forward, and what they were not looking at was the risks involved in such an epic explosion. It can be sort of explained because people were looking and saying "This has worked in the past."

Professor Davis: I was to going to say it is very easy to let the equity exposure grow because, obviously, the asset returns themselves increase the portfolio share and therefore it seems like you are doing nothing when actually the portfolio share of equities is rising. With the stories that were mentioned there, I think there are more interesting parallels more widely in the asset management industry, as in Phillips & Drew, was it not, where the chief asset manager sought to be very cautious, worrying about these things, and he lost his job. Everyone else carried on investing in shares.

Q  Mr Beard: The Myners report recommends strongly that more resources should be devoted to the asset allocation position. Is it your impression that these recommendations have been ignored?

Ms Francis: They have certainly not been ignored. A lot of time and effort has been spent in looking at what the Myners report said and how to implement it. I could not tell you exact figures in detail on what resources were or are now put into asset management, and I would be very glad to have a further look at that for you. It is an area where the new regulatory regime is requiring a great deal of information about asset allocation and it is one where the new accounting standards and new approaches to prudential reporting are going to be looking very carefully at these issues. So our companies take them extremely seriously.

Mr Cazalet: Just on asset allocation, I think in the context of life insurance companies (going back to with-profits, yes with-profits is in decline), it is not just about the asset allocation - what are the risks of equities against bonds - it is also about the liabilities embedded in the contracts, and the with-profit contracts typically have been characterised by some level of guarantees but, also, in some more recent products, some degree of optionality, where all sorts of terms and conditions and ifs and buts and maybes are written into the contract. What we saw, certainly during the 1990s, was that people were writing with-profits, in particular with-profit bonds, which is a lump sum investment, and saying to the policy holder "You can have this, we will guarantee this, and at the fifth anniversary this will happen and this will not happen", and when we were looking at this with a sort of fairly cold, capital markets eye, we were saying to insurance companies "What you have done there is given an option or provided a guarantee. Where is your reserve for this? If you went to the market, went to the City and went to an investment bank - the public markets - to try and buy this protection it would cost you 7 or 8%. Where is your reserve for this?" The answer was "We do not need a reserve; we have got all this spare capital. Why should we go and buy this reserve?" So I think what has happened is that as the with-profit sector, in particular, has found its capital base has been severely eroded, what has happened is that these options and guarantees - these sweeties and freebies that were tucked away - suddenly now the bill has arrived for them.

Q  Mr Beard: As with Equitable?

Mr Cazalet: Equitable is one example, but there are plenty of others. Where is the money going to come for this? Going back to the point Chris made earlier, when the excess capital levels came down, when you have got plenty of excess capital you can sort of cross-subsidise and, maybe, re-engage (?); when the excess capital is very thin, and Equitable is a good example, then Peter is being robbed to pay Paul and he knows he is having his pocket picked. I think the industry needs to look at asset allocation but, also, asset liability management. I think it is fair to say that there is some evidence that the FSA were quite concerned about the lack of asset liability management. I think there were some people who, perhaps, had come from a banking regime when the FSA came into being and were looking at the life assurance industry and saying "What is going on here? This is a one-eyed look at the world; it is all about assets and all about equities. What about the liabilities and the risks?" I think that is a real shock to the insurance industry, and you would imagine that of all people the life insurance industry would be on top of asset liability management, but it has not been.

Ms Francis: May I just comment briefly on that? I think perhaps Ned did not distinguish very clearly between the guarantees that had been given that were guarantees and expectations of future terminal bonuses which, by most companies, have always been made very clear; they are discretionary. My understanding of the regulatory regime is that those guarantees that build up year-on-year and are clearly guarantees have always had to be fully reserved for. What is at issue is whether companies should reserve for the expectation that there will be something at the end that is added on. What was unusual about Equitable Life was that they indicated virtually in the form of a promise certain future expectations, which when you look at the documentation, as I have, of other companies it is very, very clear on the face of those annual statements sent out to policy holders that there is not a firm expectation of a particular pay-out. Nevertheless, it is the case that the reporting requirements that the FSA is introducing will make it very clear indeed whether people are holding back a reserve for some final, extra payouts or not, and that will be very much to the good. I think this does all come back to what the regulator was looking at and what the regulator was asking, because it was for the regulator, at any time in the past, to ask any questions it wanted to about what companies were reserving for and whether they had sufficient capital or not.

Mr Cazalet: If I can just clarify what I meant: I specifically was not talking about reasonable expectations, I was talking about embedded optionality, when you give somebody an option to cash their policy in at a particular date without a particular level of clawback - that sort of thing. I was not talking about reasonable expectations. There is a whole raft of quite complex reserving issues where nobody was paying any attention because they believed that all that was going to happen was the stock market was going to go up. "Why should we think about this? We have got capital, we will cover it if the problem arises." What we have seen now with the FSA's new regime is realistic reporting which sort of suggests that what went on before was perhaps unrealistic. Within CP195, I think it is, there is a lot of talk about getting a market value on these more complex liabilities so that when you present your books to the regulator you are actually saying "What would this cost if we had to go out and buy it?" So I was talking about that rather than softer issues about terminal bonuses.

Q  Mr Beard: You have all mentioned that since the 1990s when the emphasis was on equities there has been a switch-over to much greater emphasis on bonds. Is this a short term expedient to adjust to the regulator, or is it a real repentance?

Mr Cazalet: It is not short term, it is long term.

Q  Mr Beard: How can you say that with such confidence?

Mr Cazalet: I keep going back to with-profits but that is where this issue resides. The with-profits story was that "We can take your money and we can give you some guaranteed element but we will mismatch; we will not have to stick your money in boring old bonds, we will stick it into equities and equities will roar ahead and they are quite groovy investments to be in." But in order to do that you need excess capital; you cannot mismatch without any excess capital. The excess capital, as I mentioned earlier, in the life insurance industry, on our measure - the number does move up and down - but on a true look-through measure, true economic measure, what has been lost, if you like, in the with-profits industry is certainly in excess of 100 million in three years. We see company after company - if I can mention some names, there was a story about AMPF trying to sell off its UK businesses; we have seen Equitable Life, we have seen all sorts of companies - that are now closed to new business. We have looked at how their asset mix could move. Companies that had 75% in equities three years ago are now down to 15%. The reason why they are down that far and will stay down is because they do not have the excess capital, and they will not, to any significant extent, be able to rebuild because they are concerned on a long-term basis about the thing not falling over, and keeping a grip of the liabilities, and there is really no room for many of these companies to start saying "Hey, you know what? The market is looking a bit perky, let's move from 15% or 20% up to 50 or 60." They simply do not have the excess capital to allow them to do that, even if they wished to do so.

Ms Francis: I think that may be the case for some companies, especially smaller ones. The majority of savers have their money in the larger and better capitalised companies and I think the ratio between bonds and equities in those funds will depend entirely on the way the markets move. If equities do recover then I would expect to see some move back into equities, and I would guess that that is beginning to happen already. If the equity markets remain depressed then it would be sensible of the companies to remain more in bonds. It will depend on the way the markets move.

Mr Cazalet: Can I add a point about smaller companies? I will name names otherwise it gets impossible. I will name groups of companies that have closed. Equitable Life is over 15 billion in size; the Royal and Sun businesses that have closed and are not going to be back in equities in any big way are 25 billion in size. Within Abbey there are life companies that are not writing with-profits of about 20 billion in size; the A&P businesses, which are mostly with-profits businesses, are 30 billion in size. I think the idea is that you have got some tiddly little companies that no one has ever heard of that are struggling and you have got some great titans out there that are higher. I would thoroughly disagree with the idea that this is all a few little fishwives' friendly societies with three policy holders that are suffering; these are big institutions and they move markets. The fact that those big institutions have had to sell equities has been one of the reasons why the stock market in the UK has been poor over the last few years.

Q  Mr Beard: There is a difference in emphasis between Ms Francis's answer and yours, Mr Cazalet, because you are saying "Yes, they have repented, they are going to keep their investments in bonds much more" and Ms Francis is saying "When the sun shines again they will move back into the sunshine".

Ms Francis: I am saying that the larger and stronger funds - and I think Ned is quite right in mentioning some of the well-known names who have closed but there are a lot of smaller ones and there are also some extremely well-known names who do have the larger share of the market - will be able to take advantage of equity growth on behalf of their policy holders if we see that come about, but there will be a mixed pattern according to companies' financial strength. It is absolutely right that a company, whether or large or small, that does have fewer capital reserves should be more cautious in its investment policy, and I think it is reassuring to know that that is what is happening.

Q  Mr Beard: UK insurers are still more heavily weighted towards equities, even despite all that we have been talking about, than overseas' insurers. Does that mean to say that United Kingdom insurers are inherently more risky?

Ms Francis: Just very briefly, I think it is the point that Professor Davis mentioned earlier, that UK insurers provide pensions whereas, on the whole, the continental insurers are providing much shorter term forms of saving, so with a long-term pension saving that is going on for 25, 30 years you would expect to invest in equities which yield, in the long-run, a better rate of return. That is one of the main distinctions between the UK market and continental markets.

Professor Davis: Just an extra point there which I could have mentioned earlier (I have just checked) is that US life insurance companies are not even allowed to have more than 15% in shares. That is just a regulation that is typically adopted. In terms of the portfolio share of equity, obviously it depends on the liabilities; as the liabilities shift then the equilibrium share of equities will change, but it would not surprise me if it did return to a slightly higher level than we have now, but nonetheless not the peaks that we saw in the 1990s when, maybe, the equilibrium level was over-shot. A substantive point that I think is worth making is that when we say "bonds" we have to remember these are not homogenous instruments and they are not necessarily safe government bonds. What the insurers may be doing - and others may wish to comment - is taking credit risk on corporate bonds and other credit risk transfer-type instruments, which is sensible, of course, because financial institutions are supposed to take risks, but they will seek obviously the highest yield they can within the yield category consistent with their risk management. Therefore, it is not just government bonds that they have moved into, I think it is fair to say.

Mr O'Brien: In fact, much of the move into bonds in the past two or three years has been into corporate bonds which do give an extra yield compared with gilts, which obviously introduces some extra risk, although interestingly it is not as if it is the weakest companies that have been looking for the corporate bonds' extra return - that is not, in fact, the case. What I think is quite comforting is that in the new FSA rules and CP195 then it is saying that insurance companies have got to take into account credit risk when they are looking at their assets and liabilities and solvency in a way that they probably have not done before. Maybe just to correct an impression we had earlier, in terms of the amount of effort that goes on into asset liability management, then that effort has multiplied tremendously over the last two or three years. There is a lot of work that now goes on into looking at the possible scenarios and stochastic modelling to look at what are the risks and returns of alternative scenarios, so as to develop asset allocation techniques on a much more scientific basis than before, and if we say that there is a problem that the life offices have now got less surplus than they had ten years ago, one of the dangers of having large amounts of surplus is that maybe you take your eye off the ball. But we have now got a lot more emphasis on asset liability management than we had ten years ago.

Q  Mr Beard: So, in summary, you are saying with Footsie now above 4000, the emergency that enveloped the life insurance industry at the beginning of the year is now over. Is that right?

Mr O'Brien: I think companies obviously differ, and I think that is quite important to bear in mind.

Q  Mr Beard: Taking the industry as a whole.

Mr Cazalet: If you take the typical, what is called a non-link portfolio or the unit link business, where it is all transparent and there is no asset liability issue, the typical weighting in equities across the aggregate industry - this is for the with-profits business and other stuff that is unit-linked - is funded at 30%, so where the FTSE is up 15% since the start of this year what you should bear in mind is that the total return on gilts if you had an aggregate gilt portfolio is slightly negative and on all bonds it is only slightly positive by about 1%. So when you look at the typical portfolio, and throw a bit of property in there as well, I guess, in the year to-date it has probably meant that the aggregate portfolio has been about 5%, which is not fantastic. So people have imagined that they have looked at the stock market or the NASDAQ and it is up 15% and said "This is the UK life industry", it is not, it is only about 5%. In some companies the returns are closer to zero and in some with higher equity ratings it might be closer to 10, but the average is about 5. For those life assurance companies that are still writing new business and they spend money on a daily basis, the life assurance industry in aggregate last year spent 7 billion on trying to procure new business. The number is staggering. That money comes from somewhere and it comes from the excess capital. So if the industry has made a 5% return you have then got to knock off the amount of money in short-term spending on new business, you have also got to allow for the fact that many companies are still paying bonuses, and that has to come out of something. So the 5% probably means that many companies are just about treading water, if they are lucky, in terms of their solvency. So I would not regard this as being a leap forward, but it does vary between companies.

Q  Mr Beard: With the heavier emphasis on bonds that we are talking about, that means that the returns to customers are going to be much less than they expected when they invested in these policies. Apart from the ones that are in closed funds, have they been told that this is the likely upshot of the last couple of years?

Ms Francis: Yes. There have been a number of comments from the life insurance companies, from their chief executives and from others, to explain that in line with everybody else who is saving in assets at the moment - financial assets - the returns are lower and are likely to continue to be lower for a while looking forward than people have been used to. This is not something that is peculiar to insurance, this is something that savers are seeing in every single kind of investment that they have had, and nobody has ever suggested that any one particular kind of form of saving gives you an ability to buck the market. So in line with everybody else, yes, returns are going down but certainly, as I illustrated, returns on with-profits policies at the moment are considerably better than on your average unit-trust or, certainly, your average direct investment in shares.

Q  Mr Beard: It is less than they might have expected three years ago.

Ms Francis: Yes, but that applies to every single person who is investing in financial assets, at the moment.

Q  Mr Beard: The FSA's new arrangements for regulation, to avoid the tailspin arrangement whereby people were forced to sell equities in a falling market, is this going to cure the present arrangement?

Mr Cazalet: When the FSA first started fiddling around with the rules (the announcement was put out on the morning of September 11 2001 and has changed into what was known as the Brazilians' test) the objective was to prevent or to avoid life companies having to sell equities. In the, I think it was, 15 months following that initiative life insurance companies went ahead and sold 25 billion worth of equities. I have a slight problem with the idea that the regulator can type something up, put it on an e-mail and that will affect the underlying economics of life assurance companies.

Q  Mr Beard: That really was not what I was asking. I was asking whether their change in the rules and the new arrangements would avoid that sort of artificially forced sale because the solvency rules caused it?

Mr Cazalet: I am not sure that it was that artificial, to be blunt, and people were complaining about the insolvency rules - I remember being at the life actuaries convention about three years ago and there was a session there saying "It is absurd to have rules which say we must allow for a 25% fall in the stock market and then when the stock market has fallen by 25% we must allow for another 25% fall." Look what happened. I think if the capital base has been diminished then life assurance companies will find the level that suits them sooner or later in terms of their risk profiling. I am not sure why the regulator needs to be concerned about that. If there is undue artificiality, yes, but I am not sure it has been to the extent that people might have imagined.

Ms Francis: I think this was the problem, that the previous rules had a rather blunt instrument effect, that they required every company to do the same thing in the same conditions. The new rules look in a more realistic way at the individual company's position and say if the view of that company's position is that it does have a sufficient buffer of capital to protect solvency securely then that company does not necessarily need to sell shares into a falling market. I think that is a very sensible approach.

Q  Mr Beard: Just one last round-up. The IMF and World Bank have commented: "The quality and effectiveness of financial sector supervision in the United Kingdom is strongest in the banking and securities areas ... In the case of the insurance industry, UK authorities are developing proposals to significantly strengthen supervision ... The proposed reforms are likely to deal with most of the weaknesses observed in the current supervisory framework relative to the enhanced standards that are more pertinent for an advanced and international insurance centre like the United Kingdom." Also, we have Sir Andrew Large, the Deputy Governor of the Bank of England warning about the potential for systemic risk because the insurance industry is not as well-regulated internationally as, say, the banking sector is. What are these weaknesses? What do you reckon are the risks, internationally, that have to be guarded against?

Ms Francis: I take from what the IMF were commenting on, basically an expression of confidence that the new regulatory regime is going to be a sound one.

Q  Mr Beard: It mentions these weaknesses, Ms Francis. You cannot avoid that; it is not a complete carte blanche saying everything is all right.

Ms Francis: I do not know exactly what they are referring to. My guess would be that it probably is coming back to this question that the UK insurance industry, because it provides so heavily for pensions, is more heavily into equity investment than in other countries and is therefore more exposed to the fluctuations of equity markets. That is my guess. Those are precisely the kinds of issues that the new regulatory regime is addressing.

Q  Mr Beard: So they are expressing some anxiety?

Mr O'Brien: We do not quite know what exactly the IMF were referring to, but I think Mary Francis is probably right in surmising that they have been concerned about, for example, asset liability management within UK life insurers. Whilst we have been critical of the regulatory regime that there has been, which has been somewhat artificial in reporting - albeit for some good reasons that applied in the past but do not really apply now - the FSA has been ahead of the game in terms of moving the industry towards more realistic reporting, and indeed that is what the life insurance industry has always wanted.

Q  Mr Beard: They have recognised that, and despite that they are still saying that weaknesses remain. That part of the quotation I gave said they recognise that the regulations have been tightened but some weaknesses are still there.

Mr O'Brien: I am not quite sure what weaknesses they are referring to. Of course, the new regulations are about realistic reporting which will enhance consumers' and analysts' understanding of life companies and give proper incentives to life companies to manage their affairs better. Those rules have not actually yet come in, so maybe the IMF was referring to that.

Q  Mr Beard: No, they are not, because they say ... "UK authorities are developing proposals to significantly strengthen supervision" - and those proposals will cover most weaknesses, but there are still some left.

Mr O'Brien: We do not quite know what the IMF is referring to there.

Q  Chairman: We will take that up with you. I want to look at the issue of closed funds, and address my concerns to Chris O'Brien. The switch into bonds normally associated with closed funds reduces probable returns but lowers volatility, as we all know. If someone, for example, has a personal pension fund of 50,000 and has 10 years to go to retirement, how much, on standard actuarial assumptions, are they likely to lose on the final value of their fund when they retire by being tied into a closed fund relative to a fund with the average asset allocation of an open fund?

Mr O'Brien: Is this on a with-profits we are talking about?

Q  Chairman: Yes.

Mr O'Brien: I would prefer to do the calculations in writing and get them right rather than off the top of my head.

Q  Chairman: We just want a ballpark figure.

Mr O'Brien: No, I am not dealing with ballparks either. What we are saying is that the returns to the saver are likely to be lower than otherwise. However, furthermore, it is likely to be somewhat more secure, and that is the quid pro quo that says that people are concerned about the volatility of equities. If you have a fund which is more in bonds then whilst you have got lower expected returns you have got somewhat reduced risk. The other issue that I think is important in with-profits funds which are closed is what is going to happen to what is called the orphan state or the unattributed assets - in other words, the surplus assets that probably arose from prudence in the past and underpayments to previous policy holders. I think it is important that when companies close to new business they establish what is their policy about the financial management of the fund going forward, and the extent to which the investment strategy is changing and, also, how to deal with what unattributed surpluses there may be. If those past unattributed surpluses are now to be given out to the present generation of policy holders then that is something of a windfall that can offset what might be the reduction in expected returns from being more in bonds than previously. So there are quite a few things there.

Q  Chairman: Maybe if you could work on something before the end of the week, that will help us. What we are looking at is asking if the six million savers already locked into closed funds have been treated fairly? Can you think of any other industry where firms can sell consumers one product, for example, an equity-based savings policy, and then unilaterally change it to a bond-based closed fund?

Mr O'Brien: I am not sure that there would be any other examples of the way in which the product changes position which would have that kind of effect on its customers. So the answer is probably no, there are not any other examples.

The Committee suspended from 11.00 to 11.02 am

Q  Mr Ruffley: Can we get on to Sandler products and industry costs. Sandler told us that between 1986 and 2000 admin expenses per contract in the life insurance industry rose by 5.7% per annum in real terms and marketing costs per contract grew by 10.8% per annum in real terms. That explosion in costs in the life industry is a problem, and it has been suggested that consumers are suffering because the industry has been very slow to get a grip on costs in the new, harsher investment world. What is your assessment of that?

Mr Cazalet: Put it this way; see if this makes sense to you: the total cost base of the life assurance industry last year was about 12 billion. That is commission, administration and so forth. That is around about 570 per household in the UK. The total costs to the industry last year in procuring new business, commission and other expenses, was about 7 billion, which is roughly about 330 per household. That was not a one-off it was broadly the same number the year before and the year before that. So I guess you have to ask the question "Is an industry that costs each household 570 a year in aggregate and an industry that spends over 300 per household per year in trying to procure new business, is it a business model that actually makes an awful lot of sense?" When you look at the numbers in aggregate in that way you have then got to say "Well, in order to work out whether it makes sense or not, what is the added value that is delivered to the consumer?" Part of that added value might be convenience, explanation - the knowledge of these products - and so forth, and part of the value might be "Well, we're going to put you into equities and property and you would not be able to do that with your 15 a month otherwise". One of the real problems for the industry is that the numbers have been going up year-on-year. Why have they been going up? I guess that is because there has been a lot of competition in the industry. You might say "Well, hang on a minute here, surely competition should drive prices down." The way in which competition, I think, manifests itself in the industry, or has done, is that the life insurers are trying to get to who? They are not really trying to get to the end customer because 90% plus of all life and pension business in the UK is done through intermediaries, it is done through the sales force and it is done through IFAs. The costs of reaching those people have gone up. We used, in the UK, in the late 1980s, to have commission that was voluntarily regulated because there was a commission agreement. It was thought that actually the OFT might have something to say about this, and it was no longer possible to have an industry-wide agreement to regulate commissions. When that industry-wide agreement fell apart, what happened was that commissions went up. In the stock exchange they went down but in this industry they went up. Why was that? It was because people were bidding furiously for the attention of intermediaries, for the IFAs, or to get people to join them as direct sales people. You have got to work out who the customer is here. I think for the life insurance companies the customer, in that sense, has been the intermediary. If you have no intermediaries you are finished, so you need to do what they want. That is what has driven those costs up. You have given a number for 1986 to 2000 in average annualised terms, and I am not sure whether that was a steady increase each year or whether there was a big sort of spike-up in any particular period of time, but I think a big part of that cost base has been because of the need to secure distribution. Going back to those numbers of 12 billion, and 5 billion of that is admin and 7 billion is new business, those numbers make less and less sense, relatively speaking (I am not sure they ever made any sense but that is beside the point) because you have moved over the last 15 years in particular from an environment where double-digit inflation was common. Go back to the 70s and 20%t inflation was the norm. If you had said to somebody in 1975 "You know what, we will be worried about 2% inflation", well the men in white coats would have been called and you would have been carted away. In an industry that has grown up mostly on packaging up equities and charging - and taking out quite chunky charges - if, after taking out quite generous charges, it still makes sense to the policyholders because the net amount is still attractive relative to other savings, OK, fair enough. I think the problem for the industry - not to blame the industry but just things that are happening - is that low inflation means that the nominal returns we should expect on equities and, for that matter, on bonds will be lower than in the past. It is the nominal amounts that matter. I guess the industry has been struggling with a cost-base and a distribution style and an industry-wide spend that was built up during the high, nominal number years of the 70s, 80s and early 90s, but now we are talking about (and these are consensus numbers from the life assurance companies) expecting returns on equities of 7% just about and on bonds 5% . So if you have a managed fund with a mix of those, possibly no more than 5 or 6% to the consumer before any taxation. Then you look at those numbers and say "Actually, that might be 4 or 5 after tax and after charges might be 3 for some contracts. Does that make a lot of sense? Is it worth spending all that money, 7 billion a year, on new business to encourage people to buy into that?" I think this is the big challenge for the industry. I am not trying to blame anybody here, but the numbers are quite stark.

Q  Mr Ruffley: You say it is a big challenge but you have said earlier in your remarks "Is it a business model that makes sense?" That is very useful. Can I ask Mary Francis, first of all, whether you agree with that analysis? Is it really so bad that the business model is flawed, having regard to these costs we have just been discussing? How long can it go on if it is flawed?

Ms Francis: One point that the Sandler Report made, which was based on the research that had been done for them by Booz Allen the consultants, was that the costs of the UK industry, the UK industry's efficiency, compared extremely well with costs in most other countries' insurance industries, including on continental Europe. So I think it is important to get this into perspective: Sandler found that the UK industry was more efficient than others. He did, indeed, find that costs had been rising and one of the main reasons that he said that costs had been rising, was the cost of regulation. That is not necessarily a bad thing but that is a cost imposed on the industry externally, and I think that brings you to the reason why it is so expensive to sell new business for the industry because there are very, very heavy requirements about the way in which you sell to the consumer, requirements that are actually going to protect the consumer and provide the consumer with a lot more information, advice and help than in most other countries in the world. It takes about 12 hours to achieve one successful sale of a pension or other form of long-term saving in the UK, and that is what causes the cost.

Q  Mr Ruffley: That is interesting but the question is, is it so flawed a business model that it cannot continue?

Ms Francis: I do not believe so.

Q  Mr Ruffley: You do not think it is flawed?

Ms Francis: I do not believe so and the Government does not believe so because it is looking to the private industry to help with achieving more saving. I believe that the long-term business model of selling, say, a 30-year pension makes perfect sense if you put a good deal of effort into the process at the beginning to explain to the customer what suits their needs and what the product consists of. The key is that the customer does continue to save and that the initial costs are spread over the life of the policy.

Q  Mr Ruffley: Can I go on to the Sandler suite of products and the 1% cap. I think it is fair to say that the fund management industry has been lobbying fast and furious against the 1% price cap on the Sandler suite of products, and they seem to be suggesting that at this level of fees, as capped, they will not be worth selling from their point of view. Is it not also the case that from the consumer's point of view Sandler products will not be worth buying if the fees are set higher than 1%?

Ms Francis: Again, can I just make a comparison with other countries. At 1% the UK would be unique in the world in the low level of fees that were charged. Every other country that you compare with, including countries such as Australia, have a higher charge. What is far more important is delivering investment growth over the length of the savings period. The average amount that is going into a stakeholder pension at the moment is about 120 a month. That yields under 14 in the first year to cover sales costs that are very considerably in excess of that - about 300, as Ned Cazalet has mentioned. A charging structure that enables you to get something more up-front to cover realistically the cost of giving advice and reaching the customer can be then spread over the length of the policy, but you do need some additional charging up-front to enable you sensibly to cover the cost of advice, information and so forth.

Q  Mr Ruffley: What is the answer to the point that Sandler products will not be worth buying if you are a consumer if the fees are higher than 1%?

Ms Francis: I do not think that is the case. If you are somebody buying a long-term pension, a fee of 1.5%, or a fee that includes more being taken out in the first year to cover the costs of selling and providing information about the product seems to me to be an economic structure that ----

Q  Mr Ruffley: Why do the Government and Sandler not support that argument? Do you see them getting rid of the cap? They seem to have dug in. You have articulated reasons as to why they are wrong and the cap should not be set that low. What is going to happen on that, because it seems to me there is a stand-off.

Ms Francis: I wish I knew. The Government is very fairly looking at the issue; it has commissioned consultants to look more carefully at the issues. It is looking at what they have reported at the moment. So both the Treasury and the Department of Work and Pensions, I believe, are dealing with this in a very fair and careful way.

Q  Mr Ruffley: The insurance industry has argued that the relatively weak take-up of stakeholder pensions reflects the fact that with the 1% there is little incentive to really market it properly or aggressively. Does not the popularity of CAT-standard ISAs, also with a 1% cap, demonstrate that simple flexible products are popular enough with savers among the lower income groups to sell well without expensive marketing?

Ms Francis: I have not got the figures about sales of CAT-standard ISAs at my fingertips. My understanding was that most of the ISAs that are sold are actually not CAT-standard ones. On stakeholder pensions we have seen a falling off in sales and as the business climate has become more difficult insurers have found that selling at 1% and putting the huge amount of capital allocation up-front to provide for the cost of sales which they will recoup only very, very gradually over the life of the policy has meant that they have had less and less money to put into information, advice and marketing. I think, as night follows day, therefore, sales have fallen off.

Professor Davis: I was going to say, to some extent the selling costs and advice issue is a consequence of the fact that we are selling voluntary products out here. In a sense, if we had compulsion then the ballpark could be rather different and one might have rather simple products, like car insurance, it seems to me.

Q  Mr Ruffley: Could you amplify that? If it was compulsory you would be able to squeeze costs more?

Professor Davis: I think so, yes, because people would not need to be advised; they would have to buy the thing anyway, but also there may be some benefit from economies of scale in the industry that could be reaped. I know more about mutual funds than life insurance, so other people may want to comment, but my impression in mutual funds is that if we have a sufficiently large company then the 1% might well be manageable. Equally, even on pensions, my impression is that there are benefits to be reaped from workplace group-type provision and that 401K funds in the United States do not have immensely high commission charges, but you may be more informed on that than me. Just one other country that may be worth looking at, although this is much more of a systemic model business, is the Swedish one where the Government has this, what we call, Monopsony; they take bids from mutual funds etc, asset managers, to manage social security pension funds and the prices there are extremely low. Of course, the advice element there is not so present as well.

Q  Mr Cousins: Just on the Sandler suite of products, such as they may in the end be, whoever may be supplying them - and the answer is, as time goes by, there seems to be less of them and less providers. However it ultimately ends up, are you satisfied - and this is a question I am addressing to you, Mary Francis - that the Sandler products will meet the test of suitability and that we will not have people being bribed, cajoled, encouraged by the offer of a pen or a cordless 'phone or 5000 points in some supermarket reward scheme to buy something the ultimate effect of which is only to exclude them from the availability of state benefits?

Ms Francis: The sorts of questions that you have raised are precisely the ones that the Financial Services Authority is looking at the moment about what should be the requirements for selling the so-called Sandler products. These are simpler and standardised products that Ron Sandler recommended in his report should be a model for selling in the future. This is a recommendation from Ron Sandler, it is not a proposal from the industry.

Q  Mr Cousins: The issue is not the design of the product, it is the suitability for the person buying it. That is the issue.

Ms Francis: What Ron Sandler was trying to get at was a balance between having a somewhat simpler and standardised product that would require somewhat less regulation about the nature, about the time it takes to sell in order to cut down precisely the kind of heavy costs that we have been talking about. However, getting the right balance between a safe sale and the nature of the product is a very, very difficult one.

Q  Mr Cousins: Let us be clear about this: we are selling products without a strong emphasis on suitability, given the person's circumstances, with light regulation, with no regulatory recourse, so that when they find out that the effect of their efforts is to deny them Pension Credit (let us say) they will have nowhere to go and no one to complain to.

Ms Francis: As I say, these are questions that you need, primarily, to address to the Financial Services Authority because it is they who are looking at what should be the kind of regulation that applies to selling these products.

Q  Mr Cousins: What representations are you making on this point? Is your industry comfortable to sell millions of things at supermarket checkouts accompanied by bribes without a strong test of suitability? Are you comfortable to do it?

Ms Francis: No, we are not comfortable with the idea of selling products at supermarket checkouts and subject to bribes. I would never dream of suggesting that we should. We have been consulted on the kind of regime that should apply to the regulation of selling these products. The FSA has proposed three different options, one of which requires a 30-minute discussion with the customer in which very basic things, like whether state benefits are the thing that they should be relying on, are explored, and that is the option which our industry and my association has said that we believe could be made to work. We are working very carefully with the Financial Services Authority on trials of that kind of approach. As I say, the broad point we have made is that if the price cap regime is not got right then this kind of product may not be sold very widely at all. The last thing that the industry wants is to have an unsafe and unreliable form of selling of any kind of products. With these new products it is very important that we get it right.

Q  Norman Lamb: Coming on to the issue of mis-selling, we probably all agree the extent of the damage that has been done to the industry's reputation because of this. Part of the problem has been misleading information or material. We have been talking about the amount of money spent on marketing and promotion, but a lot of it has been misleading. The latest example has been with precipice bonds. Because of time I do not expect everyone to answer these questions and I am interested to know which of you would be most appropriate to respond. Could I deal, first of all, with the idea of pre-vetting of adverts by the Financial Services Authority? When I wrote to the FSA back in April the response I had from David Kenyer(?) , the Director of the Investment Firms Division was - just to quote from his letter: "We have therefore decided to ask all firms producing brochures on these products in future to submit their advertisements to us before releasing them to the public, at least for a short period." We have since heard that the FSA did not proceed with that, there was no pre-vetting; all they are doing is to look at the adverts that are going out so that they have an idea of what is going on in the market. Can I have a comment from one of you (perhaps Ned Cazalet or Mary Francis) as to your view about this apparent volte face by the FSA? Would it better where there is clear evidence of a problem to be calling in promotional material to make sure that we avoid the problem rather than closing the door after the horse has bolted?

Mr Cazalet: My only thought on this is perhaps this is an issue on what the regulator's real role is? Are we going to go down the route of free carrots, and everything, and how is that justified and so forth? I think it is a very tricky area, as we have seen.

Q  Norman Lamb: What about where there is evidence of a clear problem?

Mr Cazalet: I think if there is evidence of a clear problem then the regulator should act and should err on the side of prudence.

Q  Norman Lamb: Which might include calling in adverts?

Mr Cazalet: If the ads look a bit crackers then surely it is part of their regime to do so. If people are encouraged to invest in the stock market in a straightforward manner and the stock market goes down then that is not anyone's problem, really. However, if the FSA has concerns I do not see why - it is like the old Bank of England Governor's eyebrows - we perhaps should not say "Hang on a minute here." I guess it is probably a question for the regulators as to what their rules allow them to do.

Ms Francis: I would make a similar comment. I am afraid I do not know enough about precisely what the regulator has been doing with individual companies or across the board to be able to add to that. I think it is one to ask the regulator.

Q  Norman Lamb: There has also been the problem of direct mail selling of products such as precipice bonds, with the sellers of these products being able to avoid liability by claiming that they have not given advice, that they have simply sold the product. What is your view about whether complex products, such as precipice bonds, are appropriate for sale in that way? Particularly to a vulnerable group of pensioners.

Mr O'Brien: I think it is not just the case that they are complex products, precipice bonds. I think you have to say "What kind of customer need was met by precipice bonds?" You really struggle to find an answer, and you probably end up saying "People want to speculate."

Q  Norman Lamb: So this is a con from the start?

Mr O'Brien: What it is saying is that it is the kind of product where (and I do not quite know what the advertisements have said) if the income return had been 8% that needs to be accompanied by something that says "The income return is 8% but the expected return is X%, where X is a rather lower figure because there is a chance that you will not get all your capital back." That is a way in which you can express to the customer that this is a gamble. The regulation needs to address not just the complexity but the fact that it is an element of speculation.

Q  Norman Lamb: So, in other words, the customer needs advice?

Mr O'Brien: I did not say the customer needs advice. In that situation it is wrong to concentrate on the 8%, it needs to be accompanied by something that realistically tells you "Your capital is at risk and the expected return is not 8 it is something else", or "There is an X% chance that you will not get your capital back because that is the nature of the product." It is having to express that gamble.

Q  Norman Lamb: Are you concerned that there appears to be a potential loophole in terms of the protection of the consumer, that if the seller of the product can simply claim they have sold it by direct mail shot, whatever the mail shot has actually said, the customer has no recovery; they cannot claim compensation in those circumstances?

Mr O'Brien: I am not particularly keen on outlawing products as such. My first port of call would be to ask whether the nature ----

Q  Norman Lamb: It is not to outlaw products, it is to give consumers rights if they have been misled.

Mr O'Brien: If they have been misled then one can judge whether they have been misled by saying "What was the kind of material that was issued to them and did it actually express the fact that this was, basically, a speculative venture?"

Professor Davis: I agree with that point very much.

Ms Francis: I would agree with it. As far as I am aware it is open to any purchaser of any financial services product to complain to the company that they bought from and if they do not get satisfaction then to complain to the Financial Services Ombudsman.

Q  Norman Lamb: Can I just read you a quote from The Observer in August of this year? "The small print in their documentation will blow the claims of many out of the water and it will matter not a jot that the bond was marketed to them by an independent financial adviser, because IFAs can quite legally sell direct to investors through mail shots without interviewing their customers. This is a rotten system and the Financial Services Authority must review it."

Ms Francis: If it is a problem the Financial Services Authority should indeed review it. I do not think that contradicts the point that the complaint mechanism is still there, but I would entirely agree with what others have said, that this is something for the regulator to be very, very careful about what the literature says and what are the rules of selling. I should just make the point that I do not understand that precipice bonds are primarily manufactured and provided by insurers; they are provided by other types of company as well.

Q  Norman Lamb: Can I ask one final question about the sanctions that are available to the Financial Services Authority in mis-selling cases? Lloyds TSB was recently fined 1.9 million for the mis-selling of precipice bonds. That compares to the Post Office being hit for 7.5 million for delivering post late and Argos being fined 17.3 million from the OFT for price-fixing in the toys market. Are the sanctions simply not big enough to deter providers of financial services and products from mis-selling in this way?

Ms Francis: I am not aware there are limits. It is within the FSA 's discretion so it is a question to ask them.

Norman Lamb: They need to wield the bigger stick.

Q  Chairman: We did ask them last time they were here and they did say that Lloyd's was compensated 98 million.

Ms Francis: Yes. A comment the FSA always make is that there is great damage to a brand as well as to finances from a fine. But it seems to me this is primarily a question for the FSA.

Professor Davis: Generally this just shows the lamentable lack of education of consumers in this country who are not taught somehow that there must be some reason in terms of risk for an 8% return with a bank interest rate of 3%, that they need to diversify and look into details of financial products.

Q  Chairman: Are you putting the blame on the consumer here? You are giving the impression that we have dumb consumers, and if consumers are dumb, so be it. Is that the impression you are giving?

Professor Davis: No, it is not. It means until the consumers are educated, we need very strict regulation.

Q  Chairman: There needs to be good practice by the sellers.

Professor Davis: Absolutely agreed.

Q  Mr Cousins: While we are waiting for consumers to be educated and, bless them, some of them do seem to be a bit slow but that is how you go, while we are waiting for this great day to arrive, do you say to your members when they are showering the world with invitations to engage in execution-only products, "Perhaps it would be sensible to stick on the bottom that if Ali Baba and Al Karti Emerging Equity Markets Inc goes pear-shaped, you have no come-back"? Do you advise them to do that?

Ms Francis: I know that execution-only products do not account for a very large segment of the market, so they are not being showered. Secondly, there are strict regulatory rules about advertisement and promotion.

Q  Norman Lamb: They do not appear to have worked. A lot of pensioners have suffered big losses through these products.

Ms Francis: And if they have, thirdly, I understand there is redress through the Financial Services Ombudsman, but again I think these are questions which need to be primarily addressed to the Regulator.

Norman Lamb: But you represent the industry which is doing this.

Q  Mr Cousins: What advice do you give on best practice when you are doing execution-only work? What advice do you give?

Ms Francis: We advise our companies to abide extremely strictly by the regulatory regime.

Q  Norman Lamb: Are you disappointed that they do not?

Ms Francis: Yes, of course. If there is at any stage a lapse from high standards and from compliance with the Regulator, it creates less confidence in the market and less confident customers, and less confident customers are extremely bad for the industry. So I would most certainly be advising any member company that the regulatory requirements must be fully abided by and that companies have the highest obligations of customer care.

Q  Norman Lamb: When you get evidence of misleading advertisements, do you write to these companies? Do you engage with them?

Ms Francis: We are not ourselves a regulatory body. If there is any evidence of that kind brought to us we will either ourselves send it to the Regulator or advise the person who has that evidence to send it to the Regulator. We do not hesitate to do so. More generally, as I mentioned at the beginning, we have a number of initiatives at the ABI to promote high standards. We have a voluntary quality mark about the use of plain English and clear explanation of products. We are extremely anxious to ensure those kind of initiatives are as widely taken up as possible.

Norman Lamb: But you have acknowledged that the industry has failed.

Chairman: We are going to look at endowment mortgages and have a special session on that on 2 December, but before that we want to get a feel for that matter and your opinion on them.

Q  Angela Eagle: We have had a very interesting discussion on the structure of the industry, particularly from Mr Cazalet who has given us some very interesting figures. When Philip Warland moved from the Investment Management Association, he said, "... too much of the life assurance industry's business has been characterised by misrepresentation of the product and bribery of the distribution channels." Following the evidence that we are having given to us and particularly what Ned Cazalet and Mary Francis have been saying to us, that seems to be a pretty fair assessment of the industry, does it not? Misrepresentation of the product - that happens all the time and it costs a great deal of money. Bribery of distribution channels. That is about it in a nutshell, is it not?

Ms Francis: Where there is evidence of misselling or poor practice, the industry has the strongest possible interest that those cases should be investigated and looked at.

Q  Angela Eagle: If you do not mind me saying, you have been incredibly complacent about that today. You have just been complacent about precipice bonds. You do not seem to be worried about the industry and its wider reputation.

Ms Francis: A considerable part of my job is to think about the industry's standards and reputation, and, as I described, the ABI with its members is undertaking a great deal of work to ensure that past concerns, whether it is misselling or any other problems, are addressed.

Q  Angela Eagle: But misselling is going on, is it not, now? We have the issue of misselling of endowment mortgages coming up. It is already a big issue but it is a huge time bomb waiting to explode on the industry and damage its reputation again. Do you think it is acceptable that when people went to buy a house in the 1980s they ended up with a life assurance product when what they wanted was actually a mortgage?

Ms Francis: Again, I think those are questions which it is quite right for you to address to the industry but you also need to address to the Regulator.

Q  Angela Eagle: You are representing the industry today, Ms Francis. Do you think it is correct that when somebody went to buy a house in the 1980s they ended up being persuaded into buying a life assurance product, because they were told it was cheaper, the repayments would be less and they would end up with a nice big, fat lump sum at the end? What they were not told was that the person who was pushing them to buy that product was on a great big, fat commission. Is it any wonder that 90% of those products are now going to fail to pay off the mortgage, let alone give them the big, fat pay-off at the end they were promised? Is that an acceptable outcome for your industry? Is it an outcome you are proud of?

Ms Francis: It is completely unacceptable that anybody was advised to buy an endowment mortgage on the basis that they could be sure a certain sum would be achieved. Anybody who was given that advice and who has lost out has grounds for a misselling complaint, and I believe it is absolutely right they should be able to have that complaint investigated and they should be able to achieve compensation if it is the case. Without pre-judging your inquiry, the number of people who are complaining at the moment is between about 21/2 and 5% of people who had endowment mortgages, and the Ombudsman is rejecting about half of the cases that come to him.

Q  Angela Eagle: So you do not think it is a problem?

Ms Francis: It is clearly a problem where cases are identified there was misselling. There clearly are some cases where misselling has been found and it is absolutely right that compensation should be given.

Q  Angela Eagle: There are millions of cases, are there not?

Ms Francis: No.

Q  Angela Eagle: There are potentially many millions of cases in the pipeline?

Ms Francis: I do not know potentially how many cases there are because it is right the Ombudsman should review them. So far the number of cases is relatively low and the complaint rate is relatively low, but where there is a problem it is absolutely right it should be investigated.

Q  Angela Eagle: I find your answers incredibly complacent. Mr Cazalet, what is your view of this mortgage endowment problem?

Mr Cazalet: The complaint rate may have been low but I am aware of quite a few large insurance companies who have over 100 staff doing nothing but deal with complaints. Whether these have got to the Ombudsman is another matter, but it is quite a long time process. We are aware of a number of companies which are unable to meet the Regulator's eight-week timetable for dealing with complaints and have asked for a waiver so they might be able to deal with them in 16 weeks, but now there is a suggestion they cannot deal with the volume of complaints within 16 weeks. The complaint level might be very low, that might have been the case but I think it is escalating. There was a remark that grounds for misselling are that the sum could be achieved, well that was the whole point. I do not think anybody said, "Mrs Miggins, about your home loan, have an endowment, the sum needed to cover the home loan might not be achieved." If they were told that, they would not have bought it.

Q  Angela Eagle: Nobody would have bought them.

Mr Cazalet: It is one of the fundamentals of the thing. We can argue what was said at the time and so forth but I think the fundamental ----

Q  Angela Eagle: I can tell you what was said at the time. I was besieged by endowment mortgage offers when I bought property. I did not buy one because I knew what they were, but if I had had no knowledge of what they were it would have been the obvious thing to do. I was shown repayments per month which were much lower than under a repayment mortgage. I was given all this guff about how it was going to be much easier and cheaper to do it this way and there would be a nice tidy sum at the end. I cannot believe I was the only person who was told that. I think this is a huge scandal which needs to be dealt with and I find the complacency in the industry about it absolutely incredible.

Mr Cazalet: The industry includes the lenders as well because the lenders sold these products. The insurance companies may have hatched them but the banks and building societies were making the commission. There is a very large insurance company which earlier this year - and I can remember the phrase because it struck me as being quite extraordinary - in a press release said that this issue was one of shattered dreams but not a nightmare. Any industry which says, "Actually it's not that bad, it is just a shattered dream, it could be worse", I think needs to get a grip on itself. To say that the complaint level is this, that and the other and therefore it is not a problem, I think the industry, and that includes the lenders, needs to aggressively communicate with the people who have these products. I remember speaking to a man who runs quite a large insurance company which has a lower socio-economic profile than the average one, and he said when they send out the projection letters his real worry is that they do not get enough angry phone calls, and he is worried that people do not open these envelopes, they think it is another insurance thing or credit card offer, or if they do open it, they do not understand it. There is the old line that 50% of people do not know what 50% means. I have had IFAs, and good quality IFAs, phone me up and say, "Terribly sorry to bother you, my clients have just had this letter from XYZ Life, it is a projection letter, what exactly does it mean?" These are much more complicated than you might think. So we can argue about what was said at the time, and I agree with your analysis and what you were hearing, my recollection is the same, but I think the industry now needs to say, "Things have not worked out as planned, what is the best solution for the consumer", rather than saying, "The complaint rate is only 2% or 5 %."

Ms Francis: If I can add to that. The industry has agreed, and has been now doing so for three or four years, to send out regular projection letters. Many companies already did so but every single company now sends out projection letters to keep customers informed about what the prospects are for their mortgage.

Q  Angela Eagle: But do you think it is acceptable that millions of people who set out to buy a house ended up with a life assurance product? They wanted to buy a house!

Professor Davis: It seems to me there was a paradox in that, as far as I remember, and others may correct me, it was in1984 that the tax relief, which really made endowment policies attractive, was abolished. So in a sense it was almost a band wagon that continued.

Q  Angela Eagle: Was that not driven by the high levels of commission?

Professor Davis: That is my second point. A question for the industry and financial services generally is, why does the commission have to come up-front and therefore make it so attractive to sell certain products and not others? Could not the commission somehow go over the life of the product and be related to its performance? Then there would be in a sense sharing of the pain and much more care in terms of the sales.

Q  Angela Eagle: That is a very good idea.

Professor Davis: Maybe there are good reasons for not having this, but I have not heard them.

Q  Angela Eagle: Mr O'Brien, do you have any views on that, because we are looking to see what we can do to improve this industry? It seems to me we have large commissions up-front and we have an industry driven by intermediaries, who are really the customers, as we heard earlier, rather than the actual customers, who seem to be cash cows to me. What can we do to change the structure of the industry and make it more focused on the actual customers who are the people putting their money in?

Mr O'Brien: One thing is communication. There are all sorts of issues but let us take the costs. On costs, we have said the typical cost of acquiring life assurance policies is 82% of the first year's premium. That does not leave very much left over. If the cost is spread out, in terms of the way the costs are incurred, that would be a lot easier, although a lot of life insurance companies have been, in terms of the surrender value they have been given, spreading the cost rather more than they did back in the 1990s. So there has been some move to not up-front the costs quite so much. The other aspect is communication. I am a great believer in thinking what are the needs of the customer and how do products meet those needs. There were a number of companies that said quite explicitly with endowment mortgages that you could do some calculations and show it looks a better deal than repayment mortgages but there are some risks which the customers need to know - and I appreciate not in every case did they know - but a number of companies have said, "We will keep this under review and every so often we will do a re-projection and write and tell you if you need to increase the premiums." Bearing in mind that rates of interest fell, that meant that people had got a bit left over because they were paying a lower amount of interest to their mortgage provider. Some life insurance companies got criticised in the mid-1990s when they were writing to their customers to say, "You need to increase your premium because the stock market fell in 1994", but actually ----

Q  Angela Eagle: But do you think it is right in principle that somebody who goes to buy a house ends up with a life assurance product?

Mr O'Brien: It depends. In some circumstances that is fine, because you can do the calculations and say it looks a good bet compared with repayment mortgages on an assumption ---

Q  Angela Eagle: We know whose interests were being pursued here, do we not, it was the interests of the people on a large amount of commission who were selling them, and that makes the point about the structure of the industry which we have heard come over very strongly today, which is that the real customers of the industry are the intermediaries, they are not the people who are buying the products.

Mr O'Brien: The industry still has a large number of providers. For a mature industry the life insurance industry has a very large number of firms still in it. An alternative scenario we might get to is where there is a smaller number of firms, each doing large amounts of business with economies of scale and communicating with and responding to the needs of the end customers.

Mr Cazalet: You talk about customers, but what do life assurance companies do? We have sat here this morning for two hours but we have not talked much about the insurance of lives, i.e."If you get hit by a bus we will pay out", which is fine, but if you look at these products, the low cost endowments - and you mentioned tax relief being withdrawn in 1994 - were invented in about 1983. Why were they invented? Who dreamt this up? For what purpose? They flourished for ten years and have fallen away. The personal pension came about in 1988 and we are told it was missold like crazy. With-profit bonds, with which people have a problem, were only invented in the late 1980s. Precipice bonds were the child of the early 1990s and had a ten year run.

Q  Angela Eagle: It is hard to avoid the conclusion, is it not, that actually they were invented for the people who were selling them to make a bit of money in the short-term and leave somebody else to clear up the mess.

Mr Cazalet: I would look at it this way and say, what do banks do? They do the same thing broadly speaking as they did 100 years ago and they will do the same thing 100 years from now. They offer you money transmission and keep your money safe. What does a life assurance company do? What are its products? It seems to me that every few years a new product comes along and whether they are sold or missold it is opportunistic product design. So when people talk about consumers being educated, how on earth do you educate consumers about precipice bonds or with-profits bonds or low cost endowments? You might have been in school in the 1960s when low cost endowments had not been invented. There is this challenge that the consumer should be able to know this, I think it is just madness. Yes, they should know about bank accounts and they should perhaps understand the stock market, but the packaging which has been so much a feature of the life assurance industry, partly driven by tax reliefs which were there and are no longer, has driven this crazy product development which takes people's eye off the ball so people think they are buying a deposit-type product when in fact they have a leverage play on the stock market. That is a fundamental point. All this talk about consumer education, we will never catch up with financial inventions and have no chance of doing so.

Professor Davis: On your question about endowments, there is a fundamental problem in that you have a nominal liability which is the bank loan which is mortgaged out there but you are investing it in assets (equities) which in a sense give a nice real return, but if you get disinflation, as we did of course, the return on them is going to go down. That is fine for pensions, you have real liabilities, you want income in retirement, but the problem with endowment mortgages is you have this nominal liability and it isn't going to be covered when you get disinflation without more in-payments.

Q  Mr Plaskitt: These millions of letters are going out to people who bought endowment policies saying, "It is not going to deliver for you what we said it was when you bought it", but according to your paper the big hit is still to come in terms of the profile of maturity?

Mr Cazalet: Yes.

Q  Mr Plaskitt: Your graph shows the biggest hit being 2011 to 2013. Do we have any figures on how many people have bailed out of those policies, dumped them before the policies dumped on them?

Mr Cazalet: We know how many policies were in force at the end of last year.

Q  Norman Lamb: The 9 to 10 million?

Mr Cazalet: Yes, roughly. The number moves because people die and one or two things mature. Quite a lot of people have surrendered their policies and this is another worry. I do not want to criticise directly anybody but there are ads in the Sunday papers saying, "Don't surrender your life assurance policy in such-and-such company, sell it to us." That might be fine if you genuinely want to surrender a policy but I suspect a number of people say, "I have a life policy, this is worth money, I'll phone up the second-hand policy guys" and do that. These guys do a lot of business every year, hundreds of millions of pounds of business, year on year on year. I can tell you overwhelmingly the policies which are traded in this market place are already taken out for house purchases. So it begs the question on those policies which are surrendered back to the life company or are traded actually in how many cases is somebody just quite keen to get their hands on some cash for some short-term need and in how many of those cases do people say, "Now I have got rid of the endowment I have absolutely nothing to help with the repayment and therefore I will go onto a repayment basis"? I suspect not many people are and I think there is a second layer issue there. People have got rid of the endowment altogether and have not done anything else and will find there is a hole.

Q  Mr Plaskitt: Do we have numbers? Do we know how many people have sold off their policies before their projected maturity date, either because they have been enticed by this second-hand market which is advertising very, very heavily on radio and in the newspapers, or they have simply bailed out for their own reasons, "It is not going to mature, I will get out of it and convert the mortgage to repayment"? There are people abandoning this whole policy area, but do we know the scale of it?

Mr Cazalet: I will have to get members of the ABI to give you the detail. I have not got the numbers in my head.

Q  Chairman: I read in the weekend papers on endowments or indeed any life sale figures, that the ABI said that no figures were available before 1994. To get a handle on this thing, which goes way back to the 1980s, we would like to get information on the figures going back maybe to 1975. So this is a plea, Ms Francis, to get those figures from you, but from the press reports at the weekend your office is saying there are no figures available before 1994.

Ms Francis: I would be glad to provide what we have. On the number of people who have endowment mortgages actually still being used to cover their purchase of property, our estimate is that about 6 million people have one or more endowment policy. Of those about 1 in 5 are no longer covering the house purchase. So it is something considerably under the 9 million who are actually using endowments still to cover their mortgage.

Q  Norman Lamb: That still leaves 5 million people.

Ms Francis: It could be around that. It is decreasing of course all the time because sales have pretty well stopped now. So as maturities come through, the total numbers are reducing all the time. Perhaps I could just make the point also that the reduction in interest payments has meant that now that policy holders are given information, the amounts which are needed to cover shortfalls can, for very many people, be saved through applying the saving in investment payments they are making now compared to the time they took out their mortgage. That is in no way to say where people think they actually were missold they should not pursue that complaint, but I would just like to put in perspective that for an individual person to actually make up their shortfall, where their policy has some years to go, it is probably manageable. One of the things which the ABI is keen to do is ensure people take action where necessary.

Professor Davis: If we had a repayment mortgage, we would have got the benefit anyway. So I am not sure that argument really works.

Q  Norman Lamb: It is a tiny proportion of people who have complained, is it not? Is that through ignorance or because they are happy?

Mr Cazalet: If you look back through the letters which insurance companies have sent out - and some have been doing it every two years and they are not all doing it on the same day - at the start of the programme of insurance companies being required to communicate with their customers, the first lot of mailings which went out - and we are talking about 2000-01 - the markets really had not fallen by very much at all, so an insurance company might have sent out 100,000 letters and 98,000 of those were saying, "You are probably on track." Two years later, the number goes down to 75% on track. Then another two years later it is, "No one is on track". We have seen companies where in their first mailings almost everybody was on track - in the green zone if you like - and then in subsequent mailings almost everybody is in the red zone. So you went straight through amber. This is the thing which is catching people out. This is no one's fault in particular but one of the dangers is that someone gets a letter and it is a bit like the television programme, Dad's Army, where the chap says, "Don't panic, don't panic", there you are in your house, you are paying something for insurance, you do not know what it is, and one day ten years into the whole thing you get a letter saying, "Don't panic" and you say, "I wasn't panicking anyway, what was all that about" and you throw the letter in the fire. Then two or three years later you get a letter saying, "Panic". Some people will have read the first letter and said, "What is all this 'Don't Panic' rubbish" and they will throw the second one in the fire. What we have observed is that some people get the second letter and get really angry saying, "You, the insurance company, told me I was all right. You went to all this bother two years ago." It is not really the insurance company's fault in that sense, the market has moved against them, but there is a big issue here about what consumers understand. I go back to one of the companies we spoke to earlier this year with a lot of customers and the chief executive said his worry was people do not read these letters, do not open them or, if they do, do not understand them. That was directly from somebody who was concerned he was not getting enough complaints. These are hugely complicated issues and people are not comfortable with them. I am not saying they should complain to the insurance companies saying, "I have been a victim" but they need to take action and we are not getting the feed back to say a lot of people are taking action. The complaint levels are rising, they absolutely are rising, but the worry is that people are complaining but not taking action.

Mr O'Brien: One goes back to the reduction in interest rates. If people have an endowment mortgage, they still have the whole of the loan outstanding and the reduction in interest rates applies to the whole of the loan. If they have a repayment mortgage then the reduction in interest rates applies to that part of the loan which is still outstanding. So if you have an endowment mortgage you are gaining from the gradual reduction in interest rates.

Q  Chairman: There appears to be widespread consensus that, whatever sort of review we have, tidying up the mortgage endowment mess could eventually cost the industry even more than the pensions misselling scandal, but the FSA told us it was keen to avoid compensation costs "forcing capital out" of the business. Our question is, has the industry got the resources to cope with these costs? Is the FSA in danger of getting into an Equitable Life style situation, where it is allowing consumers to put cash into companies it knows face enormous financial challenges?

Mr Cazalet: This is a tricky one for the Regulator. What do you do? Do you have everybody stampeding for the exit? On the pensions misselling, everybody knew how many pensions had been sold, the actual level of compensation may be varied. With the level of pensions which were in the pensions misselling review, I think I am right in saying there is a lower level than the number of endowments. Our numbers were slightly higher than the ABI's but we are talking certainly in excess of 5 million and probably 6 to 8 million and if you had a formal review it is very difficult. If life assurance companies paid out to ten customers, it is going to be very difficult to say to the other 90, "You are just unlucky, that bit of the sales force was rotten", or if you were sold through a building society, "It was only those branches which missold things, they were all trained by the same people." I think the Regulator has to tread a fine line here. When we had pension misselling that was paid out of a long-term fund but during the 1990s markets were going up and the capital was there and markets repaid for this. Now we have a situation where the capital base of life assurance businesses has taken a hammering and the Regulator is saying, "If we have a widespread review here, what will the cost be?" It will be several billion pounds. Some companies may sail through that okay but for some others 500 million or 100 million is way more than the capital they have. They are damned if they do and damned if they do not. If we have a review, those customers who are Smart Alecs and go on some association internet site and complain are ahead of the game, but those people who are not financially savvy are most in the dark.

Ms Francis: The FSA has made it clear that on complaints at the moment it is very difficult to forecast exactly what the rate of successful complaints will be. The FSA has said that complaints are only successful where someone has actually lost out. At the moment people who had endowments are still getting extremely good returns, people are getting for a 25 year mortgage endowment at the moment about 70,000 compared with, say, a balanced managed unit trust of 50,000. So at the moment it is difficult to foresee precisely what rate of complaints are likely to prove successful and it will depend ultimately on the way markets move. Already in the last few months the market has recovered 35%, so the forecasts are difficult. The FSA at the moment is probably right to rely on the complaints mechanism.

Q  Mr Cousins: This is not a simple question, and I have some thoughts about it, but how can we get good financial advice to the people who now, effectively speaking, do not have access to it, so their overall needs can be taken into account and they can be steered into the right activities for them which maximise their income from the state benefits sector and savings?

Ms Francis: I think that is absolutely the central question at the moment. My answer, based on quite a lot of research we have done at the ABI, is that the work place is probably the key to this. This is where you can get economies of scale, where you can actually bring for instance skilled financial advisers in, and the employer can help with this, and we would like to see the Government provide some financial incentive to employers to do so. We would also like to see more employers chipping into their employees' pension funds. The work place and how to bring advice and help to the work place and help employees to think about financial issues at the place where they get their salary cheque is probably absolutely the key. We are very supportive indeed of the initiative the Financial Services Authority is taking to look at ways of improving customer education and awareness and I think they also are looking at the work place as perhaps the key to this.

Q  Chairman: I notice from Mr Cazalet's submission that, "Assuming endowment policy investment growth of 6% per annum after tax, the average shortfall will be a little over 11,000..." equivalent to one-third of the targeted home loan. With a base of investment growth of 4 % the average shortfall will be close to 14,000." That is one heck of a lot of money. How much extra per month would the average family have to have to make good the shortfall on their endowment policy? Going back to the beginning and what we said about the savings gap, is this a good background from which to suggest to families they should save more with life insurance companies to bridge the pension gap we were discussing?

Mr Cazalet: I think in the note we tried to work out, if you complained and got paid the average that people are being paid and used that to reduce the loan, and then moved to a repayment, I think we were talking about - and it is somewhere in the document - 100 a month or something of that order depending on interest rates. Is it a good starting point? I go back to what is the savings gap. If people are not saving enough, what does that mean for the wider economy. The life assurance industry has been very inventive in creating all these products and it could be argued a lot of these products have not worked, to be blunt about it, for whatever reason, things have happened, it is not a maligned industry, but people have a shortfall on their house purchase, that is not what was intended. I guess the question is, is saving all about the life assurance industry because you can invest in a unit trust or a mutual fund - and actually I do not have any money in the stock market - or stick your money in a deposit account or a TESSA or a cash ISA. Even for things like pensions, Virgin has a pension contract but there is no life assurance company involved, Nationwide Building Society has a pension contract but there is no life assurance company involved. So I think really the question about what it is this industry does, and going back to the business model issue, is it sustainable going forward. As for the work place being the way forward, fair enough, but if I was running a chicken factory with 15 employees, would I want my employees being diverted on this? We have seen work place initiatives, particularly around stakeholder pensions, we have seen a number of organisations - Pearl Assurance is one, Abbey National is another, Marks & Spencer is another - which have gone forward with work place initiatives. They have stopped doing so and the reason is they have not resonated. That is not to blame them or to criticise them for trying, but I think it is a lot more complicated. If this industry keeps inventing complicated products, how on earth is the consumer going to get to grips with that? From the point of view of our lawmakers, the conflicts which exist between the benefits system and the taxation system are quite staggering, and for anyone to get their head round the legislation to do with pensions, how do you manage it as an ordinary individual? Life assurance companies usually in the pensions market will have a guru - there is a guru at Scottish Life, there is a guru at Standard Life, this is the man with three brains who knows all about pensions - but the very existence of these gurus suggests it is all far too complicated for ordinary people to remotely get a grip on. So I think the legislators have a big part to play in simplifying the landscape and maybe we can then construct products which can be sold easily because you do not need three hours of explanation on how it fits in with legislation and your benefits.

Professor Davis: I would agree with the point about the means testing. It is a big problem which needs to be thought about more. The life insurance industry is worried now that anyone under maybe 50% of the average income distribution could be missold products because they might end up being caught by the means test. I would add one other point which has not been mentioned, the future savings gap is not going to be helped by all the student debt that is going to be around because people will be worried about repaying student debt and not making their most remunerative ----

Chairman: Give us a break please!

Q  Mr Cousins: Some of us are already inclined to naughtiness on that topic! We need the Whips here!

Ms Francis: My final comment would be to come back to what is the insurance industry and its products. You urge us to sell more simple products, the majority of the insurance products which are now being sold are not with-profits, they are very straightforward unit-linked business, where the person purchasing has a clear sight line through to what is going on in the underlying shares or other assets. Therefore the complexities which you mention about pensions, for instance, come from outside the industry, from the tax and the regulatory regimes, often quite rightly, but the nature of the products now is that the majority are simple unit-linked products. I would be very glad to write to the Committee to explain that further. I would just urge that in thinking about the industry, you are thinking about the industry in the round - 60% of its activities we have not talked about this morning.

Q  Chairman: Yes, but we are now running an inquiry and we will take the best advice to ensure we get a very comprehensive look at the industry, and we are delighted with your suggestions to us on that.

Mr O'Brien: I would emphasise "keep it simple". If it is simple, it is less costly to produce, less costly to administer, fewer things will go wrong and there is a much better chance of the customer understanding it and it meeting a need.

Professor Davis: That is true.

Q  Chairman: Any final, final comments, Mr Cazalet?

Mr Cazalet: I have said enough.

Q  Chairman: Thank you for your time, we have gone on a bit this morning but it has been very helpful to us in outlining what our inquiry should be. I am not further forward in terms of education about with-profit bonds, with-profit policies, but maybe I will pick that up as we go along and people can come along and educate us on these particular issues. On the life insurance figures, we would like figures as far back as possible on that, Ms Francis, so we will write to you on that matter.

Ms Francis: Yes.

Chairman: Thank you for your time.