Select Committee on Treasury Written Evidence

Memorandum from Peter Bloxham, Prudential Nominated With-Profits Policyholder Advocate


  1.1  In March 2007 Prudential announced that it was considering a possible reattribution of the inherited estate in the with-profits sub-fund of Prudential Assurance Company. As part of this process, I was nominated by the company as the independent Policyholder Advocate (PHA) to represent the interests of policyholders in any reattribution.

  1.2  Issues arising in relation to inherited estates and reattributions cannot be separated from the wider framework of how with-profits products operate. With-profits products have features which distinguish them from other investment products. They are characterised by large amounts of discretion conferred on the insurer and by a lack of transparency.

  1.3  Insurers commonly use the "asset share" concept as a benchmark to measure policyholder entitlements. The use of standard terminology may give the impression that this is a single uniform industry-wide concept, whereas, in practice, there are various different approaches within the insurance industry to measuring policyholder entitlements.

  1.4  The whole with-profits fund, including the inherited estate, belongs to the insurance company.

  1.5  In a reattribution, the starting point is that policyholders do have expectations of a future distribution from the inherited estate. If a company announces its intention to explore or propose reattribution, it is implicitly acknowledging these expectations as, otherwise, there is no transaction to negotiate.

  1.6  It is important that the inherited estate be available to support existing with-profits business, including after reattribution, to protect the fund against unexpected events. In addition, policyholders' contractual rights and their reasonable expectations must be met.

  1.7  I consider that, in the context of an investment product where so much is discretionary and there are many areas where conflicts of interest can arise, there is a particularly strong justification for the FSA insisting that the "treating customers fairly" principle should inform all aspects of an insurer's conduct towards its policyholders.

  1.8  A with-profits committee can play a valuable role in monitoring governance and assisting in addressing conflicts of interest which arise in the running of a with-profits fund. These conflicts may increase post-reattribution. As a result, the role of a with-profits committee may need to be reviewed and expanded as part of a reattribution.


  2.1  In March 2007 Prudential announced that it was considering a possible reattribution of the inherited estate in the with-profits sub-fund of Prudential Assurance Company. As part of this process, I was nominated by the company as the independent Policyholder Advocate (PHA) to represent the interests of policyholders in any reattribution. Nomination covers the initial fact-finding stage where I gather information and begin the process of investigation. On this basis I welcome the opportunity to respond to the Committee's call for evidence.

  2.2  The Financial Services Authority (FSA) requires any company considering a reattribution of its inherited estate to identify a potential Policyholder Advocate at the earliest opportunity.[77] This requirement has two practical consequences:

    —  there is, in effect, a two-stage process—nomination of a Policyholder Advocate while the company's investigations are at an exploratory stage, followed by actual appointment once the company has made a firm decision to go ahead.

    —  at the nomination stage, there is no certainty that the company will proceed with the reattribution and, therefore, there is no certainty that a person nominated as a potential Policyholder Advocate will ever be appointed.

  2.3  The decision whether to proceed from nomination to appointment is Prudential's, as is its timing. Even if I am appointed as Policyholder Advocate, Prudential could decide not to go ahead at any stage.

  2.4  The Policyholder Advocate is, and must be seen to be, independent of the company and it is important that the Policyholder Advocate should be able to communicate freely with the FSA, with policyholders and with other interested parties.


  3.1  The "inherited estate" is part of the with-profits fund. The FSA state that it is the excess of a fund's with-profit assets over its liabilities[78]. The inherited estate is used to provide working capital (which is required for the day-to-day running of the fund) and regulatory capital (which protects against adverse market conditions).

  3.2  Although there is a general acceptance of what is meant by inherited estate, what is more difficult to agree is how to calculate the two numbers (assets and liabilities including future projections). It is also worth noting that these numbers will fluctuate, notably as the investments and liabilities within the fund change in value.

  3.3  One of my areas of focus to date has been the question of what policyholders can expect to receive and how policy benefits are both explained and calculated. The reason why this is particularly important is that the with-profits investment product gives insurers a large amount of discretion in deciding what benefits to award to policyholders. Unlike, for example, a unit trust product, it is not possible to state in advance how a policyholder's benefits will be calculated. There are two factors to mention:

    —  A common benchmark now used by insurers is the concept of "asset share". This concept is designed to describe the contributions (net of expenses) a policyholder has made and the rolled up investment return, by reference to the overall results of the with-profits fund, attributable to those contributions. However, there are a number of different approaches which are adopted to the exact mechanisms used by insurers for calculating asset shares. It may be difficult for a policyholder to understand some of the details of these differences. As asset share is commonly used as a benchmark for the liability of the company to the policyholder, the methodology used to calculate it will have an impact on computations of the inherited estate.

    —  The practice of "smoothing", ie withholding part of the returns earned in good years to reduce the swings in overall returns between policies maturing in good and poor times.


  4.1  My initial thoughts are:-

    —  there is clearly a conflict of interest for the company if new business (or strategic investment) is carried out on terms which require the with-profits fund to provide a subsidy;

    —  accordingly, the terms on which new business in the with-profits fund is written should not disadvantage existing policyholders;

    —  the FSA has established rules dealing both with new business and with strategic investments.

  4.2  When a fund closes, policyholders have a much clearer right to distributions, over time, of any inherited estate. A Policyholder Advocate will have to form a view on realistic levels of future new business in the with-profits fund and on the prospect of the with-profits fund closing in the foreseeable future.


  5.1  An inherited estate belongs to the company. The company is not the same as its shareholders. The whole with-profits fund belongs to the company, in the sense that with-profits policyholders are unsecured creditors of the company, not (for example) beneficiaries of a trust. However, policyholders have at least a contingent right to a distribution from the inherited estate.

  5.2  Slightly confusingly, there is a concept of "excess surplus", where a company's inherited estate becomes sufficiently large that FSA rules require a company to consider taking specific action to reduce the excess surplus. The existence of this mechanism supports the proposition that an insurer should not consider that policyholders' rights or expectations in relation to distributions from the inherited estate are of no value.

  5.3   During reattribution, policyholders are asked to give up their rights to a future distribution from the inherited estate, and are compensated by the company from shareholder funds for doing so. I consider that the launch of a reattribution process by an insurer (and even the nomination of a Policyholder Advocate) constitutes an acknowledgement by the insurer of its policyholders' rights. Otherwise, there is no transaction to negotiate.

  5.4  However, a reattribution may allow policyholders to opt in or out (in other words, some policyholders may choose to keep the status quo and not accept any compensation). In such a case, clearly the inherited estate needs to be fairly divided so as to preserve the part attributable to policyholders choosing the status quo.

  5.5  For those who give up their future rights, it is very important for the ongoing protection of policyholders' investments, that the inherited estate should continue to be available, where needed, to support the with-profits fund even after reattribution. Accordingly, an important, and complex, part of the negotiations between the company and the appointed Policyholder Advocate will be in relation to the controls over use of the inherited estate post-reattribution (including controls over distributions to shareholders post-reattribution).


  6.1  The FSA has made its position clear at an appearance before the Treasury Select Committee in January 2008. I share its view that policyholders' reasonable expectations do include a contingent right to a future distribution from the inherited estate. I also believe that this right has a positive value. As previously mentioned, I consider that an insurer which embarks on a reattribution is acknowledging that policyholders' rights to the inherited estate must have a positive value.


  7.1  There are several points to make:-

    —  the first is that the term "distribution" is a bit of a misnomer, in the sense that most distributions relating to a with-profits policy will not be immediate cash payments, but will be additions of value to a policyholder's policy, which will only actually fall due for payment when the policy matures. To this extent, distributions of benefits (apart from terminal bonus) are generally deferred. It is, of course, expected that there will be a regular bonus distribution (by way of uplift to policy value) each year;

    —  it is not clear to what extent promises of future distributions are at risk of withdrawal or reduction;

    —  distributions, once made, may be eroded if market conditions deteriorate prior to policy maturity.


  8.1  A Policyholder Advocate exists for the benefit of policyholders, and to seek to achieve the best possible outcome for policyholders.

  8.2  The role of the Policyholder Advocate is to ensure that, in a reattribution, the interests of policyholders are protected. To this end, the Policyholder Advocate:-

    —  acts independently of the company;

    —  consults with policyholders;

    —  establishes multiple channels (e-mail, letter, telephone) for policyholders to communicate with the Policyholder Advocate;

    —  negotiates with the company on behalf of policyholders on the terms of the reattribution and, in particular:

      —  the compensation to be offered by the company to policyholders for the rights policyholders are being asked to give up; and

      —  the governance rules and protections for the fund and the inherited estate going forward; and

    —  writes a report containing his recommendations on any offer made by the company to policyholders.

  8.3  The role of the Policyholder Advocate is limited to the immediate reattribution and to the with-profits fund in relation to which the Policyholder Advocate is appointed. The Policyholder Advocate should, nevertheless, undertake a thorough analysis of the particular fund in relation to which he has been appointed, including how it has been operated in the past, to help inform the negotiations. This approach was endorsed in the FSA's letter of 6 December 2007.[79]

  8.4  It has become apparent to me that a policyholder will only understand reattribution if he understands how with-profits work. As a result, I and my team have put a lot of effort into producing materials which, we hope, will provide simple and clear explanations of these processes to policyholders.

  8.5  Since being nominated I have begun to prepare for possible reattribution by:-

    —  setting up an independent office;

    —  putting together a small team to work with me;

    —  dealing with policyholder correspondence;

    —  commencing due diligence;

    —  participating in regular meetings with FSA and Prudential;

    —  making arrangements for policyholder meetings to be held around the country;

    —  preparing to establish a call centre and fully operational website for communicating with policyholders.

  8.6  If appointed, I see my main roles as those of:-

    —  listening to policyholders;

    —  ensuring policyholders receive independent, clear and timely communications about the process;

    —  helping policyholders better understand the nature of the with-profits investment product they have paid into;

    —  conducting a tough negotiation with Prudential on the terms of the reattribution, so as to produce the best realistic outcome for policyholders;

    —  engaging with Prudential on "structural" issues such as which policyholders are eligible for any incentive payment;

    —  ensuring a fair allocation of the overall compensation between different groups of policyholders.

    —  Another factor I am aware of is the risk that some policyholders may miss out because of the protracted nature of the process. I will do my utmost to avoid unnecessary delays.


  9.1  The FSA set the guidelines for the reattribution negotiations between a Policyholder Advocate and the insurance company. I will have to carry out my role (if I am appointed) within the guidelines prevailing at the time of my negotiations.

  9.2  The relevant FSA rules[80] recognise that a degree of flexibility is required and that each reattribution will be different.

  9.3  If appointed, I would propose to approach this with the aim of getting the best outcome for policyholders. As with any complex negotiation there will be a large number of issues to debate, some of which are very technical. Much of the detail of the negotiations would be confidential and I would be reluctant to publicise my negotiating strategy before appointment.

  9.4  Some aspects of the negotiations may relate to the history of the fund and the way it has been managed in the past. I welcome the FSA's clarification, in its 6 December 2007 letter, that the appointed Policyholder Advocate can examine all aspects of past conduct of the fund.

  9.5  In my experience, no negotiation produces a perfect solution for either party. An appointed Policyholder Advocate's job is to negotiate the best realistic deal available in all the circumstances for policyholders. Within that, one of the more difficult challenges is to ensure a fair allocation of the compensation between different groups of policyholders.

  9.6  As already mentioned, it is important to ensure that the inherited estate is available, if required, to continue to support the with-profits fund. The Policyholder Advocate's responsibilities, as part of the negotiations, include building in suitable protections for the policyholders post-reattribution.


  10.1  The general "treating customers fairly" principle applies to with-profits products, as it does to all investment products. However, there are good reasons why special rules have been formulated to apply this principle specifically to the with-profits sector. A few examples:-

    —  the very large measure of discretion afforded to the insurer in a wide range of areas, notably, investment powers and level of benefits to policyholders;

    —  the relative lack of transparency inherent in a number of core features of the product (for example, smoothing);

    —  the scope for conflicts between the interests of policyholders on the one hand, and of the company and its shareholders[81] on the other;

    —  the consequent need for rigorous governance procedures.

  10.2  The FSA has, over time, taken a series of steps to reinforce governance, notably, the requirement on insurers to produce and abide by statements of Principles & Practice of Financial Management ("PPFMs") and the requirement to establish independent review of compliance with PPFMs. In large companies, this is generally achieved by establishing a with-profits committee.

  10.3  In view of the points made in 10.1, the function of with-profits committees, as well as the with-profits actuary function, is very important as a method of ensuring governance and of monitoring conflicts of interest generally.

  10.4  The discretionary nature of the policyholders' entitlements under with-profits products, and the lack of transparency, referred to in 10.1, creates scope for conflicts. Those conflicts of interest could increase post-reattribution and it may well be that a with-profits committee's status and role would need to be reinforced, as part of the enhanced governance arrangements emerging as part of the negotiations over a reattribution.

April 2008

77   FSA rules and guidance on the reattribution of inherited estates can be found in Chapter 20 of the Conduct of Business sourcebook. Back

78   FSA letter on `Reattribution of inherited estates', 6 December 2007 ( Back

79   FSA letter on `Reattribution of Inherited Estates', 6 December 2007 ( Back

80   The professional framework is paragraph 20.2 of The FSA's Conduct of Business Rules. Back

81   In relation to a proprietary company, not a mutual. Back

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