Financial Services Authority Annual Report 2008-09 - Treasury Contents

Written evidence submitted by the Association of Mutual Insurers


FSA's Dear CEO letter and Legal Advice

  1.  Nearly 60 friendly societies and mutual insurers received a letter from the FSA in October, setting out its views on various aspects of with-profits business, and asking firms to respond before the end of December.

  2.  The FSA has sought legal advice on the extent of the interests of with-profits policyholders in the with-profits fund. This advice has concluded that "the general position is that the with-profits policyholders, in their capacities as policyholders and as members of a mutual, will be entitled ultimately to all or almost all of the assets in a mutual's long-term fund after the mutual's contractual obligations in respect of policies written into that fund have been satisfied".

  3.  The letter goes on to explain the FSA's view that where there is not a material volume of with-profits new business, irrespective of the amount of non-profit business[6] being written, then the firm could be deemed to have ceased writing new business, and should therefore consider whether it should distribute its excess assets to the with-profits members.

  4.  The FSA also says that if it is not possible to effect new business on terms which allow the with-profits business to run-off fairly then they may require the firm to close to new business completely.

  5.  The letter goes on to discuss what alternatives there may be for a firm in this situation:

    —  continue to write new non-profit business for a limited period of time;

    —  develop a new "participating" type of non-profit contract;

    —  a strategic investment option; and

    —  seek the consent of with-profits policyholders on how its capital may be used.

Our assessment of the letter

  6.  Many mutuals have been in business for 150 plus years. Most wrote business initially on a non-profit business, and developed with-profits business for a limited period (mainly from the 1970s to the 1990s), as a means of sharing the excess capital they have built up over generations.

  7.  Clearly the firm has a responsibility to protect the interests of its with-profits policyholders, as it has a responsibility to protect the interests of all its members. However, the FSA's stated view is that all the surplus in the fund, including the present value of profits on the non-profit business, should be distributed to the members holding with-profits policies as these policies run-off.

  8.  We consider that the legal advice is flawed, and it contradicts the advice that the industry has received, as well as the detailed examination of practice within the sector that has been undertaken. This supports the case that often all forms of business have been written into a common fund, and that the assets in the fund are held in perpetuity, for the benefit of current and future policyholders, as well as providing the working capital to allow the mutual to fund new business and product development (on the understanding that policyholder funds are replenished over time).

  9.  Friendly societies that provide Holloway contracts (a form of income protection product which also pays bonuses out of excess premiums) have also been caught up in the issue, even though they are specifically excluded from the relevant FSA rules (COBS 20). FSA argue that this is on the basis of the same duty to treat policyholders fairly.

Implications for the sector

  10.  Each Board will need to satisfy itself that it has a coherent strategy. Where it is writing stable/ material volumes of with-profits new business the FSA letter does not present a significant obstacle.

  11.  For the majority of mutuals, who are not writing material volumes of with-profits now, even where they have an effective business plan to write other forms of business, there is a greater challenge. Some journalists have assessed the impact on the sector as cataclysmic, and our legal advice concludes that the letter is "highly likely to drive with-profits mutuals out of business even where they have viable streams of non-profits business". Overall we expect a range of possible outcomes:

    (a) The legal advice received by some of the larger mutuals suggests the practices and norms within the firm are sufficiently robust to provide an exception to the "general position" as set out in paragraph 2 above.

    (b) Some firms are exploring new forms of product with FSA that will enable them to write participating variants of current non-profits products.

    (c) For some there is a significant possibility that they will be forced to close to new business and reattribute excess capital to their policyholders, which as the recent Norwich Union exercise has shown is a costly and drawn out process which destroys policyholder value.

    (d) Some may conclude that they should explore mergers.

  12.  Overall, whilst firms have still to finalise their situation, we expect the letter will intensify further pressure for consolidation, shrink the size of the mutual insurance sector, and reduce consumer choice.

Are there any alternatives?

  13.  The industry has been carefully drafting alternative solutions that do not diminish policyholder rights, but which provide a viable future for a mutual.

  14.  There appears to be a willingness across all political parties to strengthen the mutual sector, and to signal support for mutual insurers and friendly societies. FSA's position is in stark contrast to that. But at the moment this is seen as an issue that should be resolved between FSA and the industry.

  15.  We conclude that political pressure on FSA is necessary for them to take a more enlightened view on the relevance of the mutual model and to reconsider their position.

24 November 2009

6   This might include protection policies without any investment element, or the Child Trust Fund. Back

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