Memorandum from Co-operative Financial
CFS is the Financial Services part of the Co-operative
Group. The principal subsidiary companies of CFS are Co-operative
Insurance Society Ltd (CIS), which is the life assurance subsidiary
of CFS, CIS General Insurance Ltd (CISGIL) which transacts general
insurance, and the Co-operative Bank. CIS Unit Managers Ltd (CISUM),
a unit trust company, is a subsidiary of CIS and smile, the internet
bank, is a subsidiary of the Co-operative Bank.
CIS and CISGIL are Industrial and Provident
Societies, as are CFS and the Co-operative Group; the Co-operative
Bank is a public limited company (plc).
CIS is the UK's only Co-operative life assurance
company. Its method of operation is unique in that, although it
has a shareholder, it operates entirely for the benefit of its
policyholders. This distinguishes it both from true mutuals, which
have no shareholders and are owned by their customer members,
and from proprietary companies which operate for the benefit of
Proprietary life assurance companies usually
transact their with-profits business on the basis that profits
are split between policyholders and shareholders in the proportion
90:10. Non-profit business is typically transacted on a 0:100
basis, ie all the profits go to the shareholders. Mutual assurers
conduct their with-profits business on a 100:0 basis (all profits
go to the with-profits policyholders) and typically transact non-profit
business for the benefit of with-profits policyholders.
In line with its Co-operative status, CIS transacts
its business for the benefit of all its customers, both with-profits
and non-profit. In the case of with-profits business, the profits
of the business are applied for the sole benefit of the with-profits
policyholders, ie the basis is 100:0. In the case of non-profit
business, products are generally priced at the lowest possible
price consistent with charging appropriately for the risks involved.
Any profits (or losses) that emerge from this business are therefore
expected to be small and will fall into the Inherited Estate,
ie they are not distributed to with-profits policyholders.
This basis of trading is summarised in the statement
that has been made repeatedly over many years in sales literature,
in advertisements and in the Principles and Practices of Financial
Management, and which is stated in the annual returns to the FSA:
" . . . the whole of the profits of the
Society's life assurance and pensions business must be applied
for the sole benefit of the life assurance and pensions policyholders,
including for this purpose the making of reserves with the aim
of preserving the strength of the Society for the benefit of current
and future life assurance and pensions policyholders".
3. THE ORIGINS
CIS's inherited Estate is derived from the following
1. direct and indirect contributions made
by the shareholder;
2. the excess of the asset shares of with-profits
policyholders who have left the fund over the claim values paid;
3. the excess of the amounts paid into the
fund by non-profit policyholders over the amounts required to
market and administer their policies and to pay claims;
4. investment returns earned on each of
The asset share of a with-profits policy is
the accumulated value of the premiums paid allowing for the investment
return earned and after deducting amounts required to cover marketing
and administration costs, and amounts in respect of risk and guarantee
costs. To the extent that the amounts deducted in respect of guarantees
are less than the cost of meeting those guarantees, the shortfall
is taken from the Inherited Estate.
Because of the difficulty of obtaining detailed
individual policy data in respect of past contributions and charges,
CIS has not attempted to estimate accurately the precise contributions
to the Inherited Estate from each of the four sources above. However,
some investigations into the sources of the Inherited Estate have
been carried out and these indicate that a substantial part has
been derived from the first source, contributions made by the
shareholder, together with the investment return earned on those
Since the capital contributed by the shareholder
to CIS has been provided without any expectation of a return to
the shareholder, CIS's life assurance fund has always been operated
so that the risks to which the fund is exposed are borne by the
fund itself, that is, by the Inherited Estate, and not by the
shareholder (on the basis that the shareholder should not bear
risk unless it is compensated for this by the prospect of potential
4. USE OF
The Treasury Committee has asked for information
on "the extent to which life assurance companies should be
permitted to diminish the inherited estate in order to subsidise
corporate activity . . . ". The word "subsidise"
in this context has, potentially, two rather different meanings.
It could mean that the subsidy being provided is in the nature
of either a gift or a loan.
If the subsidy were essentially a gift, it would
mean that money that formed part of the Inherited Estate was being
spent with no expectation of return or, more probably, that money
derived mainly from policyholders was being used to finance activity
that would benefit shareholders disproportionately so that, in
effect, a gift of policyholders' money was being made to shareholders.
If, on the other hand, the subsidy were in the
nature of a loan, it would mean that the Inherited Estate was
being used as working capital for the fund, to provide capital
for investment which was expected to benefit the original contributors
to that capital broadly in proportion to their contribution.
In general terms, a subsidy in the form of a
gift from policyholders to shareholders must be, at best, questionable,
whereas one that was essentially an investment would seem to be
In the case of a mutual insurer, there are no
shareholders and all capital has been derived from policyholders
and will be used for the benefit of policyholders, so the use
of the Inherited Estate to finance corporate activity is both
necessary and reasonable.
In the case of CIS, much of the Inherited Estate
has been provided by the shareholder and it is to be used solely
for the benefit of policyholders. In this case, to the extent
that there is a subsidy being provided from the Inherited Estate,
the subsidy is from the shareholder to the policyholders. We therefore
believe that the use of the Inherited Estate to finance corporate
activity, including financing new business and making strategic
investments, is in our case entirely reasonable; it is, in fact,
an essential part of our business model that has operated successfully
for over 100 years. Furthermore, as stated in section 3, we believe
that it is appropriate that the Inherited Estate should be used
to meet risks to which the fund is exposed. These include insurance
risks, economic risks and new business sales risks, including
As CIS's fund is not a 90:10 fund, we do not
propose to comment on the principles that should guide the division
of the Inherited Estate in such funds. It is, however, reasonable
for us to comment on two other points raised by the Committee:
the appropriate sharing of the Inherited Estate between current
and future policyholders, and whether policyholders' reasonable
expectations of distributions from the Inherited Estate should
be zero or have a positive value.
In a fund that is open to new business, such
as ours, we do not believe that policyholders should have an expectation
of a distribution from the Inherited Estate. However, FSA Rules
require Boards to review regularly the size of the Inherited Estate
and, following such a review, the Board could at its discretion
decide to distribute part of the Inherited Estate if it believed
that the Inherited Estate was larger than was needed to meet the
risks inherent in the fund and to support future new business.
It is clearly important that current policyholders should be treated
fairly, but we believe that fair treatment can be provided by
returning to policyholders at the end of the policy term an amount
broadly equivalent to their asset share and that policyholders
are not entitled to expect more than this amount. This is consistent
with representations made to policyholders at the time their policies
were taken out.
If a fund is closed to new business, however,
it would be reasonable for the Inherited Estate to be distributed
over the remaining lifetime of the policies and policyholders
might reasonably expect to receive a share of such a distribution.
If the fund is mutual, or run exclusively for the benefit of policyholders
as is the case with CIS, the distribution of the Inherited Estate
following closure would be 100% to policyholders.
The fact that, if a fund were to close to new
business, policyholders would expect to receive a share of the
Inherited Estate whereas, if it were to remain open, they would
not does not mean that life assurers have any obligation to close
their funds. If there are two possible outcomes for policyholders,
just because one outcome leaves them better off than the other
does not mean that they have been treated unfairly if the other
outcome is the one preferred by the Board. The decision to remain
open to new business or to close should be taken having regard
to normal business considerations such as whether new business
can be written profitably, not by whether one group of policyholders
(the current generation) happens to receive a windfall that they
could not reasonably have expected.
6. THE APPROACH
Current rules and guidance of the FSA make it
potentially very difficult for mutual insurers, and for CIS,
to continue transacting life assurance business unless they continue
to sell material volumes of with-profits business. At a time when
the value to consumers of with-profits business is increasingly
being questioned, this makes it difficult for such companies to
diversify away from with-profits business to other forms of long-term
savings and protection (eg unit-linked business, term assurance,
critical illness cover etc).
This situation has arisen because of FSA guidance
COBS 20.2.60, which states
"If non-profit insurance business is
written in a with-profits fund, a firm should take reasonable
steps to ensure that the economic value of any future profits
expected to emerge on the non-profit business is available for
distribution during the lifetime of the with-profits business."
This statement effectively prevents non-profit
(including unit-linked) business being written over timescales
that extend beyond the lifetime of existing with-profits business,
and would therefore force mutual insurers to close their funds
if they were to stop writing with-profits business. Proprietary
companies are largely unaffected by this statement as they typically
write non-profit business in separate, shareholder-owned funds.
We believe that COBS 20.2.60 is wholly inappropriate
to CIS, which as explained above does not write non-profit business
on the basis that future profits are distributed to with-profits
policyholders. It is also likely to be inappropriate for mutual
insurers, as it prevents them from evolving their business model
into a model that is more suitable for the needs of modern consumers.
COBS 20.2.60 does permit insurers to make alternative
arrangements for continuing to carry on non-profit business "where
it is agreed by its with-profits policyholders". However,
CIS's with-profits policyholders are not members and they have
no direct interest in the non-profit business within the fund,
so it is difficult to see the relevance of this concession in
our case, and it may also be unduly restrictive in the case of
other mutual insurers.