Memorandum from Peter Bloxham, Prudential
Nominated With-Profits Policyholder Advocate
1 EXECUTIVE SUMMARY
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 INTRODUCTION
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 REGULATORY
DEFINITION OF
THE INHERITED
ESTATE
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. USING INHERITED
ESTATE FOR
CORPORATE ACTIVITY
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 THE SHARING
OF INHERITED
ESTATE
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 POLICYHOLDERS'
REASONABLE EXPECTATIONS
OF DISTRIBUTIONS
FROM THE
INHERITED ESTATE
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 PHASED DISTRIBUTIONS
OF BENEFITS
FROM THE
IINHERITED ESTATE
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 ROLE AND
RESPONSIBILITIES OF
THE POLICYHOLDER
ADVOCATE
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 THE FRAMEWORK
FOR NEGOTIATION
BETWEEN THE
POLICYHOLDER ADVOCATE
AND THE
LIFE ASSURANCE
COMPANIES
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 THE ROLE
OF THE
WITH-PROFITS
COMMITTEES OF
LIFE ASSURANCE
COMPANIES
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 (http://www.fsa.gov.uk/pubs/other/reattribution-letter.pdf) Back
79
FSA letter on `Reattribution of Inherited Estates', 6 December
2007 (http://www.fsa.gov.uk/pubs/other/reattribution-letter.pdf) 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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