Further memorandum from the Association
of Mutual Insurers
WITH-PROFIT MUTUAL LIFE ASSURERS DISCUSSIONS
WITH FSA ON THE APPLICATION OF FSA CONDUCT OF BUSINESS RULES TO
MUTUALS—PROJECT CHRYSALIS
PURPOSE
1. The purpose of this paper is to:
a. Describe the issues that mutuals were
having with the application of the FSA rules applying to with-profit
business and the approach proposed by the mutuals to resolve the
problem;
b. Describe the current positions of both
parties; and
c. Describe the process that is underway
for the resolution of the issues.
BACKGROUND
2. The Association of Mutual Insurers (AMI)
is the trade organisation which represents the interests of the
mutual insurance sector in the UK. AMI has 31 member organisations
which represent 99% of sector in the UK, a total of 15 million
policyholders and £83 billion in assets under management.
3. Mutuals have been writing life assurance
business for well over 150 years starting off primarily seeking
to assist self-help for the poorest in the community. The initial
business written was non-profit in nature but, as the businesses
grew and in accordance with the origin and purpose of the mutuals,
profits started to be returned to the members as they arose. This
became formalised in the creation of with-profits business which
was written in the same mutual fund as the non-profit business.
4. Over the decades mutuals have successfully
mixed their new business levels between non-profit and with-profit
business dependent on the market conditions prevailing at the
time. This has never caused a problem in the past with regard
to the application of the rules of the Regulator and we do not
believe that recent market and product evolution should cause
a problem now.
5. With-profit mutuals continue to provide
good quality products to consumers. The most recent 2008 Money
Management with-profits survey shows that a 25 year with-profit
endowment payout from a mutual is 26% higher on average than that
of a PLC.
6. The life insurance industry, under the
auspices of the ABI, has started providing the results from surveys
of customers. In the latest set of annual results, mutuals fared
better than PLCs in a majority of measurements including clarity
of communication, ability to solve customer queries, customer
service and likelihood of recommendation. This is no real surprise
as mutuals are better able to place the interests of members and
customers at the heart of everything that they do whereas PLCs
have to be very cognisant of the needs of their shareholders.
MEMBERSHIP
7. It is important to understand the issue
of ownership in a mutual. Each mutual insurance company is owned
by the ever-changing group of policyholders who happen to be its
members at any point in time. It is not owned by a fixed group
of past or current members, except in the unusual circumstance
where it is forced to close to new membership—even then
policyholders cease to be members as their policies mature and
are paid out. Some with-profits policyholders may be members,
and some may not. Some non-profit policyholders may be members,
and some may not—it all depends on the definitions contained
within each individual mutual's constitution. Payment of bonuses
to with-profits policyholders is standard practice but does not
in itself confer exclusive ownership rights. Benefits that relate
to membership and/or ownership clearly apply to all members, whether
or not they are with-profits policyholders.
8. Most mutuals were established for the
benefit of their members before with-profits business came into
existence. If a mutual decided not to write with-profits business
in the future for whatever reason, in our view it would and should
be possible for it to continue in existence to serve its members
much as other mutuals which have never written with-profits business.
(Some friendly societies and all building societies currently
operate for the benefit of their members without any comparable
class of "with-profits" business).
DETAIL
9. The starting point for the Chrysalis
Project was the realisation by the with-profit mutuals that the
combination of the way that the FSA Conduct Of Business rules
(COBS) are framed, together with the current challenges associated
with with-profits business, had the potential to inflict damage
on the whole mutual insurance sector. As we have demonstrated,
the sector has generally served its customers well and has the
ability to continue to do so in future—we do not believe
there should be any reason, or desire, to cripple it.
10. Most mutual insurers have been around
for about a hundred years or more and continue to be a force for
good in the marketplace. Most of them started by writing non-profit
business and the problem we are focusing on here has been created
by the overlay of the FSA Handbook with its associated Glossary
and COBS rules in recent years.
11. The COBS rules require a Glossary definition
to enable their proper application to the "with-profits fund".
Proprietary companies have clearly-defined with-profits funds
which are distinct from their shareholders' funds and a few mutuals
that have acquired funds from other insurers also operate ring-fenced
with-profits funds for the acquired business. However, apart from
these special cases there is no clear definition of what a "with-profits
fund" is in the context of a mutual. The wording in the FSA's
rules is ambiguous: it could either be taken to refer to assets
that underpin with-profits policies only, or it could be taken
to mean a greater proportion of the assets of the mutual and maybe
even the assets that underpin all of its business, not just with-profits
business. This lack of clarity is clearly an unsatisfactory situation
in itself.
12. Apart from the special cases described
above, there is only normally one single fund in a mutual—we
describe this as the Main Mutual Fund. There is no with-profits
sub-fund (unless one has been established for particular historic
reasons, like a merger). When declaring bonuses to with-profits
policyholders, a mutual takes into account the contribution made
by with-profits policies themselves (generally using asset shares),
and would also give consideration to the performance of the Main
Mutual Fund and the extent to which it provides backing for all
of the business of the mutual.
13. We had been comforted to hear during
discussions with the FSA that in framing the COBS rules in the
first place, the FSA always intended to allow for the existing
manner in which mutuals conducted their business. However this
was recently contradicted by the FSA. We are concerned at the
possibility that, due to the lack of clarity in the rules, different
firms will be treated in a different manner by the FSA.
14. Inappropriate application of a particular
interpretation of the FSA's rules in this unclear situation could
well cause the closure of a mutual, and result in a "windfall"
payment to the generation of with-profit policyholders whose policies
happened to be in force at the time of closure, which would be
in excess of their true interests and rights—and would be
paid to them at the expense of other policyholders who also constitute
the membership of the mutual, as well as at the expense of future
generations of with-profits and non-profit policyholders.
15. The mutuals held a number of meetings
with the FSA in spring and summer of 2007 to explain the problem
and propose a solution. Our proposed solution involved the establishment
of industry guidance for mutuals that would have been approved
by the FSA and would have clarified how the COBS rules would apply
in practice. The FSA indicated that they were looking for something
more explicit and we confirmed that we were equally happy to discuss
any other way of eliminating the risk of damage caused by an application
of the rules that did not match their original intent.
16. At the heart of our proposed industry
guidance was a new definition of a with-profits sub-fund for a
mutual, so that the COBS rules could apply properly to it and
could be seen to apply more transparently. The corollary of this
was that the mutual would have capital outside the with-profits
sub-fund, which we refer to as "mutual capital". Movements
between the various sub-funds would be explicitly declared and
subject to due process in terms of governance. The rights of with-profits
policyholders would not be affected in any way by the adoption
of clearer definitions which support greater transparency around
the way that best practice has always worked in mutuals. With-profits
policyholders would have no greater or lesser rights to profits
arising within the mutual than in the past but would benefit from
the increased transparency.
17. We did not seek to make a case that
"mutual capital" already explicitly exists within a
mutual as that would require a pre-defined with-profits sub-fund.
However, mutuals have operated in a way that is consistent with
such a distinction—as they have always had to meet the appropriate
solvency requirements at the time. We have therefore made the
case that for the COBS rules to apply as originally intended,
it would be helpful to create a clear definition of a with-profits
sub-fund for mutuals—and therefore, by implication, of mutual
capital.
18. To define the with-profits fund as equating
to the Main Mutual Fund would have the effect of transferring
ownership of the mutual capital from members as a whole (who,
it should be remembered, will include non-profit policyholders)
to the exclusive ownership of with-profits policyholders. This
would directly conflict with the obligations of mutuals to comply
with their constitutions and in practice, over time, would force
a large number of mutuals to close—whether or not they were
operating in a sound commercial manner. Naturally we believe that
this is neither desirable nor acceptable to us, or, we believe,
to society in general.
19. An important practical point is that
the introduction of new definitions to support the fair implementation
of the rules does not require any form of reattribution process
to establish clarity around ownership, since no rights are being
altered and no money is changing hands. The new definitions simply
make the situation clearer and minimise the risk of unintended
application of the COBS rules. Each mutual would need to create
an opening definition of the size of the newly-defined with-profits
sub-fund and of its mutual capital, but we believe this can be
done in a fairly straightforward manner.
20. Having reached what we thought was a
clear consensus with the FSA about the problems and the potential
solution in July 2007, the FSA said that they needed to consult
internally. They subsequently indicated that they needed to take
their own legal opinion.
21. The FSA came back to us in late March
2008 and it became clear there was a difference of opinion between
us. Accordingly we have now embarked on an exercise with the FSA
to look at a number of with-profit mutuals as case-studies and
understand how their constitutions and legal documentation interact
with the established practice within the mutual and also to determine
the boards' views of what the interests and rights of with-profit
policyholders are compared with the interests and rights of members
generally. This should enable the FSA to gain a better understanding
of how mutuals operate and hence enable clarification of how the
Main Mutual Fund might be hypothecated between the members and
with-profits policyholders.
22. This process is likely to be completed
in the autumn of 2008.
On behalf of: Engage Mutual Assurance; Exeter
Friendly Society Limited; Liverpool Victoria Friendly Society
Limited; MGM Assurance; National Deposit Friendly Society Limited;
NFU Mutual; Police Mutual Assurance Society Limited; Reliance
Mutual; Royal Liver Assurance Limited; Royal London; Scottish
Friendly Assurance Society Limited; Teachers Provident Society;
The Children's Mutual; Wesleyan Assurance Society.
28 May 2008
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