With-profits is currently in the spotlight. The FSA and the Sandler committee are reviewing it. The Consumers Association has been slamming it for some time. Some of the national press have picked up on the issues and are publishing a steady stream of critical articles. What is the consumer to think?
The stance of the FSA and the Consumers Association
The Consumers Association are not arguing for with-profits to be banned, nor apparently does the FSA.
The Consumers Association says: "There's nothing wrong with the theory behind with-profit funds — the idea of smoothing investment returns to protect policyholders in bad years. However, in practice, the way these funds are run is so complex and opaque that no one, except the handful of industry professionals who run them, can understand how they work, or if they are doing what they are supposed to do." [Which? Magazine February 2002.]
Both the Consumers Association and the FSA agree on the areas where modernisation is needed.
These are:
- clarity
- discretion (Life Companies have too much freedom in setting
bonuses and applying Market Value Reductions) - use of assets
The improvements Clerical Medical has made so far
The box at the bottom of this page shows how we have already modernised our running of with-profits and our approach has been well received by IFAs – indeed Chartwell Investment Management recently applauded us for "taking transparency that next step further".
However we know there is still a lot to do, much of which will be defined by the FSA proposals due to be published in June 2002, and we are already working on a number of improvements in anticipation of their report:
— providing more information pre-sale to improve investors' understanding of the risk/reward balance of a with-profits investment
— improving communications to with-profits policyholders, in particular annual statements
— extending the range of policies on which we provide information about the relationship between returns on assets and bonuses added to policies
— developing the accounting framework to show improved fund-level information in FSA returns. Amongst other things, this would demonstrate both that a formal accounting structure underpins the operation of the withprofits funds, and that there is no 'leakage'. The new disclosure is not aimed at a consumer audience, but rather at expert commentators, who can then advise clients
— further refining guidelines we publish, saying how we will manage the assets and decide the bonuses and MVRs
Why have we taken this lead?
These improvements have all been introduced to restore consumer confidence in with-profits by addressing two fundamental concerns:
A lack of understanding...
We agree with the Consumers Association that the problem has been that with-profits has been so complex and opaque that not enough people understand how they work. We believe that this is what has been the problem, not that with-profits investments have failed to deliver what they set out to do.
...which leads to a lack of trust...
This lack of understanding has led people to believe that with-profits is performing badly and that companies cannot be trusted. This is not surprising, especially in the light of what Equitable's policyholders have been through and the controversy over Axa's orphan assets. Our view is that, on the whole, companies can be trusted, but they just need to work harder at demonstrating that they can be trusted. By being very vocal in their distrust, the media, and at times the Consumers Association, make it harder for the companies to regain that trust.
...so we need to regain that trust.
We believe that clear and full explanations will help to regain that trust. This includes both information in advance with clear guidelines on how we will run with-profits, and information post-sale which demonstrates that we have applied those guidelines and acted fairly.
The bare essentials of with-profits
We believe that these improvements we have already made and those planned for the future will help to bring with-profits up to today's standards of scrutiny, and help to restore confidence in it.
But there are certain things about with-profits that should not change:
Companies must retain some discretion
Whilst our published guidelines for how we run with-profits will constrain us, they will still allow us an element of discretion. We strongly believe that this works to the benefit of investors. Markets can be irrational and if we were to follow rules mechanistically in all investment conditions, there would be times when those rules could work unfairly in favour of one class of investors at the expense of another class.
Bonuses must still depend on the fund performance
The underlying assets of with-profits funds will continue to include a substantial proportion of equities, and the performance of policies will reflect this. The investment returns of the assets in the fund can vary considerably over time.
Although we aim to smooth out some of the effects of the fluctuations, annual and terminal bonuses can still vary quite a bit over different investment periods. A major objective of improving with-profits communications is to help investors 'peep inside the box' and understand the nature of the underlying assets, their performance, and the effect on bonuses.
Investors must continue to share in the fortunes of the whole fund
The fundamental principle of with-profits is the sharing out of the performance of the with-profits fund (the 'profits') to its investors. This does not mean that all investors get the same return. By smoothing through the fluctuations, sometimes policies get more than the unsmoothed performance and sometimes less.
As well as smoothing, another part of the with-profits package is an element of guaranteed performance. Each policy has a guaranteed minimum value in defined circumstances, and each policy may bear a deduction to support the guarantees on other policies. In this way, all of the investors share in the fortunes of the fund.
There will still be some complexity
Even with better communications, we have to accept that the way in which with-profits returns are arrived at is more complicated than many other investments and clearer written communications need to be complemented by verbal explanations by the investor's adviser.
Conclusions
We recognise that with-profits funds and products needed modernising, to make them less opaque and more customer-friendly. In the main they have delivered what they set out to do, but this fact has been masked in recent years because failings by some providers certain areas has led to with-profits in general coming under critical scrutiny.
In many areas, we have already made the necessary improvements. We have a transparent structure for unitised business; our with-profits summary meets modern-day standards for explaining how we run with-profits; and we already have in place a formal framework for ensuring that bonus decisions are taken in policyholders' interests. And we plan to make further improvements as time goes on.
We believe there is still a huge market for an investment medium that spreads risk, smoothes returns and incorporates guarantees. The main change that is needed is for investors to be better informed, both about how companies run their with-profits funds and also the fundamental principles of with-profits.
We will be working closely with advisers to help them achieve the restoration of client confidence in with-profits, and we will also be working hard to achieve a better "press" for with-profits by continuing to influence industry decision-makers and commentators as the topic remains in the spotlight.
Our with-profits charter
Clarity
— Our unitised with-profits fund structure is simple and clear. All the charges are explicit, and the shareholder does not take a 10% cut of bonuses
— We have produced a clearly-written with-profits summary, explaining how we run our funds. A copy of the summary is issued pre-sale for all With-Profit Bonds and Flexible Bonds
— We publish the returns we earn on assets and include a commentary on the investment performance
— We have introduced a sales-aid for our With-Profits Bonds which shows how our payouts reflect our investment returns and the impact of taxation and smoothing on these payouts
— We have removed headline rates on With-Profits Bonds which show unsustainablyhigh first year returns.
Discretion
— Our detailed with-profits summary gives detailed information on how we run with-profits, telling consumers in advance the rules we will follow to manage the assets and decide the bonuses and MVRs. This means that we do not have complete discretion on how we run withprofits, but we follow defined guidelines which we make public
— We already have in place a formal framework for ensuring that bonus decisions are taken in policyholders' interests. We have a committee of executive and non-executive directors that is separate from the main board and which is responsible for ensuring policyholders' interests are looked after
— Our appointed actuary, who recommends bonus decisions, is not a member of the board, but attends all board meetings. When bonus decisions are taken and there may be conflicting views, there are separate board papers by the appointedactuary and by management
Use of Assets
— We will not use our with-profits fund to invest in potentially loss-making ventures in other parts of our business
— We do not use our with-profits fund to pay for special offers
— Our with-profits fund is kept separate from the non-profit fund
— We have no intention of giving ourselves the right to remove free or 'orphan' assets from our with-profits fund, and have not done so in the past. We retainall the free assets for the benefit of policyholders, now and in future.
