COB 6.10 Principles and Practices of Financial Management (PPFM)

Principle 6 (Customers' interests) requires a firm to pay due regard to the interests of its customers and treat them fairly.

The rules and guidance in this section are intended to secure an appropriate degree of protection for policyholders,4 and potential policyholders,4 of firms carrying on with-profits business by requiring them to define and make available their Principles and Practices of Financial Management and to produce, for their with-profits policyholders, and potential with-profits policyholders, a consumer-friendly version of them4. The rules and guidance in this section 4 are also intended to enable policyholders,4 and potential policyholders,4 of firms carrying on with-profits business better to understand the way in which firms carry on their with-profits business.

A firm's Principles and Practices of Financial Management also play an important role in promoting confidence among with-profits policyholders and in the governance arrangements for with-profits business set out in COB 6.11 (Reporting to with-profits policyholders on compliance with PPFM).

In relation to EEA insurers, the rules and guidance in this section are intended to enable UK policyholders properly to understand the essential elements of the EEA insurer's commitment under the relevant with-profits policy. 4The effect of COB 6.10.21A R to COB 6.10.21K R4 is that an EEA insurer that carries on with-profits business must provide its UK 4with-profits policyholders with information equivalent in scope and content to the information that a UK insurer must provide in its 4Principles and Practices of Financial Management and in its consumer-friendly version of them4.2

Whether a separate PPFM is needed for each with-profits fund is a matter for the firm in the light of its circumstances, including previous management of those funds and any relevant representations made by the firm to with-profits policyholders.

In order to comply with COB 6.10.5 R a firm should:

1. (1)

   establish and maintain a document approved by its governing body, setting out its PPFM; and

2. (2)

   keep a record of each version of the PPFM as it changes over time.

In addition to providing copies of its PPFM, pursuant to COB 6.10.8 R, a firm may also wish to publish its PPFM on its website.4

4A firm may also provide a copy of its CFPPFM with, or as part of, any other document.

4In complying with COB 6.10.9B R (1) and COB 6.10.9BR (2), a firm should:

1. (1)

   have regard to Principle 7 (Communications with clients);

2. (2)

   give its CFPPFM a consumer-friendly title (for example, 'How we manage our with-profits business - a guide');

3. (3)

   include a short and clear statement at the beginning of its CFPPFM (for example, on a front cover) explaining its purpose and the importance of the information in it;

4. (4)

   use a contents page, bold headings, bullet points and colours, whenever that will help to make the CFPPFM more accessible and more easily understood;

5. (5)

   provide information in context, whenever that is necessary or appropriate (for example, by explaining what a with-profits policy is, and how it works, before describing the most important information set out under each of the headings in the firm's PPFM);

6. (6)

   use, short and concise paragraphs and, whenever reasonably possible, active verbs and personal pronouns rather than passive verbs and indirect pronouns (for example, a question could be: 'How do we make our bonus decisions?');

7. (7)

   avoid using technical, or industry specific, terms whenever that is reasonably possible (if a firm cannot reasonably avoid using such terms, it should explain, in plain language, what those terms mean);

8. (8)

   refer to its CFPPFM in:

   1. (a)

      any annual statements sent to its with-profits policyholders;

   2. (b)

      its key features for with-profits policies; and

   3. (c)

      any other material document produced by the firm, where such a reference would be useful or appropriate;

9. (9)

   explain in the CFPPFM that:

   1. (a)

      readers should refer to the firm's PPFM for a fuller description of the ways in which the firm manages its with-profits business; and

   2. (b)

      copies of the firm's PPFM, or its relevant PPFM, are available on request (see COB 6.10.8 R) and how copies can be obtained.

The with-profits principles within the PPFM must:

1. (1)

   be enduring statements of the overarching standards the firm adopts in managing with-profits funds; and

2. (2)

   describe the business model used by the firm in meeting its duties to with-profits policyholders and in responding to longer-term changes in the business and economic environment.

The with-profits principles are not expected to change often. However, they should be informative enough to enable the directors, any actuary appointed under SUP 4 (Actuaries) and any With-profits Committee, amongst others, to judge whether existing or potential with-profits practices are appropriate for the firm.

A firm may give the notice required under COB 6.10.12 R by including the required information in any annual statements sent to with-profits policyholders if this is at least three months in advance of the effective date of the proposed changes.

Changes to the with-profits principles of a firm are likely to trigger one or more of the firm's obligations to notify the FSA under SUP 15.3 (General notification requirements).

Subject to the with-profits principles, a firm's with-profits practices are expected to change as the firm's circumstances and the business environment change, with some alteration, for example, every few years.

A firm may give the notice required under COB 6.10.18 R by including the required information in any annual statements sent to with-profits policyholders. The notice can be in arrears but should be within a reasonable time period from the effective date of the change.

Changes to the with-profits practices of a firm may trigger one or more of the firm's obligations to notify the FSA under SUP 15.3 (General notification requirements).

An EEA insurer may wish to publish the information provided pursuant to COB 6.10.21A R on its website.4

2An EEA insurer may give the notice provided under COB 6.10.21D R by including the required information in any annual statements sent to with-profits policyholders if this is at least three months in advance of the effective date of the proposed changes.

2An EEA insurer may give the notice provided under COB 6.10.21H R by including the required information in any annual statements sent to with-profits policyholders. The notice can be arrears but should be within a reasonable time period from the effective date of the change.2

In addition to the issues in COB 6.10.22 R(2), a firm's PPFM should also cover any other areas that are important to the management of its with-profits funds and that may affect the amounts payable under with-profits policies.

A firm's PPFM should reflect any requirements or constraints relevant to the management of with-profits funds that apply to the firm as a result of previous dealings: for example, previous business transfer schemes. The PPFM should also set out the extent to which the firm's freedom to alter its PPFM is constrained, including by such previous dealings.

3A firm's PPFM should describe the nature and extent of any shareholder commitment to support the with-profits fund. It should also describe when and how that commitment will take effect.

The rest of this section includes rules on each of the issues that a firm's PPFM must cover, followed in each case by guidance on how various information relevant to that issue might be split between with-profits principles and with-profit practices.

A firm may use a number of methods to determine the amount payable to a with-profits policyholder and may use more than one method to determine the amount payable to a particular with-profits policyholder.

The firm's with-profits principles should describe:

1. (1)

   the aims of the methods the firm uses to determine the amount payable to with-profits policyholders;

2. (2)

   the degree of approximation that the firm is prepared to allow in the application of those methods and in the application of its with-profits principles;

3. (3)

   how the firm controls changes to those methods; and

4. (4)

   the circumstances under which the firm might change any historical assumptions or parameters relevant to those methods: for example, previously applied investment returns, charges, or allocations of miscellaneous surplus, that have been derived from the historical experience and actions of the firm.

The firm's with-profits practices should describe, for each major class of with-profits policy:

1. (1)

   the methods that the firm currently uses to determine the amount payable to with-profits policyholders;

2. (2)

   the methods that the firm currently uses to determine the main assumptions or parameters that determine the output of those methods;

3. (3)

   the degree of approximation that the firm allows when it applies assumptions or parameters across generations of with-profits policyholders or across different types or classes of with-profits policies;

4. (4)

   the formality with which the firm documents the methods, parameters or assumptions that it uses to determine the amount payable to with-profits policyholders; and

5. (5)

   the firm's internal procedures for changing either the current methods or the current parameters or assumptions relevant to a particular method; and3

   3
6. (6)

   the firm's target range, or target ranges, that have been set and specified pursuant to COB 6.12.17 R; and3

7. (7)

   the factors that the firm is likely to regard as relevant under COB 6.12.59 R.

The firm's with-profits practices should describe how the firm brings investment return, expenses or charges and tax into account and how the firm determines the impact of those items on the amount payable under a with-profits policy. In particular, the firm's with-profits practices should describe:

1. (1)

   any distinctions that the firm makes in recognising the investment return from a subset of the total assets of a with-profits fund;

2. (2)

   whether the firm apportions expenses fully between all the policies in a with-profits fund or apportions expenses in some other way, for example, by meeting some expenses from the firm'sinherited estate;

3. (3)

   the relationship between the actual liability to tax of a with-profits fund and the tax that the firm imputes to determine the amount payable under a with-profits policy;

4. (4)

   the impact on the amount payable under a with-profits policy of any liability to tax of a with-profits fund as a result of the firm making a transfer to shareholders; and

5. (5)

   how the firm brings any other items into account, including, for example, charges made for the costs of guarantees, charges for the use of capital and charges for other risks.

The firm's with-profits principles should:

1. (1)

   describe the firm's general aims in setting annual bonus rates and the constraints to which the firm may be subject in changing economic circumstances; and

2. (2)

   indicate how the firm would determine the range of with-profits policies or generations of with-profits policies over which the firm believes a single bonus rate would be appropriate and the circumstances under which the firm believes a new bonus series would be necessary.

The firm's with-profits practices should:

1. (1)

   describe the firm's current approach to setting annual bonus rates, including the weight given to recent economic experience;

2. (2)

   indicate the frequency at which the firm re-sets or expects to re-set annual bonus rates;

3. (3)

   indicate the maximum amount (if any) by which annual bonuses would alter if the firm were to re-set annual bonus rates; and

4. (4)

   describe the firm's approach to setting any interim bonus rates before the next declaration of annual bonus rates.

The firm's with-profits principles should describe the firm's approach to setting final bonus rates, in the context of the firm's general aims in determining the total amount payable under with-profits policies, and by reference to the constraints to which the firm may be subject in changing economic circumstances.

The firm's with-profits practices should:

1. (1)

   describe the firm's current approach to setting final bonus rates, including the weight given to recent economic experience. The description should include any distinctions that the firm makes between with-profits policies that remain in force until contractual dates, or dates on which no market value reduction applies (for example, maturity or retirement dates) and policies that are surrendered or transferred at other dates;

2. (2)

   describe the relationship or interaction between final bonus rates and any market value reductions, if both can apply at the same time;

3. (3)

   describe how final bonuses influence the value of with-profits policies that have formulaic surrender or transfer bases (for example, older conventional policies rather than unitised policies); and

4. (4)

   indicate the frequency at which the firm sets or expects to set final bonus rates and the circumstances under which changes in the economic environment would cause the firm to change the time between re-setting.

The PPFM should describe the firm's approach to smoothing the value of with-profits policies, including those matters required under COB 6.12.47 R.3

The firmwith-profits principles should:

1. (1)

   indicate whether and in what respect the firm takes a significantly different approach to smoothing depending on the type of claim arising from with-profits policies;

2. (2)

   indicate whether the firm intends smoothing to be neutral over time;

3. (3)

   indicate whether there is any total scale or cost of smoothing to the firm over the shorter-term that the firm believes should not be exceeded. The FSA takes the cost of smoothing to mean the extent to which the amount actually payable under a with-profits policy diverges from the theoretical determinant of policy value under COB 6.10.26 R, except where due to applicable guarantees; and

4. (4)

   indicate whether the firm's applies market value reductions, or changes the surrender bases for with-profits policy that are not unitised, only to reflect changes in underlying asset values.

The firm's with-profits practices should:

1. (1)

   indicate how rapidly the firm might need to adjust the value of with-profits policies, by specifying any period over which the firm expects smoothing to be neutral;

2. (2)

   indicate whether there is any overall limit to the accumulated cost of, or excess from, smoothing that the firm is prepared to tolerate;

3. (3)

   indicate whether the firm applies a single smoothing strategy to all generations and types of with-profits policy, or applies different smoothing strategies to subsets of the with-profits fund, in particular whether (and in what respect) the firm applies a different smoothing strategy to new entrants to a with-profits fund when the accumulated cost or excess from smoothing is large;

4. (4)

   describe the firm's current approach to smoothing: for example, the acceptable degree of change in the value of similar with-profits policies from one year to the next, or the formula the firm uses to recognise recent investment performance as a determinant of the value of a with-profits policy;

5. (5)

   describe how the firm applies smoothing to classes of with-profits policies that participate in final bonuses indirectly: for example, older policies with formulaic surrender or transfer bases;

6. (6)

   describe how accurately the firm applies market value reductions or surrender and transfer bases to give effect to smoothing; and

7. (7)

   describe how the firm accounts for partial payments under with-profits policies to which no penalty (for example, by market value reductions) is applied, in determining the eventual total value of a with-profits policy.

The firm's with-profits principles should:

1. (1)

   set out the firm's investment strategy in terms that allow alternative with-profits practices to be judged and where necessary rejected. The firm's with-profits principles should therefore specify the specific factors that drive the firm's investment strategy, in more detail than, for example, simply achieving the best return within the framework of the likely volatility of asset values;

2. (2)

   if the firm relies on assets outside a with-profits fund to maintain the firm's investment strategy, state on which assets and to what degree the firm relies;

3. (3)

   set out how the firm views the use, as part of its investment strategy, of derivatives and other instruments that may alter the economic out-turn from assets;

4. (4)

   set out any constraints on the firm's investment strategy either with respect to parts of a with-profits fund (for example, classes of with-profits policy or bonus series) or between different generations of with-profits policyholders; and

5. (5)

   set out any overarching constraints on the firm's exposure to any one counterparty including derivative exposures.

The firm's with-profits practices should:

1. (1)

   describe what procedures the firm follows to transfer assets to the with-profits fund under COB 6.10.41 G(2) and at what point such transfers would be recognised as irretrievable by the provider of outside assets;

2. (2)

   set out the period between formal reviews of the firm's investment strategy;

3. (3)

   describe the degree of matching the firm maintains between the assets of a with-profits fund and liabilities to with-profits policyholders and other creditors, and the basis of the liabilities assessed for such purposes;

4. (4)

   explain the firm's approach to investment in different asset classes, and assets of different credit or liquidity quality. This may include, for example, the firm's guidelines as to the overall limit on the amount of a with-profits fund that may be invested in particular asset classes and the overall crediting rating of parts of the portfolio, the minimum credit quality of new and existing investments as well as the overall liquidity constraints on the with-profits fund; and

5. (5)

   explain the approval process that the firm operates before investing in new or novel investment instruments.

A with-profits fund may include assets that would not normally be traded because of their importance to the firm. These might be physical assets: for example, the firm's head office building, but may include contingent support or guarantee arrangements to or from other entities.

In relation to assets that would not normally be traded because of their importance to the firm, the with-profits principles of the firm should:

1. (1)

   describe why such assets are of use to a with-profits fund;

2. (2)

   describe what reviews the firm carries out to ensure those assets still remain of use;

3. (3)

   set out any limits that the firm imposes on the scale of investment in those assets;

4. (4)

   indicate whether the out-turn from investment in those assets will impact on the amounts payable under with-profits policies; and

5. (5)

   indicate what credit or liquidity requirements the firm applies to investments in those assets.

In relation to assets that would normally be trade, the with-profits practices of the firm should describe those assets, their current application in determining claim values and any constraints imposed on the firm's investment freedom as a result of its investment in those assets.

Business risk for a with-profits fund can include a number of exposures, for example:

1. (1)

   exposure to maintaining and acquiring with-profits policies;

2. (2)

   exposure to maintaining and acquiring non-profit policies;

3. (3)

   exposure to risks from other investments: for example, in investment management companies, service companies or overseas subsidiary insurance companies.

The PPFM of a firm should make clear how the firm considers such exposures before they are taken up or entered into, and how the firm intends to deal with rewards or risks going forward. In particular, the PPFM should make clear what alternatives the firm sets as a benchmark when reviewing existing business risk and new business risks to determine whether the rewards are reasonable given the risks undertaken.

Where the firm explicitly excludes business risk from a class of with-profits policies there may often be residual risks from the class that are natural to with-profits policies such as guarantee and smoothing costs. The PPFM should make clear where such costs are borne.

The firm's with-profits principles should set out the general limits that the firm applies to the taking on of business risk and the control that the firm exercises over existing business risk. In particular, the with-profits principles should define where compensation costs from a business risk would be borne.

The firm's with-profits practices should:

1. (1)

   describe the current limits that the firm applies to the taking on of business risk;

2. (2)

   describe the firm's approach to the application of the rewards and losses from business risks as a determinant of the amount payable under a with-profits policy;

3. (3)

   describe the degree to which the firm smoothes any profits or losses from business risks before applying them to determine the amount payable under a with-profits policy;

4. (4)

   indicate whether profits or losses from business risks must exceed a minimum value or scale before the firm will treat them as a determinant of the amount payable under a with-profits policy; and

5. (5)

   indicate whether and to what extent particular generations of with-profits policyholders or classes of with-profits policy bear or might bear particular business risks, including, for example, crystallised or contingent guarantees to other classes of policyholder or whether the out-turn from all business risk is pooled across all with-profits policies.

The firm's with-profits principles should:

1. (1)

   describe the overall aim of the firm's approach to applying charges and apportioning expenses to with-profits policies, covering all types of charges and expenses including investment costs, commissions and charges borne from investment through collective investment schemes; and

2. (2)

   set out the factors that would drive any change to the basis on which the firm applies charges to or apportions its actual expenses amongst with-profits policies , or exercises any discretion to apply charges to particular with-profits policies.

The firm'swith-profits practices should:

1. (1)

   give a general description of the charges that the firm currently applies and the expenses that it currently apportions to major classes of with-profits policies;

2. (2)

   describe the relationship between the firm's actual charges and expenses, as applied to determine the amounts payable under with-profits policies, and the charges and expenses borne by the with-profits fund;

3. (3)

   state the circumstances under which the firm will charge expenses to the with-profits fund at an amount other than cost, and the reasons why the firm will do so; and

4. (4)

   state the interval at which the firm will review any arrangements under which it obtains out-sourced services, included those provided by connected parties, and give a broad indication of the terms on which the firm would be able to terminate the agreements to provide those services.

The PPFM of a firm should make clear the criteria that the firm will apply when it has to make judgements about how to apply charges and apportion expenses between with-profits funds or between a with-profits fund and shareholder owned funds, firms or service companies.

The firm'swith-profits principles should:

1. (1)

   describe how the firm will manage its inherited estate;

2. (2)

   describe the purposes for which the firm will apply the inherited estate;

3. (3)

   indicate the size or scale of inherited estate for which the firm is aiming, for example, by reference to the volume of the firm's existing business or the risks borne by the firm's existing business;

4. (4)

   explain the implications of the firm's preferred size or scale of inherited estate for the value of the firm's with-profits policies;

5. (5)

   describe any existing division of the firm's inherited estate between with-profits funds within the firm; and

6. (6)

   describe any constraints on the firm's freedom to deal with the inherited estate as a result of previous dealings: for example, a transfer of business scheme or attribution or re-attribution of a previous inherited estate.

The firm's with-profits practices should:

1. (1)

   describe how the firm uses the inherited estate by, for example, reference to the costs the inherited estate is meeting;

2. (2)

   state whether the firm's investment strategy for the firm's inherited estate is different to the firm's investment strategy for the rest of the with-profits fund; and

3. (3)

   describe any current guidelines that the firm has in place as to the size or scale of the inherited estate or as to how the firm would mange the inherited estate and over what time period, if it became too large or too small.

The firm'swith-profits principles should:

1. (1)

   set out the firm's approach to setting the volume of new business, both new with-profits business and non-profit business written in the with-profits fund; and

2. (2)

   set out the firm's anticipated reaction to closure to significant amounts of new business and, in particular, what action it would take in that event as regards the distribution of any inherited estate.

The firm's with-profits practices should:

1. (1)

   describe the approach the firm takes to setting any maximum volume of new business each year and any particular limits on classes of business, including non-profit business within the with-profits fund; and

2. (2)

   describe what the firm considers should be the minimum proportion and scale of new business of a with-profits type to justify the with-profits fund staying open to new business.

The firm's with-profits principles should:

1. (1)

   describe the firm's arrangements for profit sharing between shareholders and with-profits policyholders and the scope for changes in the share of profits allotted to each; and

2. (2)

   indicate the approach that the firm will take before any changes to the profit sharing arrangements are implemented.

The firm's with-profits practices should:

1. (1)

   indicate the current basis on which the firm divides profit between with-profits policyholders and shareholders, including the method of calculating the profit to be divided;

2. (2)

   indicate whether the division of profit between with-profits policyholders and shareholders would change if there was a change in the underlying basis on which the shareholder share is computed (normally the valuation basis of the mathematical reserves);

3. (3)

   indicate other factors that would have a significant impact on the balance between the shareholder share and the with-profits fund, for example:

   1. (a)

      tax or other imposts; or

   2. (b)

      distributions in anticipation of a surplus; or

   3. (c)

      the firm's approach to with-profits policies with both an entitlement to final bonus and an exposure to a market value reduction; or

   4. (d)

      the impact of guaranteed bonuses; and

4. (4)

   state whether the pricing of any policies that the firm is writing, and particular policies open to new business, appear to be significantly and systematically reducing the firm'sinherited estate if the shareholder transfer is taken into account.