COB 6.12 Treating with-profits policyholders fairly

COB 6.12.4 R means, for example, that this section does not affect a with-profits policyholder's right to a minimum amount guaranteed on death, retirement or maturity. Nor does it affect a firm's practice of making deductions in the calculation of surrender values for the purpose of enhancing maturity payments, if:

1. (1)

   the firm has reasonably exercised its discretion to make those deductions;

2. (2)

   those deductions have been made in a clear, fair, lawful and consistent way, over a period of time;

3. (3)

   those deductions have been made in accordance with the firm's previous statements to policyholders (if any); and

4. (4)

   (as a result of (1) to (3)), the fact of those deductions, and the firm's right to make them, now form part of the implied terms of the with-profits policies affected.

Some of this section may not be relevant to a non-directive friendly society. Such a firm is, for example, not required by COB 6.10 to produce a PPFM.

The rules and guidance in this section are intended to secure an appropriate degree of protection for actual and potential with-profits policyholders and to promote confidence among them.

This section is directed only towards the protection of actual and potential with-profits policyholders and does not affect a firm's obligations to its other actual and potential policyholders.

Principle 6 (Customers' interests) requires a firm to pay due regard to the interests of its customers and to treat them fairly. Principle 7 (Communications with clients) requires a firm to pay due regard to the information needs of its clients and to communicate information to them in a way that is clear, fair and not misleading. Principle 8 (Conflicts of interest) requires a firm to manage conflicts of interest fairly.

The rules and guidance in this section supplement the Principles in their application to with-profits business and in their application to the relationship between a firm and its actual and potential with-profits policyholders. However, compliance with the rules and guidance in this section will not necessarily ensure compliance with the Principles.

For example, if a firm proposes to act in a particular way, when it considers whether its proposals will be consistent with Principle 6 (Customers' interests), it should also consider:

1. (1)

   whether its proposals are consistent with its contractual obligations to its with-profits policyholders and its wider bargain with them;

2. (2)

   whether its proposals would undermine, or materially reduce the value of, a with-profits policyholder's contractual rights;

3. (3)

   whether its proposals are consistent with its previous disclosures to its with-profits policyholders and its previous approach to the same issue;

4. (4)

   whether it will be acting entirely within the scope of any discretion that it may exercise and whether it will be exercising that discretion for the purpose for which it was granted or reserved; and

5. (5)

   any other material factor that may be relevant to the fair treatment of its with-profits policyholders.

Other parts of the Handbook are also relevant to the fair treatment of with-profits policyholders, including:

1. (1)

   PRIN and SYSC;

2. (2)

   PRU 2 (Capital), PRU 4 (Market risk) and PRU 7 (Insurance risk);

3. (3)

   Part I of IPRU(INS) 3 (Long-term insurance business) (Identification and application of assets and liabilities);

4. (4)

   Part V of IPRU(FSOC) 4 (Financial prudence) (Separation between long-term insurance business assets and other assets);

5. (5)

   COB 6.5 (Content of key features and important information: life policies, schemes, ISA and CTF cash deposit components and stakeholder pension schemes) and COB 8 (Reporting to customers);

6. (6)

   DISP 1 (Complaint handling procedures for firms) and DISP 3.8 (Determination by the Ombudsman); and

7. (7)

   ENF 20 (Unfair terms in consumer contracts).

A firm should:

1. (1)

   monitor the business and economic environment continuously; and

2. (2)

   maintain procedures that will enable it to identify promptly, and bring to the attention of its senior managers or its governing body, all material legal, regulatory, tax and other developments that are relevant to the conduct of its with-profits business.

For the purposes of this section, maturity payments include all payments made on a date when the terms of a with-profits policy provide for a minimum guaranteed amount to be paid. A firm may calculate its maturity payments in a number of different ways. COB 6.12.17 R to COB 6.12.37 G do not require a firm to use a particular methodology. However, they do require a firm to manage its with-profits business with the aim that, however it calculates its maturity payments, the overwhelming majority of them fall within a target range that has been set and specified in accordance with COB 6.12.17 R and calculated using the methodology required by, or described in, COB 6.12.24 R to COB 6.12.37 G.

A firm may choose how its target range, or target ranges, are distributed around 100% of unsmoothed asset share.

If a firm uses the definition of unsmoothed asset share in COB 6.12.24 R (1)(b), it will comply with COB 6.12.17 R (5) if it:

1. (1)

   makes a maturity payment on the specimen with-profits policy, which falls within the relevant target range; and

2. (2)

   makes a maturity payment on each of the with-profits policy represented by the specimen with-profits policy, which, if adjusted:

   1. (a)

      in the same proportion as the level of premium on that policy to the level of premium on the specimen policy; or

   2. (b)

      (if it would be more appropriate) in some other proportion,

   would fall within the target range established in respect of the specimen policy.

The FSA accepts that it may not be possible (for the purposes of COB 6.12.17 R (5)) to make a payment that falls within the relevant target range in a number of circumstances, including where the firm's regulatory, or realistic, solvency position is strained, or it would be strained, if the firm made a payment within the relevant target range, and further support arrangements are not in place, for example, under an insurance business transfer scheme or a shareholder commitment described in the firm's PPFM.

To ensure compliance with COB 6.12.17 R (6), a firm should avoid favouring one group of policies over another. The FSA recognises, however, that the operation of smoothing and the payment of more, or less, than 100% of asset share at particular points in the economic cycle may mean that groups whose maturity payments are especially concentrated in a few years will see an outcome that may diverge from the 100% longer term target.

In some circumstances, it may not be fair or reasonable to calculate or assess a maturity payment using an asset share methodology. For example, a firm may use a different methodology, which delivers fair value, but is inconsistent with asset shares, or it may use bonus reserve or North American distribution methods, which deliver more uniform bonus rates than an asset share methodology would produce. Similarly, some with-profits policies (for example, annual premium whole life assurance policies) may have asset shares that are very variable. In other cases, the relevant policies may have been materially altered, or the firm may lack the historical data required to make an asset share calculation. In those cases, a firm may use a more approximate methodology to set bonus rates, provided that that methodology is consistently applied and properly reflects its representations to with-profits policyholders.

COB 6.12.24 R (2)(b) does not require the inclusion of amounts that have been used from an inherited estate to support the year-on-year smoothing of bonus declarations.

A firm may choose to use the definition of unsmoothed asset share in:

1. (1)

   COB 6.12.24 R (1)(a) for some groups of with-profits policies; and

2. (2)

   COB 6.12.24 R (1)(b) for other groups of with-profits policies.

If a firm chooses to use:

1. (1)

   both definitions of unsmoothed asset share, it should specify, in its PPFM, which method it will use for each group of with-profits policies;

2. (2)

   the definition of unsmoothed asset share in COB 6.12.24 R (1)(b) for some or all of its with-profits policies, it should also:

   1. (a)

      ensure that the specimen with-profits policy, or with-profits policies, selected have the same material characteristics as the with-profits policies they will represent, taking into account, for example, their duration and their terms and conditions; and

   2. (b)

      explain, in its PPFM, that it has chosen the definition of unsmoothed asset share in COB 6.12.24 R (1)(b) for the relevant group of with-profits policies, and then describe in general terms what effect that decision might have on the relevant maturity payments (if any).

When a firm calculates unsmoothed asset share, for the purposes of COB 6.12.17 R and COB 6.12.24 R (2), its methodology should be consistent with the with-profits principles and with-profits practices described in its PPFM.

The unsmoothed asset share, calculated for the purposes of COB 6.12.17 R and COB 6.12.24 R (2), may include any deductions that are made from asset share for the cost of guarantees or the use of capital, where that is consistent with the with-profits principles and with-profits practices described in the firm's PPFM.

Deductions for the cost of guarantees or the use of capital could materially alter asset share, circumventing the requirements of COB 6.12.17 R (6). Therefore COB 6.12.30 R and COB 6.12.31 R require that any such deductions are part of a well-formulated plan that is altered only after due consideration. The firm should therefore consider, and set out in its plan:

1. (1)

   who will bear the risks associated with any guarantees given to with-profits policyholders; and

2. (2)

   the level or type of any charges that may be made to asset shares to cover the cost of bearing those risks.

Deductions should only be changed in response to changes in the business or economic environment and not in an arbitrary way. Retrospective changes in the form of an immediate reduction in current asset shares, however so described, would not normally be consistent with a well developed plan.

A firm should ensure that any charges made under the plan described in COB 6.12.30 R and COB 6.12.31 R are consistent with its actual investment policy and its intended investment policy.

In COB 6.12.35 R, maturity payment includes a proportionately adjusted amount as described in COB 6.12.19 G (2).

The FSA accepts that, in some cases, the target range established by reference to a specimen with-profits policy may be inappropriate for all of the with-profits policies in that group. That may be the case, for example, if the premiums paid on an individual with-profits policy are significantly greater than, or less than, those paid on the specimen with-profits policy. In those cases, the FSA also accepts that it might be fair, or fairer, to make a maturity payment that falls outside the specified target range. If a firm proposes to make a maturity payment that falls outside that target range, it should be satisfied, on reasonable grounds, that that is fair from the perspective of the particular policyholder, and the firm's other with-profits policyholders.

A firm may calculate its surrender payments (including transfers) in a number of different ways. COB 6.12.39 R to COB 6.12.45 R do not require a firm to use a particular methodology. However, they do require a firm to ensure that, however it calculates its surrender payments, the amount actually paid is, in aggregate across all similar policies, not less than that which would have been paid if the firm had calculated the surrender payment using the methodology in COB 6.12.39 R to COB 6.12.45 R.

If a firm uses its own methodology to calculate surrender payments, it should take appropriate steps to check that that methodology produces a result which, in aggregate across all similar policies, is not less than the result that would be achieved if the firm used the methodology prescribed by COB 6.12.39 R and COB 6.12.40 R. The firm should decide what steps would best secure this outcome in its particular circumstances. It might, for example, ensure consistency by testing the surrender payments on a suitable range of specimen with-profits policies.

For the purposes of COB 6.12.40 R, appropriate factors that might be included in any deduction include:

1. (1)

   the firm's unrecovered costs, including any financing costs incurred in effecting or carrying out the surrendered with-profits policy to the date of surrender, including the costs that might have been recovered if the policy had remained in force;

2. (2)

   costs that would fall on the with-profits fund, if the surrender value is calculated by reference to an assumed market value of assets which exceeds the true market value of those assets;

3. (3)

   the firm's costs incurred in administering the surrender; and

4. (4)

   a fair contribution towards the cost of any contractual benefits due on the whole, or an appropriate part, of the continuing policies in the with-profits fund which would otherwise result in higher costs falling on the continuing with-profits policies.

For the purposes of COB 6.12.39 R, a firm may set a target range for surrender payments where the top-end of the range is lower than the top-end of the relevant target range for maturity payments.

If a firm has ceased to effect new contracts of insurance in a with-profits fund, or it expects to cease to effect new contracts of insurance in the near future (see COB 6.12.95 R), and, in the reasonable opinion of the firm's governing body, the firm's circumstances require, or are then likely to require, amendments to the deductions made in reliance on COB 6.12.40 R, the firm should include the changes it proposes to make in its run-off plan (see COB 6.12.98 R).

For the purposes of COB 6.12.45 R, a firm might reasonably expect a significant change in market values if, for example, that particular market has been moving in one direction and there is reason to believe that it will continue to do so. A firm might expect a high volume of surrenders if surrender volumes have been increasing, and there is reason to think that that will continue or if some unexpected and adverse event has occurred, which is relevant to the firm or the wider business or economic environment, which is likely to prompt a material number of surrenders.

COB 6.12.51 R (2) applies, in particular, to distributions that take the form of a reversionary bonus addition to conventional with-profits policies.

COB 6.12.61 R does not prevent a firm from charging a fair proportion of its overheads (including executive remuneration) to a with-profits fund.

It is for a firm to decide when, and how often, to review its guarantee charges, taking into account its circumstances and the wider business or economic environment.

COB 6.12.66 R does not apply to ex gratia or rectification payments. A firm may, therefore, correct an erroneous underpayment to a with-profits policyholder, or former with-profits policyholder, using assets in a with-profits fund.

For the purposes of COB 6.12.67 R (3), a firm's governing body should assess whether compensation or redress can be paid from the firm's inherited estate, assets attributable to shareholders or any other source by reference to:

1. (1)

   its ability to continue to meet the higher of any relevant enhanced capital requirement or individual capital assessment; and

2. (2)

   any other factors relevant to policyholders' interests.

If a report under section 166 of the Act (Reports by skilled persons) does not relate entirely to insurance business being carried on in a with-profits fund, a firm should charge a fair proportion of the overall cost of the report to the fund, but only if that would be consistent with COB 6.12.70 R.

If a firm has properly charged an amount to a with-profits fund, but circumstances later show that the charge should not have been made (see COB 6.12.70 R and COB 6.12.71 G), the firm should fully reimburse the with-profits fund.

3If a firm carries on insurance business outside its with-profits fund, it should assess the extent to which the corporation tax liability arising in respect of that business has been affected by the insurance business within the with-profits fund. If the insurance business within the with-profits fund has reduced the corporation tax liability that would have otherwise arisen in respect of that other business, the firm'sgoverning body should consider whether any unfairness results. In particular, if the firm has taken an action, or a series of actions, that were intended to cause a material part of the tax charged to the with-profits fund to emerge as a contribution to the profit of the firm, it may be unfair if no reduction is made to the amount so charged.

In some circumstances, it may be difficult or impossible for a firm to mitigate the risk of a material adverse affect on its existing, or new, with-profits policyholders, unless it establishes a new bonus series or with-profits fund. The factors that might cause a firm to establish a new bonus series or with-profits fund include:

1. (1)

   that the current investment outlook is not adequately reflected in existing premium rates. For example, a new high, or low, inflation environment, greater volatility of investment returns or a materially altered investment mix, might mean that the bonus potential for new and existing with-profits policies are materially different;

2. (2)

   high acquisition costs on the new with-profits policies, which would place an undue burden on the financial resources of the relevant with-profits fund or be detrimental to existing with-profits policyholders;

3. (3)

   that the firm has a high level of guarantees or options in its existing with-profits policies, which might place an excessive burden on new with-profits policies, or vice versa;

4. (4)

   the level of charges on the new with-profits policies, or the pattern of their emergence, if that might create a material risk of noncompliance with COB 6.12.76 G; or

5. (5)

   that existing policyholders might be disadvantaged by an adjustment to the balance of the investments held within the particular with-profits fund, which would result from the decision to materially increase the number of new with-profits policies effected by the firm.

Circumstances, in which it may be appropriate to establish a new with-profits fund, are likely to arise when the potential risks to new or existing with-profits policyholders are likely to be too great for the same with-profits fund to provide, adequately, for the interests of the two groups of policyholders, even after allowing for the beneficial effects of diversification (if any). Such potential risks are likely to arise from significant differences in the terms and conditions of the new and existing with-profits policies, including the basis on which charges are levied and reviewed.

When a firm prices the new insurance business that it proposes to effect in an existing with-profits fund, it should estimate the volume of new insurance business that it is likely to effect and then build in adequate margins that will allow it to recover any acquisition costs to be charged to the with-profits fund.

When a firm sets a target volume for new insurance business in an existing with-profits fund, it should pay particular attention to the risk of disadvantage to existing with-profits policyholders. Those policyholders might be disadvantaged, for example, by the need to retain additional capital to support a rapid growth in new business, when that capital might have been distributed in the ordinary course of the firm's existing business.

When a firm determines its strategy for new insurance business in an existing with-profits fund, it should take particular account of:

1. (1)

   the capital support available; and

2. (2)

   any benefits that may arise if, for example, the different types of new insurance business complement each other, for example, in direct financial terms or by the reduction of risk.

A firm's underwriting policy should remain reasonably consistent over time. Existing with-profits policyholders should not be exposed to the risk that a significant change in underwriting standards for new insurance business in the same with-profits fund will cause deterioration in experience that was not allowed for in the premium rates for that new business.

If a firm, or a connected person, provides support to a with-profits fund (for example, by a contingent loan), the fund might take on more risk, for example, by investing in volatile assets. However, that would not be appropriate if the support will be repaid, leaving policyholders to bear all of the risks they have been exposed to. Therefore, no reliance should be placed on that support when the firm assesses the with-profits fund's financial position unless there are clear and unambiguous criteria governing any repayment obligations to the support provider. The degree of reliance placed on that support should depend on the subordination of the support to the fair treatment of with-profits policyholders and clarification of what fair treatment means in various circumstances. For a realistic basis life firm this would normally be evidenced by the liability for such support being capable, under stress, of a progressively lower valuation in the future policy-related liabilities.

Subject to COB 6.12.80 G, if assets from outside a with-profits fund are made available to support that fund, a firm should manage the fund disregarding the liability to repay those assets, at least in so far as that is necessary for its policyholders to be treated fairly.

A parent undertaking should avoid creating an expectation that it will support a subsidiary unless formal arrangements are in place to ensure that that support will be provided, if it is required.

When a firm determines its investment strategy, and the acceptable level of risk within that strategy, it should take into account:

1. (1)

   the extent of the guarantees in its with-profits policies;

2. (2)

   any representations that it has made to its with-profits policyholders;

3. (3)

   its established practice; and

4. (4)

   the amount of capital support available.

A firm should only change its investment strategy when that is necessary or appropriate to take account of material changes in its economic circumstances or the wider economic environment, changes in policyholder utilisation of policy options or changes in the level of capital support available to the with-profits fund where further support arrangements are not in place under an insurance business transfer scheme or a shareholder commitment described in the firm's PPFM.

If a firm is considering using with-profits assets to finance the purchase of another business, directly, or by or through a connected person, or if a firm is considering whether it should retain such an investment, it should consider whether the purchase or retention would be, or will remain, fair to its with-profits policyholders. When a firm makes that assessment, it should consider:

1. (1)

   the size of the investment in relation to the with-profits fund;

2. (2)

   the expected rate of return on the investment;

3. (3)

   the risks associated with the investment, including liquidity risk, the capital needs of the acquired business and the difficulty of establishing fair value (if any);

4. (4)

   any costs that would result from divestment;

5. (5)

   whether an actuary, appointed by the firm under SUP 4 (Actuaries), would regard the investment as suitable for the with-profits fund;

6. (6)

   whether the investment has been, or will be, disclosed to with-profits policyholders;

7. (7)

   notwithstanding (6), whether a knowledgeable existing with-profits policyholder in that with-profits fund would regard it as an appropriate investment;

8. (8)

   in the case of a proprietary firm, whether it would be more appropriate for the investment to be made using assets other than those in a with-profits fund; and

9. (9)

   any other material factors.

If the firm carries out non-profit insurance business in a with-profits fund, it should review the profitability of the non-profit insurance business regularly. When it does so, the firm should consider whether, for example, its charges for that business should be adjusted, if adjustment is permitted, to maintain fairness to non-profit and with-profits policyholders. If the firm's review suggests that a change should be made, but the difference between the existing arrangements and the new arrangements is not material, the firm may choose whether or not to make it.

If a firm has reinsured its with-profits insurance business into another insurance undertaking, it should take reasonable steps to discharge its responsibilities to its with-profits policyholders, in respect of the reinsured business. Those steps should include maintaining adequate controls.

For the purposes of COB 6.12.89 R and COB 6.12.90 R, material transactions include:

1. (1)

   a significant bulk outwards reinsurance contract;

2. (2)

   inwards reinsurance of with-profits business from another insurance undertaking;

3. (3)

   a financial engineering transaction that would materially change the profile of any surplus expected to emerge on the with-profits fund's existing insurance business; and

4. (4)

   a significant restructuring of the with-profits fund, especially if it involves the creation of new sub-funds.

So that it can consider whether a proposed material transaction might adversely affect the interests of its with-profits policyholders, a firm should obtain a report from an actuary appointed under SUP 4 (Actuaries) or another appropriate professional adviser.

A firm should also consider whether a knowledgeable existing with-profits policyholder in that with-profits fund would conclude that the proposed material transaction would materially affect his interests, whether or not the transaction will be disclosed to policyholders.

A firm should not avoid taking a formal decision to cease to effect new contracts of insurance in a with-profits fund in an attempt to avoid the requirements of COB 6.12.94 R.

A firm should contact the FSA to discuss whether it has, or it should be taken to have, ceased to effect new contracts of insurance, for the purposes of COB 6.12.94 R if:

1. (1)

   COB 6.12.95 R (2) may apply;

2. (2)

   it is no longer effecting a material volume of new with-profits policies in a particular with-profits fund, other than by reinsurance;

3. (3)

   it is effecting only new reinsurance business in a particular with-profits fund; or

4. (4)

   it cedes by way of reinsurance most of the new with-profits policies it continues to effect.

A firm should also include the information described in SUP App 2.15 in its run-off plan.1

When a firm tells its with-profits policyholders that it has ceased to effect new contracts of insurance in a with-profits fund, it should also explain:

1. (1)

   why it has done so;

2. (2)

   what changes it has made, or proposes to make, to the fund's investment strategy (if any);

3. (3)

   how closure may affect with-profits policyholders (including any reasonably foreseeable effect on future bonus prospects);

4. (4)

   the options available to with-profits policyholders and an indication of the potential costs associated with the exercise of each of those options; and

5. (5)

   any other material factors that a policyholder may reasonably need to be aware of before deciding how to respond to this information.

A firm may not be able to provide its with-profits policyholders with all of the information described in COB 6.12.99 G until it has prepared the run-off plan required by COB 6.12.94 R (2). In those circumstances, the firm should:

1. (1)

   tell its with-profits policyholders that that is the case;

2. (2)

   explain what is missing and give a time estimate for its supply; and

3. (3)

   provide the missing information as soon as possible, and within the time estimate given.

To ensure a fair distribution, in compliance with COB 6.12.98 R (1), a firm will normally have to distribute that part of the with-profits fund that is not required to support any continuing business, including a fair proportion of any inherited estate attributable to it.

To ensure a fair and prudent distribution, a firm may have to distribute a lower proportion of any inherited estate attributable to a closed with-profits fund to policyholders whose with-profits policies mature in the shorter term as compared to those whose with-profits policies mature in the longer term.

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 insurance business is available for distribution during the lifetime of the with-profits business.

For the purposes of COB 6.12.105 G, where it is agreed by its with-profits policyholders, and subject to meeting the requirements of COB 6.12.73 R, a mutual may make alternative arrangements for continuing to carry on non-profit insurance business; and a non-directive friendly society may make alternative arrangements for continuing to carry on non-insurance related business.

A firm should discuss with the FSA at an early stage any significant issues it identifies relating to its proposed distribution of a closed with-profits fund.

When a firm communicates information to a customer, COB 2.1.3 R requires it to take reasonable steps to do so in a way that is clear, fair and not misleading. The guidance in the rest of this section is relevant to the application of COB 2.1.3 R to the provision of information to with-profits policyholders.

When a firm communicates information to its with-profits policyholders, it should not assume that those policyholders have a good understanding of their investment or the purpose, scope and operation of the firm's discretion. To achieve fairness, clearer explanations may be required than for some other long-term investments, especially when the firm refers to any unusual aspects of a with-profits policy.

When a firm communicates information to its with-profits policyholders, that information should properly reflect the long-term nature of the investment and the long-term nature of the firm's relationship with its with-profits policyholders. The firm's communications should also be consistent with the information that it has already given to with-profits policyholders.

To promote fairness in communications with its with-profits policyholders, a firm should:

1. (1)

   write clearly in plain language;

2. (2)

   use personal language (for example, 'we' and 'you') to make documents easier to understand; and

3. (3)

   use presentation and terminology that is consistent with the information that it has already provided.

A firm should highlight the importance of key documents, including the CFPPFM, 4indicating why it is important that with-profits policyholders should read and understand them.

A firm should give a with-profits policyholder the opportunity, and reasonable time, to act on information provided to him in accordance with his circumstances, provided that that would not adversely affect the interests of other with-profits policyholders.

A firm should give a with-profits policyholder the information he might reasonably need to take a considered decision about (or get advice on) his investment, whenever that is necessary or appropriate. The information should include, where appropriate, information about any options that are available to him, and the costs or other material factors attributable to the exercise of any or all of those options.

The information referred to in COB 6.12.115 G includes:

1. (1)

   information about the performance of the with-profits policy;

2. (2)

   a projection of the future value of the with-profits policy;

3. (3)

   information about material changes in the circumstances of the with-profits fund, or the firm's approach to managing it, which might affect the with-profits policy and future bonus prospects;

4. (4)

   information about any material changes in the firm's charges which might affect the with-profits policy; and

5. (5)

   information about any material changes in the information already provided, for example, at the point of sale.