COBS 20.2 Treating with-profits policyholders fairly
Introduction
With-profits business, by virtue of its nature and the extent of discretion applied by firms in its operation, involves numerous potential conflicts of interest that might give rise to the unfair treatment of policyholders. The rules in this section address specific situations where the risk may be particularly acute. However, a firm should give careful consideration to any aspect of its operating practice that has a bearing on the interests of its with-profits policyholders to ensure that it does not lead to an undisclosed, or unfair, benefit to shareholders.
Neither Principle 6 (Customers' interests) nor the rules on treating with-profits policyholders fairly (COBS 20.2) relieve a firm of its obligation to deliver each policyholder's contractual entitlement.
Amounts payable under with-profits policies
A firm must have good reason to believe that its pay-outs on individual with-profits policies are fair.
Amounts payable under with-profits policies: Maturity payments
In this section, maturity payments include payments made when a with-profits policy provides for a minimum guaranteed amount to be paid.
- (1)
Unless a firm cannot reasonably compare a maturity payment with a calculated asset share, it must:
- (a)
set a target range for the maturity payments that it will make on:
- (i)
all of its with-profits policies; or
- (ii)
each group of its with-profits policies;
- (i)
- (b)
ensure that each target range:
- (c)
manage its with-profits business, and the business of each with-profit fund, with the aim of making on each with-profit policy a maturity payment that falls within the relevant target range.
- (a)
- (2)
Unsmoothed asset share means:
- (a)
the unsmoothed asset share of the relevant with-profits policy; or
- (b)
an estimate of the unsmoothed asset share of the relevant with-profits policy derived from the unsmoothed asset share of one or more specimen with-profits policies, which a firm has selected to represent a group, or all, of the with-profits policies effected in the same with-profits fund.
- (a)
- (3)
A firm must calculate unsmoothed asset share by:
- (a)
applying the methods in INSPRU 1.3.119 R to INSPRU 1.3.123 R;
- (b)
including any amounts that have been added to the policy as the result of a distribution from an inherited estate; and
- (c)
subject to (d), and where the terms of the policy so provide, adding or subtracting an amount that reflects the experience of the insurance business in the relevant with-profits fund; but
- (d)
if a with-profits fund has suffered adverse experience, which results from a firm's failure to comply with the rules and guidance on treating with-profits policyholders fairly (COBS 20.2.1 G to COBS 20.2.41 G and COBS 20.2.53 R to COBS 20.2.60 G), that adverse experience may only be taken into account if, and to the extent that, in the reasonable opinion of the firm's governing body, the amount referred to in (c) cannot be met from:
- (i)
the firm's inherited estate (if any); or
- (ii)
any assets attributable to shareholders, whether or not they are held in the relevant with-profits fund.
- (i)
- (a)
Notwithstanding that a firm must aim to make maturity payments that fall within the relevant target range, a firm may make a maturity payment that falls outside the target range if it has a good reason to believe that at least 90% of maturity payments on with-profits policies in that group have fallen, or will fall, within the relevant target range.
If it is not fair or reasonable to calculate or assess a maturity payment using the prescribed asset share methodology, a firm may use another methodology to set bonus rates, if that methodology properly reflects its representations to with-profits policyholders and it applies that methodology consistently.
A firm may make deductions from asset share to meet the cost of guarantees, or the cost of capital, only under a plan approved by its governing body and described in its PPFM. A firm must ensure that any deductions are proportionate to the costs they are intended to offset.
If a firm has approved a plan to make deductions from asset share, it must ensure that its planned deductions do not change unless justified by changes in the business or economic environment, or changes in the nature of the firm's liabilities as a result of policyholders exercising options in their policies.
If a firm calculates maturity payments using the prescribed asset share methodology, it must manage its with-profits business, and each with-profits fund, with the longer term aim that it will make aggregate maturity payments of 100% of unsmoothed asset share.
Amounts payable under with-profits policies: Surrender payments
A firm may use its own methodology to calculate surrender payments, but it should have good reason to believe that its methodology produces a result which, in aggregate across all similar policies, is not less than the result of the prescribed asset share methodology. A firm might, for example, test the surrender payments on a suitable range of specimen with-profits policies.
If a firm calculates surrender payments using the prescribed asset share methodology, it must first calculate what the surrender payment would be if it was a maturity payment calculated by that methodology.
A firm may then make a deduction from unsmoothed asset share if necessary, in the reasonable opinion of the firm's governing body, to protect the interests of the firm's remaining with-profits policyholders.
Amounts that might be deducted include:
- (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)
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)
the firm's costs incurred in administering the surrender; and
- (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.
The provisions dealing with the calculation of surrender payments (COBS 20.2.11 G to COBS 20.2.12 R) do not prevent a firm from setting a target range for surrender payments where the top-end of the range is lower than the top-end of the relevant range for maturity payments.
A firm must not make a market value reduction to the face value of the units of an accumulating with-profits policy unless:
- (1)
the market value of the with-profits assets in the relevant with-profits fund is, or is expected to be, significantly less than the assumed value of the assets on which the face value of the units of the policy has been based; or
- (2)
there has been, or there is expected to be, a high volume of surrenders, relative to the liquidity of the relevant with-profits fund; and the market value reduction is no greater than is necessary to reflect the impact of (1) or (2) on the relevant surrender payment.
Conditions relevant to distributions
A firm must:
- (1)
not make a distribution from a with-profits fund, unless the whole of the cost of that distribution can be met without eliminating the regulatory surplus in that with-profits fund;
- (2)
ensure that the amount distributed to policyholders from a with-profits fund is not less than the required percentage of the total amount distributed; and
- (3)
if it adjusts the amounts distributed to policyholders, apply a proportionate adjustment to amounts distributed to shareholders, so that the distribution to policyholders will not be less than the required percentage.
A realistic basis life firm must not make a distribution from a with-profits fund to any person who is not a with-profits policyholder, unless the whole of the cost of that distribution (including the cost of any obligations that will or may arise from the decision to make a distribution) can be met from the excess of the realistic value of assets over the realistic value of liabilities in that with-profits fund.
A distribution to a person who is not a with-profits policyholder includes a transfer of assets out of a with-profits fund that is not made to satisfy a liability of that fund.
If, on a distribution, a firm incurs a tax liability on a transfer to shareholders, it must not attribute that tax liability to a with-profits fund, unless:
- (1)
the firm can show that attributing the tax liability to that with-profits fund is consistent with its established practice;
- (2)
that established practice is explained in the firm's PPFM; and
- (3)
that liability is not charged to asset shares.
Requirement relating to distribution of an excess surplus
At least once a year (or, in the case of a non-directive friendly society, at least once in every three years), a firm's governing body must determine whether the firm's with-profits fund, or any of the firm's with-profits fund, has an excess surplus.
- (1)
If a with-profits fund has an excess surplus, and to retain that surplus would be a breach of Principle 6 (Customers' interests), the firm should:
- (a)
make a distribution from that with-profits fund; or
- (b)
carry out a reattribution.
- (a)
- (2)
Compliance with (1) may be relied on as tending to establish compliance with Principle 6 (Customers' interests).
- (3)
Contravention of (1) may be relied on as tending to establish a contravention of Principle 6 (Customers' interests).
Charges to a with-profits fund
A firm must only charge costs to a with-profits fund which have been, or will be, incurred in operating the with-profits fund. This may include a fair proportion of overheads.
A firm must not pay compensation or redress from a with-profits fund, unless the payment is made to a policyholder, or former policyholder, of that with-profits fund.
A firm may pay compensation or redress due to a policyholder, or former policyholder:
- (1)
from assets attributable to shareholders, whether or not they are held within a long-term insurance fund; or
- (2)
from its inherited estate (if any); or
- (3)
from assets that would otherwise be attributable to asset shares, if, in the reasonable opinion of the firm's governing body, that compensation or redress cannot be paid from the assets in (1) or (2), or from any other source.
A proprietary firm must not charge to a with-profits fund any amounts paid or payable to a skilled person in connection with a report under section 166 of the Act (Reports by skilled persons) if the report indicates that the firm has, or may have, materially failed to satisfy its obligations under the regulatory system.
Tax charge to a with-profits fund
A firm must not charge a contribution to corporation tax to a with-profits fund, if that contribution exceeds the notional corporation tax liability that would be charged to that with-profits fund if it were assessed to tax as a separate body corporate.
New business
If a firm proposes to effect new contracts of insurance in an existing with-profits fund, it must only do so on terms that are, in the reasonable opinion of the firm's governing body, unlikely to have a material adverse effect on the interests of its existing with-profits policyholders.
In some circumstances, it may be difficult or impossible for a firm to mitigate the risk of a material adverse effect on its existing, or new, with-profits policyholders, unless it establishes a new bonus series or with-profits fund. Circumstances that might cause a firm to establish a new bonus series or with-profits fund include:
- (1)
where 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; and
- (2)
where the potential risks are likely to be so great that a single with-profits fund cannot provide adequately for the interests of new and existing policyholders, even after allowing for any beneficial effects of diversification. 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.
Relationship of a with-profits fund with the firm and any connected persons
A firm carrying on with-profits business must not:
- (1)
make a loan to a connected person using assets in a with-profits fund; or
- (2)
give a guarantee to, or for the benefit of, a connected person, where the guarantee will be backed using assets in a with-profits fund;
unless that loan or guarantee:
- (3)
will be on commercial terms;
- (4)
will, in the reasonable opinion of the firm's senior management, be beneficial to the with-profits policyholders in the relevant with-profits fund; and
- (5)
will not, in the reasonable opinion of the firm's senior management, expose those policyholders to undue credit or group risk.
Contingent loans and other forms of support for the with-profits fund
- (1)
If a firm, or a connected person, provides support to a with-profits fund (for example, by a contingent loan), 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.
- (2)
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.
Where assets from outside a with-profits fund are made available to support that fund (and there is no ambiguity in the criteria governing any repayment obligations to the support provider), 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.
Other guidance on the conduct of with-profit business
When a firm determines its investment strategy, and the acceptable level of risk within that strategy, it should take into account:
- (1)
the extent of the guarantee in its with-profits policies;
- (2)
any representation that it has made to its with-profits policyholders;
- (3)
its established practice; and
- (4)
the amount of capital support available.
If a proprietary 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 whether it would be more appropriate for the investment to be made using assets other than those in a with-profits fund.
If a firm carries out non-profit insurance business in a with-profits fund, it should review the profitability of the non-profit insurance business regularly.
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.
Major changes in with-profits funds
A firm must not enter into a material transaction relating to a with-profits fund unless, in the reasonable opinion of the firm's governing body, the transaction is unlikely to have a material adverse effect on the interests of that fund's existing with-profits policyholders.
A material transaction includes a series of related non-material transactions which, if taken together, are material.
Examples of material transactions include:
- (1)
a significant bulk outwards reinsurance contract;
- (2)
inwards reinsurance of with-profits business from another insurance undertaking;
- (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)
a significant restructuring of the with-profits fund, especially if it involves the creation of new sub-funds.
Process for reattribution of inherited estates: Policyholder advocate: appointment and role
A firm that is seeking to make a reattribution of its inherited estate must:
- (1)
identify at the earliest appropriate point a policyholder advocate, who is free from any conflicts of interest that may be, or may appear to be, detrimental to the interests of policyholders, to negotiate with the firm on behalf of relevant with-profits policyholders;
- (2)
seek the approval of the FSA for the appointment of the policyholder advocate as soon as he is identified, or appoint a policyholder advocate nominated by the FSA if its approval is not granted; and
- (3)
involve the policyholder advocate designate at the earliest possible opportunity to enable him to participate effectively in the negotiations about the proposals for the reattribution.
The firm should include an independent element in the policyholder advocate selection process, which may include consulting representative groups of policyholders or using the services of a recruitment consultant. When considering an application for approval of a nominee to perform the policyholder advocate role, the FSA will have regard to the extent to which the firm has involved others in the selection process.
The precise role of the policyholder advocate in any particular case will depend on the nature of the firm and the reattribution proposed. A firm will need to discuss with the FSA the precise role of the policyholder advocate in a particular case (COBS 20.2.45 R). However, the role of the policyholder advocate should include:
- (1)
negotiating with the firm, on behalf of the relevant with-profits policyholders, the benefits to be offered to them in exchange for the rights or interests they will be asked to give up;
- (2)
commenting to with-profits policyholders, on:
- (a)
the methodology used for the allocation of benefits amongst the relevant (or groups of) with-profits policyholders and the form of those benefits;
- (b)
the criteria used for determining the eligibility of the various with-profits policyholders;
- (c)
the terms and conditions of the proposals (to the extent that they materially affect the benefits to be offered, or the bonuses that may be added to with-profits policies); and
- (d)
the views expressed by the independent expert or the reattribution expert (as the case may be), and the firm's with-profits actuary on the allocation of any benefits amongst the relevant with-profits policyholders; and
- (a)
- (3)
telling with-profits policyholders, or each group of with-profits policyholders, with reasons, whether the firm's proposals are in their interests.
Process for reattribution of inherited estates: Policyholder advocate: terms of appointment
A firm must:
- (1)
notify the FSA of the terms on which it proposes to appoint a policyholder advocate (whether or not the candidate was nominated by the FSA); and
- (2)
ensure that the terms of appointment for the policyholder advocate:
- (a)
stress the independent nature of the policyholder advocate's appointment and function, and are consistent with it;
- (b)
define the relationship of the policyholder advocate to the firm and its policyholders;
- (c)
set out arrangements for communications between the policyholder advocate and policyholders;
- (d)
make provision for the resolution of any disputes between the firm and the policyholder advocate;
- (e)
specify when and how the policyholder advocate's appointment may be terminated; and
- (f)
allow the policyholder advocate to communicate freely and in confidence with the FSA.
- (a)
A firm may include, within the policyholder advocate's terms of appointment, arrangements for the policyholder advocate to be indemnified in respect of certain claims that may be made against him in connection with the performance of his functions. If such indemnity is included, it should not include protection against any liability arising from acts of bad faith.
Process for reattribution of inherited estates: Reattribution expert
Where a firm is not otherwise required to appoint an independent expert, it must:
- (1)
appoint a reattribution expert to undertake an objective assessment of its reattribution proposals, who must be:
- (a)
nominated or approved by the FSA before he is appointed; and
- (b)
free from any conflicts of interest that may, or may appear to, undermine his independence or the quality of his report;
- (a)
- (2)
ensure that the reattribution expert's terms of appointment allow him to communicate freely and in confidence with the FSA; and
- (3)
require the reattribution expert to prepare a report which must be available to the FSA, the policyholder advocate and the court (if it is relevant to any court proceedings).
A reattribution expert's report should comply with the applicable rules on expert evidence. The scope and content of the report should be substantially similar to that of the report required of an independent expert under SUP 18.2 (Insurance business transfers), as if (where appropriate) a reference to:
- (1)
the 'scheme report' was a reference to the 'reattribution expert's report';
- (2)
the 'independent expert' was a reference to the 'reattribution expert'; and
- (3)
the 'scheme' was a reference to the proposal for a 'reattribution'.
Process for reattribution of inherited estates: Information to policyholders
A firm must ensure that every policyholder that may be affected by the proposed reattribution is sent appropriate and timely information about:
- (1)
the reattribution process, including the role of the policyholder advocate, the independent expert or reattribution expert, as the case may be, and other individuals appointed to perform particular functions;
- (2)
the reattribution proposals and how they affect the relevant policyholders, including an explanation of any benefits they are likely to receive and the rights and interests that they are likely to be asked to give up;
- (3)
the policyholder advocate's views on the reattribution proposals and any benefits the relevant policyholders are likely to receive and the rights and interests that they are likely to be asked to give up; and
- (4)
the outcome of the negotiations between the firm and the policyholder advocate about the benefits that will be offered to relevant with-profits policyholders, in exchange for the rights and interests that they will be asked to give up.
An adequate summary of the report by the reattribution expert must be made available to every policyholder that may be affected by the proposed reattribution.
Process for reattribution of inherited estates: Consent of policyholders
A firm must give relevant with-profits policyholders the option to:
- (1)
individually accept or reject the final proposals for the reattribution; or
- (2)
(if the legal process to be followed allows the majority of policyholders to bind the minority) vote on whether the firm should go ahead with those proposals.
Process for reattribution of inherited estates: Costs
- (1)
Reattribution and insurance business transfer costs (excluding policyholder advocate costs) should be met from shareholder funds. A firm may present alternative arrangements if it can show good reasons for doing so.
- (2)
Shareholders should pay a reasonable proportion of the policyholder advocate's costs.
- (3)
If a reattribution proposal is not successful, the FSA would expect the costs of the policyholder advocate to be met by the person initiating the proposal. That will usually be the shareholders of the firm.
Ceasing to effect new contracts of insurance in a with-profits fund
A firm must:
- (1)
inform the FSA and its with-profits policyholders within 28 days; and
- (2)
submit a run-off plan to the FSA as soon as reasonably practicable and, in any event, within three months;
of first ceasing to effect new contracts of insurance in a with-profits fund.
A firm will be taken to have ceased to effect new contracts of insurance in a with-profits fund:
- (1)
when any decision by the governing body to cease to effect new contracts of insurance takes effect; or
- (2)
where no such decision is made, when the firm is no longer:
- (a)
actively seeking to effect new contracts of insurance in that fund; or
- (b)
effecting new contracts of insurance in that fund, except by increment.
- (a)
A firm must contact the FSA to discuss whether it has, or should be taken to have, ceased to effect new contracts of insurance if:
- (1)
it is no longer effecting a material volume of new with-profits policies in a particular with-profits fund, other than by reinsurance; or
- (2)
it cedes by way of reinsurance most of the new with-profits policies which it continues to effect.
The run-off plan required by this section must:
- (1)
demonstrate how the firm will ensure a fair distribution of the closed with-profits fund, and its inherited estate (if any); and
- (2)
be approved by the firm's governing body.
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)
why it has done so;
- (2)
what changes it has made, or proposes to make, to the fund's investment strategy (if any);
- (3)
how closure may affect with-profits policyholders (including any reasonably foreseeable effect on future bonus prospects);
- (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)
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 above until it has prepared the run-off plan. In those circumstances, the firm should:
- (1)
tell its with-profits policyholders that that is the case;
- (2)
explain what is missing and give a time estimate for its supply; and
- (3)
provide the missing information as soon as possible, and within the time estimate given.
- (1)
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.
- (2)
Where it is agreed by its with-profits policyholders, and subject to meeting the requirements for effecting new contracts of insurance in an existing with-profits fund (COBS 20.2.28 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.