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Treasury Committee calls on FSA to beef up regulation of with-profits sector to ensure fair and transparent use of Inherited Estates
The Treasury Committee today (19 June) publishes its Twelfth Report of Session 200708, Inherited Estates (HC 496).
The Committee concludes that the Financial Services Authority (FSA) is not providing a robust enough framework to manage the conflicts of interest inherent in proprietary life funds.
The inquiry focused on how well the interests of with-profits fund policyholders were being protected by the FSA, particularly with regard to issues surrounding inherited estates. Conflicts of interest arise because shareholders, through the management of life firms, control fund strategy and therefore stand to gain at the expense of policyholders from certain uses of inherited estate.
The report also criticises the FSA for failing to develop clear principles for the regulation of inherited estates, instead becoming embroiled in making judgements in the round and micro-regulating particular firms situations.
Chairman of the Committee, the Rt Hon John McFall MP said:
The approach taken by the FSA towards inherited estates seems a long way from the philosophy of principles-based regulation to which it aspires. Policyholders need to have confidence that their interests are being protected, but the current oversight by the FSA gives no such assurance. Policyholders deserve a regulatory framework based on a clear set of principles and unambiguous guidance on how inherited estate can be used by life firms management.
The report considers various uses of inherited estate, giving the Committees views on the appropriateness of each.
The report concludes that the use of inherited estate in smoothing returns to policyholders between good and bad years is appropriate, but calls for more to be done by the industry to improve the transparency of its application of smoothing techniques. It recommends that if the industry fails to do so, the FSA should enforce such transparency.
Funding of new business:
The report identifies particular problems in the funding of new business from inherited estates because it constitutes an intergenerational transfer from current policyholders to the future beneficiaries. This `recycling causes particular problems during reattributions because the future beneficiaries of this intergenerational transfer will be shareholders, who have (through the firms managers) discretion over both the strategy and portion of the inherited estate to be put aside for the funding of new business. The report therefore calls on the FSA to conduct rigorous assessment of the reasonableness of assumptions made by firms during reattribution negotiations, to ensure that they reflect the trend of the declining popularity of with-profits products.
Mis-selling compensation costs:
The report concludes that the charging of mis-selling compensation costs to inherited estates is inappropriate. The vast bulk of mis-selling costs must be borne by shareholders, because it is the duty of shareholders, through the managers of the firm, to ensure that staff behave appropriately when selling products.
John McFall said:
I was astonished that the Prudential had taken £1.6 billion from their inherited estate to pay the costs of compensation arising from mis-selling. By reducing the size of the inherited estate in this way, the firms policyholders have a much lower chance of receiving a special distribution than they would have done otherwise.
The report calls on the FSA to consult on the charging of shareholder tax to inherited estates by the end of 2008. This practice is, in the Committees view, a striking example of how certain life firms are able to use their discretion in a way that furthers shareholder interest to the detriment of policyholders. The report urges the FSA to launch a consultation on disallowing firms the right to charge shareholder tax by the end of 2008.
John McFall said:
Shareholder tax is another example of the FSAs barmy regulation in this field. The FSA permits the charging of shareholder tax to the inherited estate if it is a firms established practice, but otherwise it is not allowed. Having different rules for different companies does not indicate to me that the FSA is taking principles-based regulation seriously. Either it is right, or it is wrong. It cannot be both.
Phasing of special distribution payouts:
The Committee was not convinced by the arguments put forward for the phasing of special distribution payouts and the report calls for the FSA to put forward a very strong case indeed if it thinks such phasing should be allowed to continue.
John McFall MP said:
Tens of thousands of Norwich Unions longest-standing policyholders do not stand to receive the whole value of the recently announced special distribution. The Committee was not convinced by the argument that such phasing of payments was necessary for the stability of the funds concerned. In my view, phasing represents an unreasonable barrier for policyholders wishing to exit the fund.
The report expresses concern that With-Profits Committees lack adequate resources, remit and visibility for them to protect policyholders interests in with-profits funds. It recommends that the FSA consider granting With-Profits Committees an explicit role to ensure that a fund is run in accordance with the FSAs principle of treating customers fairly, rather than merely considering the firms compliance with its own internal rulebook.
Mr McFall is available for comments on the report today on 020 7219 3521 (Westminster office), 07730987802 (mobile) or 07644 004586 (pager). For all other media inquiries, please contact Laura Humble, Media Officer, on 020 7219 2003/07917 488489/ firstname.lastname@example.org