The UK has the largest insurance industry in Europe and the third-largest in the world. More than 400bn [pounds sterling] is invested in with-profits life insurance. In 2001 the newly established Financial Services Authority (FSA) undertook a wide-ranging review of insurance regulation in the UK. It recognised that the controls were weak and set out plans to strengthen them. The key event that triggered the FSA's actions was the crisis at the Equitable Life Assurance Society in 2000 after a House of Lords judgment ruled that its bonus policy was illegal, creating a significant additional liability for the society. Equitable put itself up for sale and, when no buyer was found, it stopped taking new business.
The Equitable affair led to a number of high-level investigations that identified actuarial issues of particular concern, including the high levels of discretion retained by insurers over investments, bonuses and smoothing. To address these issues, the FSA introduced a requirement for all firms operating with-profits funds to publish principles and practices of financial management (PPFMs). Insurers are now required to manage with-profits funds in accordance with the PPFMs and confirm annually in a formal report to policyholders that they have done so. In addition, there must be an element of independent judgment in confirming their compliance. Often this is provided by a "with-profits committee" of non-executive directors or independent members.
The FSA requires firms to give information on the following topics in their PPFMs:
* Amounts payable.
* The investment strategy.
* Business risks.
* Charges and expenses.
* Arrangements of the "inherited estate".
* Equity between with-profits policyholders and shareholders.
Our CIMA-sponsored study explored how PPFMs were being used both internally in firms and externally by consumers, policyholders, independent financial advisers, auditors and the FSA. We also investigated how they were being used for benchmarking.
The research involved reviewing the PPFMs and governance arrangements of mutual, proprietary and conglomerate UK life insurers. We also interviewed actuaries, accountants and other stakeholders.
Our main finding was that PPFMs--and the later, more "consumer friendly" PPFMs--were of little or no use to consumers, policyholders and independent financial advisers. This was the opposite of what the FSA had intended.
Our findings with regard to three aspects of running with-profits funds--internal management, external governance and benchmarking--were as follows.
An important concern emerging from our study was the independence of members of with-profits committees. For example, one insurer's with-profits committee included executive directors at group level as non-executives of the insurance subsidiary. It can be argued that only genuinely independent members without any other connection to the firm are able to safeguard the interests of with-profits policyholders properly.
Our interviewees agreed that PPFMs had made a big contribution to improving internal governance. This was achieved initially by the practical step of writing everything down and consolidating it in a single publication. For those respondents who were involved in fund management, PPFMs were vital documents to which they referred regularly.
Other benefits included the insurers' implementation of new management information systems to monitor and report on compliance with PPFMs. The new with-profits committees also challenged actuaries to communicate complex mathematical issues in a meaningful way to board and committee members without actuarial experience.
We found that there was no common approach to directorial "sign-offs". …