UK - The parliamentary Treasury Select Committee (TSC) has criticised the Financial Services Authority (FSA) for the "inadequacy" of the regulatory regime surrounding with-profits funds, and warned if the system is too complex the FSA needs to have a good argument why with-profits products should continue.

In its report on 'Inherited Estates' - the surplus in the with-profits fund built up over a number of years - the TSC claimed it was "not satisfied that the FSA has done enough to provide a robust framework" which decisions and performance can be assessed against.

Instead, the committee of MPs found "rather than developing clear principles for the regulation of the inherited estate" the FSA had become "embroiled" in micro-regulation of particular firms' situations and "providing ad-hoc guidance in the middle of a reattribution negotiation".

Many individuals with defined contribution arrangements in the UK still have their pensions invested in with-profits policies while with-profits annuities are widely marketed and distributed to buyers of retirement income. With-profits products are also especially popular in Germany, and the concept does now stretch to Denmark.

This inquiry by the TSC was initially sparked by the body's ongoing scrutiny of the FSA, but also follows the recent negotiations by both Prudential and Norwich Union to "reattribute" part of their inherited estate.

It is estimated in the report the Norwich Union with-profits fund - consisting of the CGNU Life and Commercial Union Life Assurance Company (CULAC) funds - is valued at  £26bn (€33bn) with an inherited estate of around £2.6bn.

Meanwhile, figures quoted in the committee's report suggest Prudential Group's with-profits fund has assets under management of £74bn, and an inherited estate valued at around £8.7bn.

The TSC admitted the pooled assets of the with-profits funds run by proprietary companies - rather than mutual companies - legally belong to the insurer and shareholders rather than policyholders, which highlighted the conflict of interest between running the fund in the interests of the shareholders but protecting policyholders.

John McFall MP, chairman of the TSC, said: "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," he added.

The report from the committee admitted the with-profits sector "is a complex business", but warned "if the FSA believes that with-profits is just too inherently complex for such a regulatory panacea to be achieved, it must make a strong rationale for its support for the continuation of with-profits investment products in the marketplace".

Even though the FSA introduced new rules for with-profits in 2005, the TSC recommended "reopening the debate about the overall regulatory system for with-profits systems" and for the FSA to "consult on a redesign during 2008".

The TSC also proposed that the FSA introduce a requirement for companies to provide "an appropriate level of support" to with-profit committees to protect the interests of policyholders, and for these committees to consider the FSA principle of Treating Customer's Fairly. 

Additional issues highlighted by the report included:

The need for further transparency and disclosure about the impact of 'smoothing' techniques Problems relating to the funding of new business from the inherited estate Differences in charging shareholder tax to some with-profits funds but not others
In addition, the committee warned using the inherited estate to fund compensation costs resulting from mis-selling is "inappropriate" and instead stated the "vast bulk of mis-selling costs must be borne by shareholders".

McFall said: "I was astonished that Prudential had taken £1.6bn 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 firm's policyholders have a much lower chance of receiving a special distribution than they would have done otherwise."

He also claimed shareholder tax is "another example of the FSA's barmy regulation in this field" and argued that 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".

However, Peter Vipond, director of financial regulation and taxation at the Association of British Insurers (ABI), claimed inherited estate have grown up over several generations and are "subject to rigorous and market consistent valuation and regulation by the FSA through rules agreed with the industry just a few years ago".

And he argued that as the benefit of with-profits funds is usually 90/10 in favour of policyholders, "it is fair the costs of these funds, including any strategic development, or the payment of mis-selling compensation, should be borne by them in broadly the same ratio. Any other outcome is unfair to both policyholders and shareholders."

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