A recent FSA consultation gave a reprieve to the mutual sector from a possibly fatal course of action. Gareth Evans explains.
As a result the part of the FSA rulebook governing with-profits funds has been tightened up quite a lot in recent years. For example, shareholder-owned insurers are no longer able to pay the costs of regulatory fines from their with-profits funds; fines now need to be paid out of shareholders’ funds.
The regulator’s developing thinking has all been subject to consultation, sometimes at length through several iterations. One of the contested parts of this process has been the question of the ownership of with-profits funds.
As a starting point the FSA took the view that, once a with-profits fund ceased to write material volumes of new with-profits policies, the insurance company should agree a long-term plan to fairly distribute the whole of the fund (including the working capital) to the remaining with profits policyholders during the remainder of their policies.
For shareholder-owned companies this would be a relatively straightforward exercise. The with-profits fund would go into ‘run off’ and the insurer would continue to support other business lines with shareholder funds. But for a mutual operating a with profits fund it represents more of a problem.
Mutuals do not have shareholder funds to finance new business. So, in the worst case, by strictly following the FSA rules a mutual that stops selling with-profits would have to put itself in run off and stop writing other lines of business, such as protection.
The mutual sector argued long and hard this would be an extremely undesirable and unjustified outcome; robbing consumers of choice and removing a competitive spur from the market. In short, strict application of rules designed to protect with-profits policyholders could have resulted in the closure of mutual protection providers and a less diverse market.
Key role to play
Now with the publication of CP 12/38 the FSA seem to recognise the key role mutuals play in the insurance sector. The paper acknowledges the forced closure of healthy, viable mutuals would be a market failure and would mark a loss of diversity in financial services.
It would also have “a detrimental effect on wider financial markets as mutuals are likely to provide stronger competition in financial markets as mutuals rather than as proprietary firms, and therefore provides better outcomes for all market participants”.
One of the ways forward for mutuals, the FSA proposes in the consultation, is a process for recognising those parts of a mutual’s fund supporting the with-profits policies and those parts supporting the rest of the mutual’s business, the working capital (or Mutual Members Fund [MMF] to use the FSA terminology).
Under this arrangement mutuals could use the MMF to support protection and other forms of insurance business, while with-profits policyholders would continue to benefit from their fair share of the profits from this other business.
If the proposals are written into the regulator’s rulebook as envisaged, many mutual insurers will make use of FSA’s new thinking and create an MMF to support their wider business. There are, of course, a number of other mutuals writing substantial levels of with-profits business in today’s market.
They can continue with their current business model for as long as the products remain relevant and customers continue to share in the success of the mutual. The knack will be maintaining the relevance of the product proposition in a rapidly changing market.
In conclusion, the really interesting part of the consultation is where FSA states that it will encourage developments which allow members of a mutual to share in the profits of the fund “through member dividends and premium reductions”.
Could we be at the start of a new period of product innovation with protection customers sharing in the success of mutual too?
Gareth Evans is head of corporate affairs at Royal London Group
