2003 Life Convention – Let’s get real! · IFAs’ confidence in with profits bonds appears to have evaporated in the last year or so Note: includes purchased life annuities and

10 November 2003

Ian Maidens

2003 Life Convention – Let’s get real!

B11 - Sandler With Profits and Alternative Structures

Market Background

Requirements for Sandler WP

What do consumers want

from WP?

What new products have

been launched?

Providing transparency in existing funds

3

Developments in the market for with-profits business

■ Market analysis for two categories of with profits business■ regular premium personal pensions■ single premium life bonds

■ Based on ABI data■ long-term trends over the period 1996 -2002■ more detailed analysis of recent experience

4

The proportion of RP personal pensions business investing in with-profits has fallen steadily

New RP Personal Pensions (£m) by Class

0

500

1,000

1,500

2,000

2,500

3,000

1996 1997 1998 1999 2000 2001 2002

Other

Linked

UWP

Note: includes individual and group personal pensions

5

Group personal pensions is the biggest source of new RP with-profits business

New RP Personal Pensions (£m) by Class - 2002

0

100

200

300

400

500

600

700

800

900

1,000

Individual PP Individual SHP Group PP Group SHP

Other

Linked

UWP

6

Virtually all UWP business is written by IFAs, but it is not a major part of their total business

UWP Other

2002 New RP Personal Pensions by Channel - in £m

0

200

400

600

800

1,000

1,200

1,400

1,600

IFA Bank &BS

OtherDSF &

TA

Other IFA Bank &BS

OtherDSF &

TA

Other

Group SHP

Group PP

Ind. SHPInd. PP

UWP Other

7

Bond new business had grown strongly until 2001 - driven by with profits and linked sales

New Bonds by Class - 1996 to 2002 - in £m

0

5,000

10,000

15,000

20,000

25,000

1996 1997 1998 1999 2000 2001 2002

Other

DistributionIncome & Growth

Guaranteed EquityUnit-Linked

With Profits

8

Sales of other bonds had fallen - until 2002

New Bonds by Class - 1996 to 2002 - in £mexcluding with profits and unit linked

0

1,000

2,000

3,000

4,000

5,000

6,000

1996 1997 1998 1999 2000 2001 2002

Other

Distribution

Income & GrowthGuaranteed Equity

9

The IFA channel remained dominant throughout the period

Note: includes purchased life annuities and other SP Life business

New Bonds by Channel - 1996 to 2002

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

1996 1997 1998 1999 2000 2001 2002

OtherDSF & TA

Tied Agent

Direct SFIFA

10

New Bonds by Class 1996-2002 - in £m

0

5,000

10,000

15,000

20,000

25,000

1996 1997 1998 1999 2000 2001 2002

OtherDistributionIncome & GrowthGuaranteed EquityUnit-LinkedWith Profits

FTSE-100

WP & UL both rising

UL fallWP still rising

WP falls UL recovery

Other bonds increase

The impact of falling equity values on the market for single premium bonds

11

In 2002 IFA business dominated each product category except for guaranteed equity bonds

New Bonds by Channel in 2002 - in £m

0

2,000

4,000

6,000

8,000

10,000

12,000

With-Profits Unit-Linked GuaranteedEquity

Income &Growth

Distribution

Other

Other DSF & TABank & BS

IFA

12

IFAs’ confidence in with profits bonds appears to have evaporated in the last year or so

Note: includes purchased life annuities and other SP Life business

Q1 2002 Q1 2003

New SP Bonds - IFA and DSF & TA - in £m

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

IFA DSF & TA IFA DSF & TA

DistributionIncome & Growth

Guaranteed Equity

Unit-linkedWith-Profits

Q1 2002 Q1 2003

13

Developments in with profits business have been dominated by the economic conditions

Intermediaries & Customers

■ Highlighted limitations of smoothing

■ Increased concern over application of discretion

■ Concern about solvency position of funds

■ Unwilling to enter fund at bottom of smoothing cycle

■ No longer a default option

Regulatory

■ Realistic balance sheet

Company Action

■ Managing existing business■ application of MVR■ cuts in bonus rates■ reduction in EBR■ hedging guarantees

■ Redesign of new business■ reduce capital required■ realistic charge for

guarantees

■ Closing to new business

Start typing the Section Page title here.



from WP?


been launched?


Market background

15

What do consumers want from with profits?

“Smoothed equity investment with a guarantee”- lower risk than direct equity investment- better returns than cash

Cash

Equities

Risk

Return

With profits ?

16

What does with profits actually provide?

■ Investment in a mixed portfolio of assets, with a significant equity content

■ With smoothing and, in some circumstances, guarantees

■ Sharing in profits from investment returns and possibly also other business risks

■ Profits allocated to each policy by way of “bonuses”

■ Life company has discretion■ to vary the asset mix of the fund ■ to determine the allocation of profits to each policy

17

The operation of with profits funds has been changing significantly in the last 15 years

■ Traditional with profits funds (mutuals and 90:10 funds)■ policyholders and shareholders share profits of the

whole with profits fund■ shareholder returns related to bonuses paid to

policyholders

■ With profits fund includes:■ investment risk■ risks in relation to guarantees and other options■ expense risk■ regulatory risk■ operational risk■ business risk

18

Recently reconstructed with profits funds have different profit sharing rules

■ With profits funds bear■ investment risk■ risks in relation to guarantees and other options■ pay explicit charges to shareholder owned funds■ shareholders have no interest in profits emerging

in the with profits fund

■ Shareholders owned funds receive explicit fees and bear■ expense risk■ regulatory risk■ operational risk■ business risk


been launched?


Market background


from WP?


20

How are the Sandler proposals for Stakeholder products different from traditional with profits?

Capital Structure

Shareholder Profits

Profit-sharing

Charges

Smoothing

Disclosure

Distribution of Profits

Capital to be provided by shareholdersEncouraged to reattribute inherited estate

Difference between the charges and the actual costs

Investment return only

Explicit charges made for management expenses, protection benefits, guarantees & smoothing? Cap on charges at 1%+?

Must be neutral in the long-termApplied on an annual basis unless MVR is requiredRestrictions on the application of MVR

Policy - unsmoothed asset share & surrender valueFund - position of smoothing account

Encouraged to use smoothed return not bonuses

21

Sandler with profits - Structural issues

■ Three sets of assets■ investment account■ smoothing account■ supporting capital

■ 100/0 participation

■ Specific charges for expenses, mortality, smoothing, guarantees

■ Separate companies to bear these risks

■ Adjustments to policy payouts to or from smoothing account

22

The inherited estate provides a smoothing buffer between classes of business for current WP

Policyholder Funds

InheritedEstate

Non Profit

BusinessSubsidiaries

Bonus Series 1Asset Share

SmoothingAccount

Bonus Series 2Asset Share

SmoothingAccount

Bonus Series NAsset Share

SmoothingAccount

Shareholderfunds

......

23

Sandler proposes stakeholder business should be ring-fenced from other business

InheritedEstate

Other With-profits

Business

Stakeholder Business

Subsidiaries

Smoothingaccount

Policyholder funds

Shareholderfunds

Non ProfitBusiness

24

The Sandler proposals would also impose other conditions on the operation of WP business

■ Asset mix■ restrictions to limit investment risk

■ Operation of discretion■ constraints on the way that MVRs are applied

■ Operation of smoothing■ additional disclosure of asset shares and position

of the smoothing account

■ Method of allocating profits■ encourages the use of smoothed investment

returns to replace bonuses

25

The different forms of with profits business have different risk and profit sharing structures

Shareholder Profits

Risks

Investment

Insurance

Guarantees & other options

Expenses

Regulatory

Operational

Business

Traditional with profits

mutual & 90:10

Proportionate tobonus paid to policyholders

Shared between

policyholders&

shareholders

Reconstructed funds

Actual costsless charges

taken

Policyholders

Shareholders

Sandlerstakeholder

Actual costs less charges

taken

Policyholders

Shareholders

26

DP20 covers issues arising for with profits generally from Sandler Review

Sandler Review FSAWP Review

SimplifiedStakeholder Products

LighterSelling Requirements

With-profitsin general

HMTreasuryConDoc FSA DP19

Issues

FSA DP20 Other Initiatives

27

Issues Covered in DP20

■ Structure

■ Investments

■ Policy Operation

■ Disclosure

■ Implementation

■ Existing business

■ Inherited estates

■ “Stakeholder” WP



been launched?



from WP?


Market Background

29

How do alternative investment products compare to with profits?

WITH PROFITS

AssetShare

Put Option(Guarantee)

ORGuaranteed

Benefit

Call Option(Future

Bonuses)

GuaranteedEquity

Product

SmoothedManaged

Fund

Range ofFunds with

Flexible Asset

Allocation

GuaranteedIncome &Growth

Bond

30

Scottish Widows Flexible Options Bond

Asset Mix

Distribution

■ Final bonus

■ Regular bonus

■ MVR

Smoothing

Guarantees

Guarantee Charge

Income Fund Growth Fund

25% property75% fixed interest

Bonus units added

Bonus units may be added

Reduction may be applied

Regular bonus

On death & protected regular withdrawals

0.2%

85% equity & property15% fixed interest

Increases unit price

Investment return usedto calculate final bonus

0.35%

May be reviewed

31

Scottish Mutual Smoothed Investment Bond

Asset Mix

Distribution

Smoothing

Guarantees

Guarantee Charge

Primarily corporate bonds

Smoothed unit price

Weighted average asset value in previous 12 monthsAdjustment (up or down) may be applied on exit

Smoothing reduction not applied on death or protected regular withdrawals

Currently 0.1% May be reviewed

Income Fund

Primarily equities

Growth Fund

32

Scottish Equitable With Profits Funds

Asset Mix

Distribution

Smoothing

Guarantees

Guarantee Charge

39% equity, 61% fixed interest

Smoothed unit price

Expected Growth Rate declared for each fundSmoothed price is half way

between EGR and actual returnSmoothing adjustment may be applied on exit

None

None

Cautions

84% equity, 16% fixed interest

Growth

33

Zurich UK Protected Profits Funds

Asset Mix

Distribution

Smoothing

Guarantees

Guarantee Charge

Max 70% equity, Min 30% cash

Init price moves daily

None

Underlying guarantee that unit price will never fall below 80% of its previous highest level

Additional 0.6% pa on AMC

Protected Profits Fund

34

Foreign & Colonial “With Prospects” Fund

Asset Mix

Distribution

Smoothing

Guarantees

Guarantee Charge

Mainly in equities

Price moves daily

“Prospect Price” as at 10 years after launch updated annually

None – but F&C invest so as to seek to ensure the price is greater than the prospect price

after 10 years

None

With Prospects Fund




from WP?


Market Background


been launched?

36

Sandler’s concerns about 90:10 funds

■ Opacity

■ Incentives for cost minimisation are weak

■ Arbitrary shareholders’ proportion obscures financial performance of fund

“The most significant concern of the Review is that the extreme opacity of the product, as it currently exists, serves to inhibit effective competition.”“The 90/10 structure also contributes to opacity”

“… costs are charged directly to the fund. This means that incentives toward efficiency are weak, because there is no effective disclosure of costs.”

“Opacity is further increased by the unclear nature of the 90:10 payment and its lack of relationship to any genuine assessment of risk to which shareholder capital is exposed”

37

Transparency could be largely achieved in existing 90:10 funds

■ The main requirements for transparency are:

■ explicit charges

■ accounts demonstrating “no leakage”

■ clear communication to policyholders

38






39

Explicit charge arrangements could be created within a 90:10 fund

■ Explicit charge means■ customers are told clearly what the charges are

before they take out the policy■ these charges can only be changed by notifying

policyholders in advance (like unit linked)■ the charges are taken from asset shares and act to

reduce the bonus rates declared (analogous to allowing for AMC in pricing units for unit linked business)

■ The explicit charges might consist of two parts:■ basic charges (i.e. initial charge and AMC)■ performance related charge to cover shareholder

transfers

40

Shareholder profits could be generated by an explicit performance related charge

■ Sandler criticised 90:10 shareholder transfers because they are opaque and do not relate to shareholders’ capital or risk■ although he accepted they had some advantages

■ Could cover 90:10 transfer using explicit performance related charge■ 10% would be an upper limit

■ Several options for structure of shareholder transfer■ 1/9th of cost of bonus■ 10% of earned investment return■ total AMC set to vary with investment performance

“The 90:10 fund has the merit of aligning policyholder and shareholder interests, since both participate in the payouts of the with-profits fund.”Sandler Report July 2002

41






42

Transparency – no leakage

■ The operation of 90:10 funds is regarded as opaque■ contributes significantly to lack of trust in WP

■ Sandler recommended:■ an investment account containing unsmoothed asset shares■ an explicit “neutral” smoothing account■ separate supporting capital■ no exposure to business risk

“They’re just dipping into our money and taking it for themselves. They’re like Maxwell”

Consumer research in January 2003

43

The Sandler model

InheritedEstate

Other With-profits

Business

Stakeholder Business

Subsidiaries

Smoothingaccount

Policyholder funds

Shareholderfunds

Non ProfitBusiness

44

It may be possible to demonstrate no leakage in a 90:10 fund through appropriate accounting

90:10 FundInherited Estate

Share of Investment Returns*

Premiums

Investment Account/Asset Shares

Bonus Smoothing

Account

Guarantee Account

Expense Financing Account

Expenses

Claim Payments

Claims

Charge for Guarantees

Policy Charges

PerformanceCharge

Shareholder profits (1/9th of

Bonus)

*Investment return excludes profits from miscellaneous sources

45

Creating this structure

■ Strict ring-fencing would close existing funds if 90:10 business not also written■ forced distribution of inherited estate?

■ Alternative version of ring-fencing within a 90:10 fund■ clear what can and can’t be charged to asset shares■ actual investment return credited to policyholder

account■ operation of stakeholder business governed by

PPFM and subject to independent review■ Stakeholder business would remain in 90:10 fund

from a legal perspective■ benefit from support of inherited estate■ would share in catastrophic losses not borne by

inherited estate…but this will always be the case within one long term fund anyway

46






47

Communicating clearly in a 90:10 environment

■ Communication needs to be appropriate to audience■ end customer■ IFAs■ special publics

■ Performance related charge is the only additional complexity in this model compared to Sandler proposals

■ Transparency doesn’t mean simplicity

48

Implementation issues

■ Care needed around implementation■ change to allocation of miscellaneous profits

would affect all existing and new WP business■ introduction of explicit charges must be fair to

existing customers■ communicating both existing and transparent

versions of with profits may cause confusion■ need to deal with top ups to existing policies or

new members to existing schemes

49

Would this structure meet Sandler’s concerns?

■ Opacity

■ Incentives for cost minimisation are weak

■ Arbitrary shareholders’ proportion obscures financial performance of fund

Can achieve transparency through:•explicit charges•accounts demonstrating no leakage•clear communication to policyholders

Explicit charges impose competitive pressureAccounts transparent

Competitive pressure on performance related chargeAccounts transparentPolicyholder and shareholder interests still aligned

50

100:0 and 90:10 could provide alternative models for with profits

■ Different financial dynamics■ perhaps both options should be available to

consumers

■ Support from the inherited estate should enable more diverse asset allocation and a greater degree of smoothing■ shareholders may not have the capital to provide

this outside of the 90:10 fund

■ Impossible to predict which will produce the better absolute returns■ a strong 90:10 fund likely to be better than a weak

100:0 fund



from WP?


been launched?

Market Background

Providing transparency inexisting funds

Questions



from WP?


been launched?

Market Background

Providing transparency inexisting funds

[email protected]

Documents

2003 Life Convention – Let’s get real! · IFAs’ confidence in with profits bonds appears to have evaporated in the last year or so Note: includes purchased life annuities and