The criticism has been leveled at the FSA by a Treasury Select
Committee (TSC) investigating life insurers’ use of funds surplus
to their realistic liabilities in with-profit funds. In the UK
these surplus funds are termed inherited estates.

The TSC focused on how well the interests of with-profits fund
policyholders were being protected. In an overview of its findings
the TSC’s chairman John McFall delivered a harsh message to the
FSA.

“The approach taken by the FSA towards inherited estates seems a
long way from the philosophy of principles-based regulation to
which it aspires,” said McFall.

In brief the TSC found a conflict of interest between shareholders
and policyholders. This, said the TSC in its report, is because
shareholders, via life insurers’ management, control fund strategy
and therefore stand to gain at the expense of policyholders from
certain uses of inherited estate.

“Policyholders need to have confidence that their interests are
being protected, but the current oversight by the FSA gives no such
assurance,” said McFall. “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.”

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Coming in for particularly harsh criticism was the charging by
insurers of mis-selling compensation costs to inherited estates.
Terming it an “inappropriate” practice the TSC stressed that 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.”

On the mis-selling issue Prudential was taken to task.

“I was astonished that the Prudential had taken £1.6 billion ($3.17
billion) from their inherited estate to pay the costs of
compensation arising from mis-selling,” said McFall. 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.”

Notably, a few days after the TSC’s report’s release Prudential
announced that it would not proceed with a planned reattribution of
its inherited estate to some 4.5 million with profits
policyholders. The planned reattribution totalled £8.7 billion, or
just on 11 percent of the total £79.1 billion fund as at 31
December 2007.

The use of inherited estates to fund shareholder tax also came in
for a lambasting. This practice is 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,”
stressed the TSC in its report.

“Shareholder tax is another example of the FSA’s barmy regulation
in this field,” commented McFall. “The FSA permits the charging of
shareholder tax to the inherited estate if it is a firm’s
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.”

The TSC called on the FSA to launch a consultation on disallowing
the use of inherited estates to fund shareholder tax by the end of
2008. The TSC also asked the FSA to consider granting insurers’
independent with profits committees an explicit role to ensure that
a fund is run in accordance with the FSA’s principle of treating
customers fairly, “rather than merely considering the firm’s
compliance with its own internal rulebook.”

Commenting on the TSC’s findings Peter Vicary-Smith, CEO of
consumer group Which?, said: “This is a damning indictment of the
FSA’s lax regulation of the with-profits industry, which has
allowed firms to take huge sums of money from their customers’
pockets.

“The TSC’s recommendations leave the FSA with absolutely no place
to hide – they must act now to ensure that these firms offer a fair
deal to their customers or face the charge that they are failing
consumers yet again.”