The Compensation Game

The Financial Services Authority has announced its intention to stop insurance companies using the slush funds ("the inherited estate") of With Profits funds to compensate policyholders, but only from the summer onwards. The slush fund consists of money earned on policyholders' investments that have not yet been added to their policies, and works as a buffer to protect the money already added when asset values fall. This means that where it is found that a policyholder was missold a policy in the past, the company can say "sorry about that" and pay-out compensation by raiding the slush fund.

Honestly, in what other world could this happen? If an IFA has been found to have missold a policy there's an expensive insurance policy with a large excess to call upon, but ultimately it impacts on the IFA's profitability. What insurance companies are doing here is effectively taking money from those policyholders who weren't missold to give to those who were. Where's the fairness in that, and where's the incentive for companies to ensure they abide by good practice?

It's simply staggering that this practice has been allowed to carry on for so long and reflects poorly on the industry and the regulator. In the case of the regulator this is a case of better late than never, but how disheartening to read the whimpering complaints and straw-clutching of insurance companies who submitted responses to the last Consultation Paper.

The FSA's announcement that this practice "may not lead to the fair treatment of policyholders" is Great British understating at its finest. Where the slush fund is raided it invariably leads to the fund having to invest in safer investments with lower expected returns. Ultimately, where it leads to the whole slush fund running dry, the fund effectively becomes a gilt fund with a risk and reward profile vastly different to the one that the policyholder thought he was buying at outset.


Two interesting points were raised in the Consultation Paper:

"Conflicts of Interest and Risk of Unfair Treatment of Policyholders"

"With-profits business differs from other types of long-term business, in that the interests of different parties in a with-profits fund and the wide discretions exercised by firms in the management of with-profits funds, can give rise to conflicts of interest and risks of unfair treatment of policyholders that do not arise in the same way or to the same extent elsewhere."

This sentence should see alarm bells going off in the heads of policyholders. Why invest your money in a fund where conflicts of interest could lead to you being unfairly treated?


Hard for Policyholders and Advisers to Understand

"The complexity inherent in with-profits makes it hard for policyholders (the principals), and in some instances their advisers, to understand elements of their funds' performance."

As an IFA with a background of educating advisers in With Profits over many years, I know this statement to be true. It's good to see the regulator recognising this fact. I hope policyholders start to realise that their With Profits policies need to be reviewed by a knowledgeable IFA.