HC Deb 14 January 2002 vol 378 cc127-34

Motion made, and Question proposed, That this House do now adjourn.—[Jim Fitzpatrick.]

10.28 pm
Mr. Barry Gardiner (Brent, North)

It may amuse the House to discover that shortly after the title for the debate was posted my office received a telephone call from an earnest young man in the Department of Health. He asked which orphans I was referring to and which of their Ministers would be the most appropriate person to respond. I trust that by the end of the next half hour, my hon. Friend the Economic Secretary to the Treasury will not be wishing that the debate had indeed been assigned to one of her colleagues in the Department of Health.

The orphan assets to which I am referring are those held by life assurance companies. They are sometimes known as inherited estates and the Financial Services Authority has helpfully provided a working definition in its recent issues paper, No. 1—part of the with-profits review. The definition is as follows: It is defined as the excess of assets maintained within the long-term fund over and above the amount required to meet liabilities.

Orphan assets are enormous. At the last estimate, 12 months ago, it was calculated that £45 billion-worth of orphan assets are held in the life assurance sector in this country, £30 billion of which is held in public limited companies and £15 billion in mutual companies. Even allowing for the decline in equities during that period, it is clear that the figure is of huge significance to the economy.

Those funds result from the build-up of successive reserves from years of over-cautious returns to with-profits policyholders. Life companies use them as an important tool to support their businesses. They provide companies with investment flexibility by enabling them to invest more in higher risk assets, thus achieving better investment returns than rivals which have to maintain greater liquidity. They act as an insulator against adverse market conditions. They are used as working capital to develop business lines and to expand into new services. Sometimes, they are used to underwrite market share by supporting commissions on new business. Above all, they are used for what is called market smoothing of the fund.

Those are not only legitimate uses of those funds; they are precisely what those funds should be used for, and it is only when an actuary advises that all those functions can be adequately met by a smaller sum than the fund contains that the question of distributing a part of the inherited estimate can arise.

In a ministerial statement on orphan assets issued on 24 February 1995, the then Minister with responsibility for corporate affairs stated: A life office may make distributions from surplus in the long-term fund as shown by the statutory annual actuarial valuation. It is common practice to make distributions to policyholders and shareholders in the proportion 90:10. In assessing policyholders' reasonable expectations, the Department would expect this ratio to be used as the basis of attribution between policyholders and shareholders."—[Official Report, 24 February 1995; Vol. 255, c. 361W.] Just over a year ago, in December 2000, the AXA Life Insurance Company drove a coach and horses through that definition of the policyholders' reasonable expectation by forcing a deal through the High Court whereby it obtained for shareholders not 10 per cent. of the value of the company's orphan assets but 45 per cent.

Given that the AXA inherited estate was valued at £1.7 billion, its shareholder value was enhanced by £595 million at the policyholders' expense. Some say that the sum is larger, but I will stick with the figure calculated by an independent actuary for the Consumers Association, which challenged the deal on behalf of the policyholders. I pay tribute to the work that it did in pursuing the case at the time. It rightly saw that the case would inevitably establish a precedent in the industry and encourage other life companies to do the same.

My hon. Friend the Economic Secretary will be pleased to hear that I do not propose to rehearse tonight all the details of AXA's deal with the policyholders, if indeed one can call it a deal—rip-off might be more accurate. However, I want to challenge her to act in concert with the Financial Services Authority, so that similar deals cannot be struck in future. As she will know, it is rumoured that the Prudential is considering what the market euphemistically calls a re-attribution and distribution of its orphan assets—a deal whereby the policyholders would be swindled out of their own inheritance by lawyers who tell them that, in exchange for giving up their contingent rights to the fund, they will get jam today.

My hon. Friend will recall, in the Old Testament, the selling of Esau's "contingent interest" in their father's estate to his brother Jacob for what was described as a "mess of pottage"—or a bowl of soup. For policyholders in Prudential, the orphan assets are evaluated at between £5 billion and £7 billion. That is an awful lot of pottage, but I suspect that it would provide very little comfort to the thousands of policyholders who are currently receiving advice from the Prudential that their policy is not on target.

Let me read to the House the lines that have become the most dreaded communication to home owners around the country: We consider it is possible that your Plan may not pay out enough. To repay the target amount for this Plan when it matures needs future investment growth to be towards the top end of the current projection rates set by the independent regulator. In view of this you may wish to think about taking action. These are the words highlighted on the Prudential endowment plan update of Mrs. Nancy Yuill, a copy of which I have here. It shows a potential shortfall of £14,600 against her mortgage repayment target of just £53,500. What Mrs. Yuill wants to know, along with tens of thousands of people like her, is why the orphan assets are not being used in the interests of policyholders to smooth out the peaks and troughs of the market as fund managers have always claimed that they would do. The money is there—all £30 billion of it. It is not being used to help the policyholders now that they need it.

Does my hon. Friend not share my disgust that people who have planned their savings and retirement on the basis that with-profits policies would provide them with a stable return are now seeing companies, such as the Prudential, sharpening their carving knives to cut them out of their fair share of the orphan assets that are supposed to underwrite their security?

With-profits funds are marketed to consumers as a lower risk way to invest. They are supposed to protect policyholders from the vagaries of the stock market by drawing on the reserves built up over years. They may not climb the heights of direct market investment vehicles, such as unit trusts, but they do not plunge the depths either. That is the theory.

In practice, there is a weak regulatory framework for with-profits funds. Directors have their obligations to maximise shareholder returns but have no corresponding duty to policyholders. The operation of the funds is not transparent. There is no obligation to disclose the amount of charges or the allocations made to policyholders or why these may differ from investment returns such as when money has been transferred into the reserves. There is no clear link between the investment performance and the annual bonuses.

Such a lack of transparency has been heavily criticised by the Consumers Association, which complains that such complexity can act as a barrier to competition. It says: It makes it virtually impossible for consumers to work out whether or not they are getting a good deal and if it's worth switching to another provider. Moreover, even if it is possible to work out the merits of switching, it's often futile. The charging structures of many of these products is such that in many cases it's not worth switching to a new product as there won't be enough time to claw back the losses. This feature of product design means there is little scope for consumers to put competitive pressure on insurance companies.

I trust my hon. Friend will agree that because policyholders are effectively locked into the contracts, there is a special obligation on the regulator to protect their interests.

The FSA's paper "Process for dealing with attribution of inherited estates" is an interesting discussion document that I welcome, but it fails to address the central issue of valuation and simply sets out various suggestions about the process itself. The FSA has been particularly reluctant to disclose the names of those companies that have been in discussion with it about orphan assets re-attribution or distribution. As ever, it hides behind the cloak of commercial confidentiality. It is a card that my hon. Friend may consider it has overplayed.

I suggest that my hon. Friend submits section 348 of the Financial Services and Markets Act 2000, which prohibits release of commercially sensitive information, to the Lord Chancellor's advisory group on the implementation of the Freedom of Information Act 2000 for review. Section 348 should be amended to restrict the prohibitions on disclosure and to allow the release of information that is in the public interest. Most information relating to attributions or re-attributions of orphan assets would, I believe, be in the public interest when one considers the need to protect the consumer in respect of funds that represent such a vast sum as £30 billion.

Transparency on that matter will certainly restrict the scope for creditors to act on behalf of shareholders to maximise their interests against the interests of policyholders. To that extent, I do not doubt that transparency would be extremely commercially sensitive. In fact, I hope that it may be considered prejudicial to commercial interests, just as withholding that same information is prejudicial to policyholders' interests. In my view, the Government and the regulator must act to protect the weaker party.

I urge my hon. Friend to ask the FSA to publish the names of companies that recently have been, or are currently, in discussion with the FSA regarding attribution, re-attribution, distribution or valuation of their inherited estate. I urge her to ask the FSA to publish both the shareholder value, disclosed to policyholders during any attribution or re-attribution, and the value subsequently presented on the balance sheet to shareholders, with an account of any discrepancy between the two. I urge her to ask the FSA to make it clear to the industry that any deals relating to orphan assets should not proceed until the review of the process and issues about ownership and valuation are conclusively established in regulation.

I also urge my hon. Friend to ask the FSA to reinforce the 90:10 rule, so that any proxy negotiator, such as those proposed by the FSA in its issues paper, should only be able to negotiate upwards from a base of 90 per cent. of policyholder value. The orphan assets should be ring-fenced so that at any given valuation point the economic value of the estate to the respective parties can be identified. That would ensure that deals represent a clear choice for policyholders between accepting a one-off payment or retaining valuable rights with a worth that is clearly quantified for their future benefit.

In particular, I urge my hon. Friend to ban deals, such as the AXA case, in which ownership is not clearly identified. Shareholders are not philanthropists and deals for contingent rights in the inherited estate are presented as if there may never be a time when the value of the fund is crystallised in a distribution. They are simply scams. Shareholders would not pay supposedly good-will gestures up front without the certain knowledge that the re-attribution of the estate following the deal is going to increase substantially shareholder value or shareholder dividend, and usually both.

Finally, I urge my hon. Friend to examine carefully, in respect of corporate accountability matters, the use to which companies have been free to put the orphan assets. Pension mis-selling was an industry scandal that went to the heart of corporate accountability. In a mutual company, the policyholders share in the risks and profits of running the business, and they must therefore bear the costs of any corporate wrongdoing. However, the whole purpose of a public company is that shareholders, not the policyholders, bear the corporate risks.

It is outrageous that many companies have sought to pay their pension mis-selling compensation out of the orphan assets. It is even more outrageous that companies such as Prudential, which was recently fined £650,000 for its delay in paying such compensation, should proceed to raid the orphan assets to pay its fines as well. That must be stopped.

The FSA has been extremely lax on the matter and has allowed the industry to use the inherited estates as some sort of shareholder slush fund to the detriment of the policyholders. In any future re-attributions, I trust that the FSA will make sure that all such borrowings from the orphan assets to pay out compensation and fines will be credited back to policyholders.

I welcome the fact that the FSA has started to examine the matter of with-profits funds. It has examined the process, and I welcome that. I trust that my hon. Friend will agree that the process alone is not enough. Policyholders must see effective regulation that protects their interests, so that the orphan assets are properly used to smooth the market downturn currently causing misery to policyholders such as Mrs. Yuill. Those assets must not become the target of shareholders' greed, to be carved up behind the back of the very policyholders whom the FSA is supposed to protect.

10.47 pm
The Economic Secretary to the Treasury (Ruth Kelly)

I welcome once again the opportunity to speak about life insurance issues, and I congratulate my hon. Friend the Member for Brent, North (Mr. Gardiner) on securing the debate. As I am sure he appreciates, the life insurance industry is currently being examined closely from various directions—not just from the perspective of the Department of Health. It is right that hon. Members with an interest in these matters should try to make sure that Ministers are aware of their views on developments.

It may help if I run through the general background to the issue. The inherited estate, also called orphan assets or orphan funds, arises as a natural consequence of the smoothing of investment re turns, which is such a significant part of the with-profits concept. In years when investment returns are good, a percentage of those investment returns is retained within the fund instead of being added to annual bonuses, so that in a year when investment returns are poor, bonuses can be supplemented from those retained funds.

However, in the long bull market in equities in the 1990s, some companies found themselves with significant surplus assets over and above those needed to meet not only the bonuses that they had already guaranteed but any future discretionary terminal bonuses. In some cases, the funds have been allowed to accumulate over such a long period that they have effectively passed from one generation of policyholders to another, hence the term "inherited estate".

My hon. Friend mentioned some of the sums involved, which are indeed huge, and he set out some of the uses of orphan assets. The inherited estate can act as the insurer's working capital, giving the business greater stability. That can act in policyholders' best interests: it provides the investment flexibility to enable greater exposure to higher risk assets such as equities, which over the long term should deliver higher investment returns; it facilitates the smoothing of bonus rates; it provides cushioning against a sudden or prolonged downturn in investment returns; and it can be used to support the costs of writing new insurance business, or can be invested in better services for policyholders.

As my hon. Friend said, however, questions then arise about how the funds are quantified, who actually owns them and how and when they should be distributed. That situation is further complicated for some life companies by demutualisation, which leads to the end of ownership of the fund by policyholders and to the introduction of shareholders who then also claim an interest in the inherited estate.

As my hon. Friend knows, the principles governing the attribution of the inherited estate between policyholders and shareholders were set out in a statement on 25 February 1995 by the then Minister with responsibility for consumer affairs, who was responsible for insurance matters within the Department of Trade and Industry, which then had responsibility for the life insurance industry. Those principles have been accepted by subsequent Governments.

Where a distribution is to be made from the surplus in the long-term fund, or rather from the inherited estate, it is common practice to make distributions to policyholders and shareholders in the following proportions: 90 per cent. to policyholders and 10 per cent. to shareholders. That is subject to variation where there is clear evidence, whether it is based on the company's circumstances, statements or practice, that a different proportion is appropriate in respect of the surplus arising from a particular part of the business. The main difference between the situation in 1995, when those principles were set out, and today is the existence of the Financial Services and Markets Act 2000 and the Financial Services Authority. The Government are no longer the regulator; that role is now taken by the FSA.

The FSA also follows the principles set out in the ministerial statement made in 1995. My hon. Friend raised the case of AXA. When AXA Equity and Law took its proposed attribution of its inherited estate to the courts for approval, the FSA made a witness statement that included a further statement of the principles generally to be followed in respect of proposals that are different from the circumstances contemplated in the 1995 statement. More recently, as he has noted, the FSA has launched a with-profits review, including an issues paper under the heading "Process for dealing with attribution of inherited estates", which was published in October 2001. The results of that consultation will feed into the overall conclusions of the with-profits review, which should, I think, be available in spring this year.

The options for review are wide ranging. Broadly speaking, they range from modification of the status quo to more radical alternatives. A modified status quo would see reports from an appointed actuary plus either an independent actuary or independent expert coupled with FSA scrutiny and greater disclosure to policyholders of the progress of the company's proposals. Alternatively, the roles of negotiating on behalf of policyholders and scrutinising proposals from a regulatory point of view could be combined within the FSA. As a variation on that alternative, an independent actuary or independent expert could be appointed as the policyholders' negotiator, leaving the FSA solely with its regulatory scrutiny.

The other options on which the FSA has consulted are either to have a proxy negotiator acting on behalf of policyholders, with the responsibilities of the FSA and of an independent actuary or independent expert left unchanged, or to have consultation with policyholders on a company's proposals in a manner that is sufficiently public to allow other interested parties to contribute.

Mr. Gardiner

Those are the proposals that are set out in the issues paper, but my hon. Friend will know that the negotiator who is acting on the policyholders' behalf is said to be there in order to obtain the best possible deal. Of course, that is based on a presumption that a deal should be done. Does not she agree that, until we move from the issue of a process in which somebody negotiating on the policyholders' behalf is looking to achieve a deal, rather than to say that there may be no deal on the table, and until the issue of valuation is addressed, it will be impossible for us to move forward from that point?

Ruth Kelly

I understand my hon. Friend's point, but I am sure he agrees that transparency is an important step forward, and that moving along that road will mean a significant improvement for policyholders. I look forward to his contribution to the FSA review.

The introduction of more open consultation with policyholders as a body raises difficult questions about commercial confidentiality and possible delays. My hon. Friend has raised several anxieties about that and I listened to his comments with interest, although I do not understand exactly how to get around the problem of commercial confidentiality when trying to encourage contributions from as wide a range of parties as possible. Perhaps we will discuss the matter after the debate.

The Government know that the Consumers Association has consistently argued that ownership of the inherited estate needs to be established before attributing or reattributing all or part of the surplus assets. The Consumers Association also disputes that the attribution of the inherited estate in the AXA case conformed with the 90:10 principle, as my hon. Friend said earlier. However, I may disappoint him by not making a definitive statement on those issues tonight.

When an insurer presents proposals to the regulator on its inherited estate, they must be considered on their individual merits, bearing in mind the general principles that I have outlined, to which the regulator and the Government have already subscribed.

It is right that orphan assets are used to smooth investment returns, but that does not automatically mean that policyholders have a right to draw them down in times of difficulty. Orphan assets should have a proper use, partly to cushion the company from unforeseen circumstances in future. If surpluses go too low, that opens the company to risk in the event of a sharp fall in the stock market, or another external event. However, I understand my hon. Friend's comments about the rightful demands of policyholders and the need to take their interests into account.

I am sure that a wide range of views has been put to the FSA in response to its issues paper on inherited estates. Attributions and proposals to buy out policyholder interests in an inherited estate are typically very lengthy processes and involve complex technical and actuarial considerations. None of that makes transparency or communicating what is happening to policyholders or their representatives any easier. Some of the information provided to the regulator as part of the process will inevitably be market sensitive and it may not be possible to share it with policyholders. However, the FSA is actively considering how the process of negotiation and the scrutiny of proposals can be made more transparent as part of its with-profits review. I await its findings with interest.

Outside the regulator, we have the Sandler review that the Treasury commissioned into the structure of the UK retail investment market. It is too early to speculate about its recommendations, especially as it has been established as an independent review.

However, much activity touches directly on the nature and scope of the life insurance industry and the products that it creates and markets. That should go some way towards reassuring my hon. Friend that we take the matter seriously. It is important to recognise that the FSA, as the regulator of the insurance industry, seeks to operate fairly within its statutory objectives and is moving to improve the regulation of insurance—

The motion having been made after Ten o'clock, and the debate having continued for half an hour, MR. DEPUTY SPEAKER adjourned the House without Question put, pursuant to the Standing Order.

Adjourned at two minutes to Eleven o'clock.