Making Your Choice

The impact on policyholders of FSA rules on with-profits funds

The policyholder advocate's guidance to particular groups of policyholders, set out on pages 7 to 11, allows you to compare whether you are likely to get more from future special distributions from the inherited estate than the cash amount Aviva is offering you.

The estimates of future special distributions used in this guidance assume that the current FSA rules about how insurance companies can use inherited estate funds remain largely unchanged. These FSA rules reduce the future special distributions that current policyholders can expect to receive. They make the offer from Aviva more attractive than would otherwise have been the case.

The FSA's rules are intended to require firms to treat their with-profits customers fairly. However, the policyholder advocate and the FSA have different opinions about whether the rules do operate fairly in practice.

The current FSA rules have the effect of reducing possible future special distributions because they allow inherited estates to be used to pay for items which, if there was no estate, shareholders would have to pay for themselves. For example, the FSA permits shareholders to use the estate to pay the extra tax payable on shareholders' bonus distributions from the with-profits fund and to pay mis-selling compensation costs.

The policyholder advocate estimates that the value to shareholders of these uses of estate funds is worth around £300 million. The effect of these FSA rules is that potential future special distributions to current policyholders are reduced by around £90 million.

The FSA rules also permit the inherited estates to be used to subsidise the capital costs of writing new life insurance business by providing the extra capital which needs to be kept to ensure that policyholders' guaranteed benefits are met. (This is explained in more detail on page 20.) The effect is that much of the estate value (and with it the possibility of getting special distributions from the estate) are passed free of charge from one generation of policyholders to the next. Each generation subsidises the next, rather than paying its own costs of the capital needed to support its policies. You benefitted from such a subsidy when your policy was created.

The practice has a very significant impact on your expectations of special distributions. The majority of the estate is, under Aviva's forecasts of new policy sales, predicted to pass to future policyholders.

This is the single most important reason why present policyholders can, under current FSA rules, expect special distributions of only a small proportion of the estate.

The policyholder advocate estimates that, in the same way that the estate passed free of charge to current policyholders, the practice transfers over £1 billion of estate to new policyholders. (For further information about why the estate is not shared 90:10 in favour of current policyholders in a reattribution see pages 22 to 23.)

The policyholder advocate has challenged the FSA vigorously on its rules. It appears particularly unfair to allow shareholders to use the estate in ways which give them more than their 90:10 entitlement, since the estate has been built up from policyholder money over many years (although current policyholders have not contributed to it). The policyholder advocate considers the free transfer of estate value to future policyholders is also wrong in principle. It will not continue after the reattribution once shareholders own the estate.

The FSA considered these challenges, but has confirmed that its current rules will not be changed in any significant way for the foreseeable future. However, the FSA said that the amount which would go to future policyholders without a reattribution should be shared with current policyholders as part of the firm's reattribution offer.

As the inherited estate is likely to continue to operate under the current FSA rules, we have used the lower estimate of total future special distributions to existing policyholders. It amounts to around £100 million which compares with the far greater total value of the Aviva offer to policyholders of £500 million.

Both the figures relate to an estate value of £1.2 billion. The offer overall, therefore, is in the interests of the great majority of policyholders. This also means that the offer can be seen as sharing between policyholders and shareholders some of the amount that would be expected to go to future policyholders if a reattribution were not to take place.

These figures form the basis of the policyholder advocates' guidance to policyholders set out on pages 7 to11.