Making Your Choice

The importance to the reattribution of the sales of new policies by Aviva

The sale of new with-profits policies requires capital to support policyholders’ guaranteed benefits and other features such as smoothing. What is unusual about this in funds with inherited estates, is that the necessary capital support is generally provided free of charge by the fund’s inherited estate. This ties up, without any compensation, the inherited estate capital which might otherwise be available to be distributed to current policyholders and shareholders as special distributions. Most importantly, the more new business that is sold on this basis, the more capital that is tied up and the less that can be paid out as special distributions to current policyholders and shareholders.

From the point of view of current policyholders this can be seen as a transfer of inherited estate capital for the benefit of new policyholders free of charge; and the new business can be seen as subsidised to that extent. However, it is fair to point out that current policyholders benefitted from the very same subsidy themselves when they became policyholders, and if things were to remain unchanged this subsidy would, under current FSA rules, continue to pass from generation to generation.

If the FSA insisted that inherited estates charged new policyholders properly for this capital support, then today’s inherited estate would still be used to provide security for policies already in existence. But over time, as policies mature or are surrendered, the inherited estate would be paid out to current policyholders and shareholders through 90:10 special distributions.

The policyholder advocate challenged the FSA’s rules on the financing of new business from inherited estates on the basis that this so-called ‘intergenerational transfer’ represents a capital subsidy from current policyholders to future policyholders. It also means that new business is not being written on a profitable basis, is potentially anti-competitive and is a clear loss to current policyholders. Despite these arguments the FSA reaffirmed that such intergenerational transfers would continue to be allowed.

After a reattribution there is no intergenerational transfer from the estate owned by shareholders. Any excess that arises after that will go to shareholders. Current policyholders considering a reattribution offer will compare it with what they might otherwise have received from any special distributions. The fund will continue to be run under FSA rules, so the loss from the intergenerational transfer reduces the amount current policyholders would receive.

In making their decision about whether or not to accept the offer, policyholders should only take into account the amount they might receive. They should not consider any amounts that are predicted to go to future policyholders. Current policyholders would never have got this money. Future policyholders would have been the recipients but no longer will be.

There was therefore a risk that Aviva might have been able in effect to take the whole of the future generations’ special distributions for a price that was just enough to exceed the value estimated for the current generation’s special distributions. But none of this money would have gone to shareholders if there was no reattribution.

The policyholder advocate challenged the FSA on the appropriateness of this, especially as the company itself had absolute control over the forecast of new business and therefore of the size of the estimated intergenerational transfer. The FSA required that the reattribution terms shared the future policyholders’ portion of the estate with current policyholders.

The fact that the FSA permits inherited estates to be used to subsidise new with-profits business in this way is a major factor in the evaluation of Aviva’s overall offer, from both the policyholders` and the shareholders` perspectives.

The amount and timing of forecast new business affects the value and timing of special distributions which current policyholders might expect to receive if a reattribution were not to not occur. This is because the amount of new business dilutes future special distributions to current policyholders because special distributions will be shared with future policyholders. It also defers any potential future special distributions as additional capital needs to be retained in the inherited estate for longer.

It is because policyholders are receiving some share of what might otherwise have gone to future policyholders that current policyholders can have reasonable comfort that they will get more from a reattribution in a wide variety of circumstances than they would by voting ‘No’.

It is also because this ‘future policyholder value’ is being shared with shareholders that the deal can both be beneficial to the great majority of policyholders as well as being attractive to shareholders. This is in spite of the very considerable costs (including additional tax cost) of the exercise. It is true across a wide range of new business forecasts and market forecasts. This is important because no one can forecast precisely how many policies will be sold in future or what market conditions might be.

In addition to the benefit gained by current policyholders from 'future policyholder value', those current qualifying policyholders also benefit from the special distribution announced in February 2008. The current generation of qualifying policyholders has not contributed to the inherited estate, but the bonus additions to their policies are being paid from it.