FCA investigation into legacy life and pensions business

The Financial Conduct Authority (FCA) announced as part of its Business Plan for 2014/2015 (published on March 31) that it is to look into business practices relating to legacy/historic business, the sale of retirement income products and implementation of rules changes made in 2012 relating to governance of with-profit funds. The review of retirement income products is part of a wider review of the annuities market and is set against the backdrop of changes proposed by the government and the Association of British Insurers. The review of practices relating to legacy/historic business is however a new review and it came as something of a surprise when it was leaked to the market in a newspaper article on March 28, 2014.

The Business Plan states that the FCA will assess whether long term insurers are operating historic products in a fair way and whether they have ‘adopted strategies’ that exploit existing customers. The FCA is concerned about firms taking advantage of customer inertia by making it difficult to switch or by being vague about the pricing of existing products or the availability of other products. The root of the problem seems to be the fact that some customers pay more due to an inability to switch to other contracts (e.g. because of exit charges). The FCA states that “If customers do not or cannot switch, firms are not incentivised to compete or to develop new products” and that the FCA will look to see whether products are being operated in a fair way or whether providers “have adopted strategies that are not in the best interests of existing customers”. This would appear to be a reference to insurers allocating an unfair amount of overheads to historic funds. It is not clear why the FCA thinks this might be the case.

Helpfully but somewhat confusingly, in other statements the FCA has said that it is not seeking to rewrite existing products to remove exit charges nor to look at historic sales practices for the relevant customers. It has also said that it will not apply current standards retrospectively. The Financial Services Authority’s previous review of closed with-profits funds was much broader and concentrated more on investment performance for such funds - which does not appear to be a feature here. That review also led to the introduction, in relation to with-profits funds, of a requirement that such funds bear a ‘fair proportion of overheads’. This presumably means this should not now be an issue for such funds.

Given all of the above and the FCA’s statement that they do not intend to remove exit fees from policies provided they were compliant at the time of sale, it is quite difficult to see where the FCA is going with this. In the pensions market in particular exit fees tend to be a feature of pre 2001/stakeholder products. Although these charges can potentially be quite high, the regulatory regime under both FSMA and the 1986 Financial Services Act included requirements at point of sale to disclose surrender charges as part of the indication of what a policyholder could get back if they surrendered early. Other charges, for unit linked contracts are normally explicit (e.g. Annual Management Charge) or result from expenses charged to the underlying unit linked funds. It is also difficult to understand the references to ‘new’ products being subsidised by the historic business. Many of the providers involved are either operating in the closed fund space (and are therefore not seeking to use their back books to provide this type of subsidy) or they have post 2001 products available and the issue is one of the acquisition cost of the historic policies being reflected in the terms (e.g. exit charges).

The FCA has said it will review 30 firms and work is expected to start in the summer. This is unfortunate as the Business Plan has raised uncertainty as to what precisely the FCA is investigating - in the absence of further FCA statements, firms are left somewhat in limbo.