Life assurance played a major part in many people’s financial plans over the years. But beset with mis selling scandals, accusations of high unit linked charges and inflexible products, can the life assurance companies learn from the past and build on the future, asks David Severn?
By David Severn | Published Mar 23, 2012
Article from FT Adviser
With profits and unit linked policies and bonds have formed the backbone of the products available to IFAs, as well as direct sales staff, over the past 50 years and have formed the major source of remuneration for many advisers.
More importantly life assurance has been the vehicle by which IFAs have met the investment and protection needs of millions of their clients, not to mention mortgage repayment vehicles and health insurance needs – although strictly speaking this latter comes under the heading of general insurance.
It is therefore no surprise that Money Management has always devoted substantial coverage to life products and their application over the past 50 years.
The launch of Money Management coincided with a major change in product design in the life industry.
Until the 1960s with profits offices had the industry sewn up. But the first unit linked contracts were soon to appear and the unit linked concept really took off when Sir Mark Weinberg founded Abbey Life Assurance in 1961.
The 1960s and 1970s were also a period of major change in other aspects of the financial sector, leading to significant pressure on offices to change.
Proprietaries, mutuals and demutulisations
Over 50 years the number of life offices has declined and there has been a shift in the legal status of many.
In 1962 Prudential and Legal & General were the biggest offices, both still around today but now challenged by giants such as Aviva. As commercial pressures mounted on mutual offices and exacting solvency requirements were imposed, an increasing number looked to demutualise or were taken over.
Becoming a public limited company meant that an office was able to access a much broader capital base. For ordinary policyholders there was the temptation of a windfall payment. The downside was that, whereas a mutual concerned itself with the interests of its members, on conversion it would be beholden to shareholders and their interests could conflict with those of policyholders.
The first significant mutual to change was Scottish Equitable, which was taken over by Aegon in 1994. Others held out for some years, Standard Life for example not converting until 2006. Some mutual offices were even allowed to keep their original names after demutualisation – Scottish Mutual, for example, became a limited company but continued to be called Scottish Mutual after it demutulised…
In terms of the total size of the life industry there were £6.7bn of assets under management in 1962, which has risen to £1,597bn in 2011. The number of policies in force in 1962 was around 14.2m and by last year it was 73.2m.
With profits
Any history of the past 50 years of life assurance products has to start at with profits policies.
Equitable Life was formed around 1760 and Standard Life and Scottish Widows in the early 1800s. For a number of reasons they started to build substantial surpluses and as mutuals they distributed some of the surpluses as a reversionary bonus to members.
This happy situation continued – excepting World Wars – until the 1960s when challenges to with profits came from a number of quarters:
• After World War II there was a major shift towards equities and offices had problems managing the greatly increased volatility of the surplus, now principally an investment one;
• The introduction of the unit-linked concept;
• The era of much greater competition in financial services starting in the 1970s and regulation.
With-profits offices tried to adapt in a number of ways. There was a shift away from reversionary bonuses, for which offices had to reserve because once allocated they could not be taken away, as long as premiums continued to be paid.
Because of the onerous requirements to effectively guarantee the payment of reversionary bonuses, there was a distinct shift towards terminal bonuses, for which, until recently, offices did not have to reserve.
But this meant that policyholders were exposed more to investment risk. The concept of unitised with profits, which did not need so much capital, was invented around the early 1980s in an attempt by with profits offices to get back the market share that they had lost to the new unit linked offices.
Unit linked
The introduction of unit linked assurance marked a radical change to the market.
A unit linked policy did not have to be equity linked, although most were, nor did it have to invest in units of a unit trust. It transferred more investment risk to the policyholder so that, at maturity of the policy or on death or on surrender, the return was the value of the units at the unit price prevailing.
The role played by the actuary in with profits offices in smoothing and determining bonuses was redundant. Also, the fact that unit linked policies were not subject to the same reserving standards as with profits meant that IFAs could illustrate better returns for unit linked plans.
When stock markets boomed unit linked products were attractive, as policyholders did not have an actuary holding back some of the investment return for a later day. But the popularity of unit linked products necessarily tracked the fortunes of the market so that, when corrections occurred such as in 1973/74 and Black Monday in 1987, new business suffered.
The performance of unit linked policies was also affected by the notorious ‘capital units’ that many employed in the 70s and 80s. They were the brainchild of Geoff Westall, the actuary at Hambro Life (later to become Allied Dunbar), the second life company to be formed by South African Mark Weinberg.
Capital units were a way in which the salesman could honestly say that 100% of the investor’s money was invested from day one – glossing over the fact that, in the first two or sometimes more years that investment would be in capital units which bore an additional annual charge of, say, 6% pa.
That in itself may not have been such a bad thing, if it were not for the fact that those capital units continued to bear the extra charge throughout the lifetime of the policy. This could be lost in the performance if that was going up, but the minute the stock market faltered the extra burden imposed by the capital unit charge began to become obvious.
Although then largely discredited as a form of charging, many life company marketing departments tried to convince us that it was in fact a fairer way of taking charges than levying, say, 50-100% of the first year’s premiums at the outset, because the premiums paid in the earlier years had the longest to grow and therefore taking out charges in one go was less beneficial to policyholders than taking them out over the term of the policy.
Unit linked life offices stopped using capital units about 15 years ago although, obviously, there are still many policies in force today that still contain them.
Following the 1987 crash the attention of some unit linked offices also turned to unitised with profits in an attempt to staunch the flow of money into with profits or other funds with capital guarantees.
It was not until 1986 that separate data was collected for unit linked policies, by which time £39.4bn was under management and by 2010 this had grown to £1,028bn (64% of the whole market).
Low cost endowments
Although just a variant of with profits or unit linked policies, the low cost endowment, generally reckoned to have been invented by Legal & General in 1972, deserves a mention.
Designed with the laudable aim of making it affordable for consumers to buy a home the low cost endowment came unstuck because it was assumed that unrealistically high returns could be sustained over the long term and be sufficient to pay off the capital sum on an interest only mortgage.
When it was clear that many policies would not deliver, the industry was lumbered with a review of past business sending ‘traffic light’ letters to many customers giving them the bad news that their outstanding mortgage would not be paid off.
Distribution
There have been major changes in the pattern of life assurance distribution over the past 50 years often driven by regulation and quite often working to the advantage of IFAs.
In 1962 and as a generalisation life offices fell into two camps.
In the first were the long established, often mutual, with profits offices. Their distribution was principally through brokers and there was often a strong link with mortgage business.
The newcomers were the proprietary unit-linked offices and their distribution was principally through direct salesforces. After Sir Mark Weinberg quit Abbey Life he formed Hambro Life and when this company took over a unit trust manager and a small bank Allied Dunbar was born in 1985.
With it came a sales and marketing approach that involved hard selling and advertising and the payment of high commissions to agents so that some competitors dubbed it Allied Crowbar.
But just as salesforces and brokers were embarking on an enthusiastic drive to sell more policies, conduct of business regulation came on the scene. The market was polarised in 1988 between independent advisers and those salesmen tied to a single product provider.
Standards were imposed on the information that advisers were expected to obtain from customers. Disclosure emerged as a key requirement originally in the form of product particulars and with profits guides.
Illustrations of the possible future value of a policy had long been a sales aid and now the regulators attempted to impose limits by prescribing a range of permissible investment returns.
Originally illustrations were based on a standard set of charges assumptions issued by the regulator for offices, its argument being that if a life office used its own charges, consumers would be too influenced by the price of a product rather than its performance.
This is an issue that Money Management fought hard to change, publishing its ground breaking surveys of own charges illustrations with the help of an actuary. In the end, as a direct result of MM’s surveys, the regulator was forced to abandon standard illustrations because, in one landmark survey, MM proved that every single life office had higher charges than the standard charges illustrations, making the whole regulated assumptions a nonsense.
The means by which life offices remunerated advisers to obtain business was as hot an issue in 1962 as it remains today. A voluntary Life Offices Association (LOA) agreement sought to control commissions but some of the newer offices stayed outside it.
Later the regulators tried to maintain the maximum commissions agreement (MCA) but that approach was struck down by the Office of Fair Trading in a landmark ruling headed by Sir Gordon Borrie. His argument was that, if the MCA were scrapped it would drive down commission levels. Exactly the opposite happened and they sky rocketed.
There is not space to cover some of the industry’s failures – the willingness to chase market share at nil or even negative profitability, the lemming like rush into appointed representatives, the bancassurers’ avarice in using low cost endowments as a revenue earner, the ‘closing down sale’ prompted by the abolition of Life Assurance Premium Relief (LAPR) that had effectively subsidised hidden charges.
But it has not all been bad news. In the past decade the life industry has made concerted efforts to try to improve the service that it provides to consumers. In 1999 it set up a pensions, protection and life assurance board, which, among other things set about devising a ‘raising standards’ quality mark.
Then in 2006 Customer Impact was set up to track every year consumer attitudes about the life industry.
Industrial branch
The past 50 years have seen the demise of industrial branch business – “the man from the Pru” making weekly door to door collections of premiums. The other big industrial branch office of the day was Pearl Assurance.
The model could not withstand the increasing costs of frequent personal collection of very small premiums and was put under further strain as more consumers got access to a bank account and regulation began to bite.
There was one industrial office whose policies held to maturity returned less than the total premiums paid. And surrender rates for policies were high so many consumers lost money that way. In 1962 there were over 114m policies in force, which has shrunk today to 10m, and for only about 20% of these are premiums still paid.
IT
It is a strain to recall the dinosaur age of IT that existed in 1962. Look for a computer and you were most likely to find a mainframe occupying a large space in a life office.
The chance of finding one in an IFA’s office was remote. It was another 20 years or so before IT started to intrude into IFA offices with videotext based quotation services.
Key events were the formation of Origo and The Exchange in 1989/90. The original purpose of the latter was to facilitate electronic new business processing with IFAs but in 1994 efforts were directed to dealing with own charges illustrations and other new regulatory requirements.
In the past decade the introduction of wraps and platforms has had a major impact on the business of IFAs improving communications and administration and providing a range of tools.
It is ironic that the level of contract and investment charges levied on consumers have generally increased at the same time as the technology to operate contracts has dramatically reduced costs; the reason seems to be the increased costs imposed by regulation militating against savings being passed on to consumers.
Regulation and compensation
In 1962 life offices were subject to prudential regulation by either the Department of Trade or the Friendly Societies Commission.
This remained the case until the Financial Services Authority (FSA) arrived. The influence of the EU has grown steadily. As early as 1979 the First Life Directive started the task of creating a single market for life insurance. More recently implementation of the Solvency Directive has proved a major task.
The failure of Nation Life led to the introduction of the Policyholders Protection Act 1975, which provided the first compensation scheme for insurance companies. The Policyholders Protection Board oversaw the arrangements until 2001 when the Financial Services Compensation Scheme (FSCS) took on responsibility, since when there has been no failure of a life insurer for which the FSCS has had to pay compensation.
Equitable Life
Although it was Equitable Life’s capacity as a major pension provider that brought about its near collapse, the consequences were to affect the whole with profits sector.
In common with others Equitable offered a guaranteed annuity rate on its personal pensions at levels that became increasingly difficult to meet as investment returns declined.
After a court action and failure to find a buyer Equitable had to close to new business in 2000 and the Government announced an enquiry into its regulation by the FSA. This was the trigger for the FSA to announce in February 2001 a review of the whole of the with profits sector.
With profits review
The FSA’s review of the with profits sector has resulted in a major shakeup and as recently as 2010 the regulator was still addressing issues such as corporate governance.
In the 10 years since the review started with profits offices have had to cope with abolition of the role of the appointed actuary, the introduction of ‘Principles and practices of financial management’ setting out how funds are run, the introduction of a policyholder advocate, new rules on treating with profits policyholders fairly, risk sensitive capital requirements and individual capital adequacy assessments, and more intensive supervision.
Closed funds and consolidators
A feature of recent years has been the increasing number of with profits funds that have closed to new business.
In 2004 the FSA reported that out of 110 funds 66 were closed to new business and those closed funds had £191bn under management, roughly a fifth of the total assets of the sector.
Closed funds have presented a new challenge for IFAs in deciding whether to advise clients to stick with their policies. Although they earned the nickname zombie funds the FSA pointed out that not all funds had closed because of financial weakness and not all were returning poor investment performance and lower bonuses.
In recent years there has been a trend for consolidators such as Resolution Life, formed in 2004, to take over closed funds with the aim of ensuring proper management in the interests of the policyholders.
Let’s end on a positive note
It has been 50 years of turmoil for life assurance and often the actions of the industry have not always enhanced its reputation among consumers or IFAs.
But it is worth remembering that many millions of consumers have saved with the industry and many have got good returns from their investments. For example in 1961 something like £405m was paid out to policyholders (equivalent to £7bn in 2010 prices) while £60bn was paid out in 2010.
Yet there are still many consumers who are failing to save or who have no protection. Last but not least many IFAs have depended for their living on the products of the industry.
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Timeline
1961 Abbey Life founded and unit-linked assurance starts to take off
1972 Low cost endowment invented
1975 Policyholders Protection Act provides for compensation
1979 First Life Directive starts the process of EU dominance in setting standards for life assurance regulation
1980s Unitised with-profits invented
1988 Life companies become subject conduct of business regulation as respects their sales and marketing
1989/90 Origo and The Exchange formed
2000 Equitable Life closes to new business
2001 FSA announces With-Profits Review
2001 Lifeline thrown to life offices by FSA to prevent forced sale of equities to bolster plummeting excess capital levels needed to support with-profits business
2002 Ron Sandler’s Review of Medium and Long-Term Retail Savings proposes Stakeholder products
2002 FSA consultation paper CP121 on depolarisation and defined-payment system
2007 Discussion Paper from the FSA on the Retail Distribution Review
2009 Tougher stress testing regime for providers introduced by FSA
2011 New requirements for protecting with-profits policyholders introduced
2011 The Prudential Regulation Authority sets out how it proposes to carry out insurance supervision
2011 Unit-linked policyholders given further protection under Solvency II to ensure offices invest prudently
Five Things You Didn’t Know About Life Assurance (With Thanks To Icki Iqbal)
Happy and glorious
The Church of England used to insure the Queen for a substantial sum. Reprinting Prayer Books costs money!
Surviving WWII
Life offices could have gone bust in WWII. Two things saved them. Actuarial valuations were carried out every three or five years so the regulator’s hand was not forced. And the Government was persuaded to cap the income tax on life funds at 7/6d to the £1.
Elementary Dr Watson
Sir Arthur Conan Doyle was one time chief medical officer of a life office.
Bastards and later issue
In his book ‘The Tebbit test’ Icki Iqbal reports the issue risk policy. One of the problems when an estate was placed in trust was that there could be children unknown or children born in the future. The executors could take out a policy to guard against this. The trick for the insurer was to make sure the couple had been happily married – which reduced the likelihood of any bastards being around - and that the wife was past child bearing age – so it was very unlikely any children would be born in the future.
Article from FT Adviser
