As the life-insurance landscape changes to meet customer needs, with-profits products remain a key aspect of the sector. Simon Perry looks at the eight challenges providers will face in 2021.
The management of with-profits business remains an active area for life insurers. This activity isn't just driven by the long-tail nature of the books, where challenges increase as run-off advances, but new challenges are also created by companies innovating in the with-profits space to find products for the customer of today. In addition, increasingly complex funds have been created by market aggregation and cross-border Brexit mitigation frameworks.
Many with-profits funds are closed or no longer actively writing new business. As the number of policies within such funds falls, anticipated future challenges for insurance firms kick in. We outline the eight challenges below.
1 Expense management
As with-profits funds get smaller, firms may need to update their approach to expense management. Challenges this may include are working out:
how to fairly allocate costs between small cohorts of policies
how to manage volatility in asset share expense adjustments
the appropriate approach to expenses for in-policy asset shares
how to address significant expected rises in per policy expenses
The solutions will be specific to each with-profits fund and may include expense allocation methodology changes, charging agreements and outsourcing arrangements. Insurers can also look to benchmarking and comparisons with industry best practice to help find the right solution for their funds.
2 Run-off plans
The recent FCA Thematic Review into the Fair Treatment of With-Profits Policyholders (TR 19/3) emphasised the active role of run-off plans in the management of with-profits business. As such, many insurers are now reviewing how their run-off plans support decision-making processes, including in some cases for open funds. A key aspect of this is ensuring the run-off plan is something that can be actively used, as opposed something created to tick a box.
3 Estate distribution
As a fund gets smaller, estate distribution management becomes an increasing area of focus to avoid the creation of tontine effects or overly fast distribution.
4 Sunset clauses
Many with-profits funds are subject to court-sanctioned schemes, which include sunset clauses to determine how a fund will be managed if it falls below a certain size. Some funds are now reaching the size that makes these clauses a practical consideration rather than a theoretical concern.
The FCA has highlighted that many of these schemes were put in place a long time ago. Companies should reconsider whether the terms still treat customers fairly – or whether they need to change current schemes. Such changes are costly and time-consuming so firms are likely to look for alternative solutions. Managing sunset clauses is further complicated for funds that include non-UK business, even more so now the Brexit transition period has ended.
5 Shrinking sales in open funds
For mutual life insurers, where the with-profits business written is an ever-smaller proportion of the business in the fund, there is the additional challenge of how to demonstrate that the fund is managed according to the requirements of COBS 20.2.53R (3).
This is sometimes known as the ‘chrysalis problem’ and thinking in this area has developed over the last 10 years, since the challenge was identified. Approaches vary but none dominate. They include the writing of new with-profits business, new with-profits products with features such as a member bonus, setting up new funds, or other means of demonstrating that with-profits customers continue to be treated fairly.
6 Capital management
An area of significant focus for many firms, capital management is made more challenging by the high cost of guarantees in a low interest rate environment. Central to the management of capital is the balancing of interests between different policyholder groups within the fund, as well as that of policyholders and other stakeholders, such as shareholders and company management.
Good capital management generally includes a capital management plan or framework for the management of capital, including a framework for the application of management actions in stressed scenarios.
Many companies wrote business under the EU regime for the ‘passporting’ of insurance business and have since the Brexit referendum put frameworks in place to allow them to continue to service contracts for EU policyholders.
Several of these arrangements include transfers of with-profits contracts to entities outside the UK, frequently the Republic of Ireland, with reinsurance arrangements in place to allow for the continued participation in the with-profit fund(s) of a UK entity.
While these frameworks ensure continuity of service, they present new challenges such as:
compliance with new with-profits regulation in the Central Bank of Ireland’s Domestic Actuarial Regime, or other non-UK regulation
additional complexity and potential constraints on capital management
significant legal and regulatory complications as a result of the UK being outside the EU for activities relying on a court-sanctioned scheme (such as restructuring or business transfers)
two regulatory relationships to manage, with the possibility of diverging regulatory perspectives between the principal state regulator in the EU college of supervisors and the UK regulator
additional governance to manage in respect of the fund
To meet these challenges, firms must ensure close co-ordination between in-group entities, and consider multiple regulatory environments when designing new systems and processes for with-profits funds.
8 Fund rationalisation
The high level of market consolidation in recent years has resulted in several firms having multiple with-profits funds or sub-funds, often within very complex governance structures. To fully realise the benefits of consolidation for both firms and their customers, it is important that firms address the high costs associated with this. It is therefore unsurprising that after a period of consolidation, we now see many firms taking steps to rationalise fund structures or to simplify complex product portfolios.
Products of the future
There are two main drivers of activity in this area. One is in respect of existing books for business. Providers have a duty to ensure that the products they provide to existing customers continue to meet these customers' needs. This was emphasised by the FCA Thematic Review (TR 16/2) & Guidance (FG16/8) on the treatment of longstanding customers. Several companies are working to change the products offered to their existing customers to better meet their needs both now and in the future.
The other is innovation in the context of future product development. Two of the areas driving this activity are:
1 With-profits are seen by many technical experts as offering great value with features like guarantees and smoothing. So can they provide the key to development of a product that meets customers’ needs without the damaged reputation of with-profits?
2 Considerations of the future of mutuality – could new products offer a route for mutuals to address the issue of diminishing proportions of ‘traditional’ with-profits business within their main funds?
Key to success will be finding a product that is both profitable for the provider and fills the gap in the product market. Low interest rates and the resultant high cost of guarantees mean that this is something that has eluded many providers to date. But this remains an exciting area of activity with the potential for a successful firm to truly differentiate itself in the market.
Fair treatment of customers
Fair treatment of customers is core to all the topics discussed above, as it is a fundamental consideration for all with-profits fund management decisions.
In addition to the impact on policyholder returns, the specific needs of vulnerable customers, or of other specific demographic groups may become more important as books of business get older. This is because of the potentially higher proportion of vulnerable customers among the policyholders, and a potential lower level of ease or access to online communications.
What is certain is that successful with-profits management for open or closed books relies on the following: good risk management, a deep technical understanding of the dynamics of the with-profits fund, and a good understanding of the needs of with-profits policyholders throughout the lifetime of their policy.
Contact Simon Perry for support with the management of with-profits funds.
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