Not surprisingly, the announcement boosted the share prices of many life insurance companies on expectations of large windfall profits. Such a reaction set alarm bells ringing among policyholders - who must now be wondering whether they would have been better off investing with a mutual.
Appropriately it fell to Sir John Nott, the former defence secretary who is an L&G policyholder to spring to the defence of fellow investors.
At issue are the surpluses that build up in insurers' long-term life funds - known as orphan estates. These are used to pay policyholders' bonuses, but recently companies have begun to identify surplus assets which they say will not be necessary to pay reasonable returns to policyholders.
In the case of insurance companies that are not mutuals the plan is to allocate ownership of these assets to the shareholders rather than policyholders.
But the issues are complex - and the ensuing debate should help to clear up the matter in a manner that protects the interests of both policyholders and shareholders.
The first company to set the ball rolling, United Friendly, provides a comparatively simple example of the issues involved.
United went to the Department of Trade and Industry to seek permission to allocate a surplus of £275m to shareholders. The DTI agreed, but this does not mean an immediate windfall for United's shareholders. What it does mean is that the £275m has been earmarked as the shareholders' interest in the fund, and United can allocate the investment income on that to shareholders in the form of increased dividends.
The question asked by Sir John is: "Who identifies the surplus and on what basis?" The answer is that the fund's chief actuary makes a calculation of the amount of capital in the fund needed to finance the bonuses payable to with-profits policyholders. Sir John points out that the actuary, who may often be a director of the company, has a vested interest in favouring shareholders over policyholders in that ultimately he is answerable to shareholders and his pay and bonuses may depend on the health of the share price.
Industry insiders point out that the actuary has a statutory duty to protect the interests of policyholders and must satisfy the DTI that all is well.
But in fact the surpluses often build up because of a conservative distribution policy by the company, whereby the bonuses it pays out are modest by comparison to the investment gains being made by the fund.
Thus in some cases, there is an argument that shareholders are benefiting at the expense of policyholders, who could have been paid higher bonuses along the way. But other cases are more complicated, because the surplus identified has come not just from better investment returns from with- profits business, but also from shareholders' capital in the life fund.
Legal and General is a case in point. It has retained capital belonging to shareholders in its life fund, because it only started writing with- profits business in 1954. The surplus accumulated before then clearly belongs to the owners of the company: the shareholders. The company also argues that shareholders are entitled to a return from the capital they put up to support the writing of new business.
In any event, L&G has begun discussions with the DTI merely to work out a more rational way of distributing investment profits from the surplus.
Currently it is more or less bound by the traditional 90:10 split between policyholders and shareholders that applies to its with-profits business. The L&G has relied not just on its in-house actuarial talent, but also on the services of actuarial consultants.
Sir John said last week that he is not specifically criticising L&G for beginning discussions with the DTI over its orphan estate; rather that he feels that the rush of insurers to the department raises general questions of accountability and the protection of policyholders in non-mutual companies.Reuse content