Funds surplus: whose billions are they anyway? LIFE POLICIES

John Murray on the battle for the life assurance companies' surplus funds

Legal & General's decision to press the Department of Trade and Industry for more flexibility in distributing investment returns to shareholders will have left millions of policyholders with a distinctly uneasy feeling.

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.

Independent Partners; Do you need financial advice on your investments, pension or insurance? Book a free consultation with an independent Financial Adviser at

Finacial products from our partners
Property search
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating

By clicking 'Search' you
are agreeing to our
Terms of Use.

ES Rentals

    iJobs Job Widget
    iJobs Money & Business

    SThree: Experienced Recruitment Consultant

    £20000 - £40000 per annum + OTE + Incentives + Benefits: SThree: Established f...

    SThree: Trainee Recruitment Consultant

    £20000 - £25000 per annum + OTE 40/45k + INCENTIVES + BENEFITS: SThree: The su...

    Recruitment Genius: Collections Agent

    £14000 - £16000 per annum: Recruitment Genius: This company was established in...

    SThree: Trainee Recruitment Consultant

    £20000 - £25000 per annum + OTE 40k: SThree: SThree are a global FTSE 250 busi...

    Day In a Page

    Isis profits from destruction of antiquities by selling relics to dealers - and then blowing up the buildings they come from to conceal the evidence of looting

    How Isis profits from destruction of antiquities

    Robert Fisk on the terrorist group's manipulation of the market to increase the price of artefacts
    Labour leadership: Andy Burnham urges Jeremy Corbyn voters to think again in last-minute plea

    'If we lose touch we’ll end up with two decades of the Tories'

    In an exclusive interview, Andy Burnham urges Jeremy Corbyn voters to think again in last-minute plea
    Tunisia fears its Arab Spring could be reversed as the new regime becomes as intolerant of dissent as its predecessor

    The Arab Spring reversed

    Tunisian protesters fear that a new law will whitewash corrupt businessmen and officials, but they are finding that the new regime is becoming as intolerant of dissent as its predecessor
    King Arthur: Legendary figure was real and lived most of his life in Strathclyde, academic claims

    Academic claims King Arthur was real - and reveals where he lived

    Dr Andrew Breeze says the legendary figure did exist – but was a general, not a king
    Who is Oliver Bonas and how has he captured middle-class hearts?

    Who is Oliver Bonas?

    It's the first high-street store to pay its staff the living wage, and it saw out the recession in style
    Earth has 'lost more than half its trees' since humans first started cutting them down

    Axe-wielding Man fells half the world’s trees – leaving us just 422 each

    However, the number of trees may be eight times higher than previously thought
    60 years of Scalextric: Model cars are now stuffed with as much tech as real ones

    60 years of Scalextric

    Model cars are now stuffed with as much tech as real ones
    Theme parks continue to draw in thrill-seekers despite the risks - so why are we so addicted?

    Why are we addicted to theme parks?

    Now that Banksy has unveiled his own dystopian version, Christopher Beanland considers the ups and downs of our endless quest for amusement
    Tourism in Iran: The country will soon be opening up again after years of isolation

    Iran is opening up again to tourists

    After years of isolation, Iran is reopening its embassies abroad. Soon, there'll be the chance for the adventurous to holiday there
    10 best PS4 games

    10 best PS4 games

    Can’t wait for the new round of blockbusters due out this autumn? We played through last year’s offering
    Transfer window: Ten things we learnt

    Ten things we learnt from the transfer window

    Record-breaking spending shows FFP restraint no longer applies
    Migrant crisis: UN official Philippe Douste-Blazy reveals the harrowing sights he encountered among refugees arriving on Lampedusa

    ‘Can we really just turn away?’

    Dead bodies, men drowning, women miscarrying – a senior UN figure on the horrors he has witnessed among migrants arriving on Lampedusa, and urges politicians not to underestimate our caring nature
    Nine of Syria and Iraq's 10 world heritage sites are in danger as Isis ravages centuries of history

    Nine of Syria and Iraq's 10 world heritage sites are in danger...

    ... and not just because of Isis vandalism
    Girl on a Plane: An exclusive extract of the novelisation inspired by the 1970 Palestinian fighters hijack

    Girl on a Plane

    An exclusive extract of the novelisation inspired by the 1970 Palestinian fighters hijack
    Why Frederick Forsyth's spying days could spell disaster for today's journalists

    Why Frederick Forsyth's spying days could spell disaster for today's journalists

    The author of 'The Day of the Jackal' has revealed he spied for MI6 while a foreign correspondent