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Orphans in search of a good home

BILLIONS of pounds of surplus funds are hidden away in life insurers' coffers, paid out neither to policyholders nor shareholders. Now, companies are looking at ways of sharing out the money. Prudential, the UK's largest insurer, recently announced it was starting talks with the Department for Trade and Industry - the regulator of insurance companies - on how to divide and distribute its spare funds, which analysts say could amount to as much as pounds 5bn. This has led some to believe that there are big windfalls to be had, similar to those in the pipeline (and already received) by members of building societies. But those who are looking at ways to make a quick buck may be disappointed.

Why have life companies got so much money to give away?

So-called "orphan assets" have built up over many decades because with- profits policyholders (including many endowment policyholders) and shareholders, have effectively been short-changed. They are called orphan because their origins and ownership have yet to be clarified. The level of orphan assets is hard to determine, based as it is on actuarial calculations about a life fund's future liabilities.

But don't life insurers automatically pass on profits to with-profits policyholders?

Life companies are obliged only to award bonuses to policyholders in line with their "reasonable expectations" - whatever they may be. It is clear that large amounts of money have been kept in reserve as a precaution.

Which policyholders could benefit from an extra distribution of assets?

Only with-profits holders will normally benefit. There is nothing in it for people with unit-linked investment policies nor for those with non-investment type policies such as car and household insurance.

Why has the question of orphan assets arisen now?

Intense competition in the personal financial services business is probably the catch-all explanation. A company that does not devise a policy on its orphan assets could find its shares are undervalued and thus vulnerable to a takeover.

If orphan assets have built up over many years, don't they belong in part to previous policyholders?

They will be distributed in a way that is approved as equitable by the Department for Trade and Industry. In effect, that means an equitable distribution between current policyholders and current shareholders. It is seen as impractical to track down past policyholders, and in many instances the records are no longer available.

Is it worth taking out a policy now in order to get a windfall?

Probably not. A with-profits policy is generally a long-term savings plan, and the net benefit of a windfall payout may be marginal. "It's much more important to get the right [insurance-based savings] contract from the right company with the right charges and right investment management," says Mike Wadsworth of consulting actuaries Watson Wyatt. He says that any windfall that equates to an extra 0.5 per cent a year over the long term of the policy would be exceptional. Furthermore, the windfalls are likely to be in the form of bonuses on the ongoing value of your policy, rather than cash.

Are orphan assets a consideration for existing policyholders?

People who currently have a policy and who have some discretion over when they take the benefits may want to consider the implications of an extra bonus. This would apply, for example, to people who have a with- profits personal pension plan. There might be a case for postponing the conversion of the policy to a pension income if there is a chance of an extra payment.

And anyone else?

Another area affected by the extra distributions is the second-hand endowment market. Prices of policies from a range of companies have already risen to reflect the expectation of a windfall. It is, however, difficult to assess whether the prospect of any extra payment is already fully in the price. It could still be the case that if you are considering selling a policy before its maturity date, it may in fact be worth delaying the sale for the possible extra bonus. This might well increase the money you get. Similarly, if you are buying a second-hand policy, then even after recent price rises you might still be getting a good deal.

What about buying the shares of an insurance company?

In principle, you could benefit; in practice, you may well not. A variety of factors affect the current share value of any quoted company. The prospect of a windfall dividend payment is a factor that will tend to push up the share price. The problem is that most life companies will already have been well researched by City analysts and any expected windfall will already be built into the share price. However, analysts can only base their recommendations on guesstimates. It is possible that they have underestimated the enhanced dividend potential to shareholders. Alternatively, any benefit to shareholders may not be passed on in the form of a dividend. It may be used to invest and expand the business, for instance by taking over another company.

Are mutual life insurance companies laden with orphan assets?

Mutual companies are owned by their policyholders, "proprietary" companies by their shareholders. If mutual companies have large orphan assets, then there is no conflict of interest with shareholders. The question is whether the mutuals will decide to distribute any orphan assets. But they may have less to distribute because of previously paying out more profit to policyholders.

But aren't mutuals planning to demutualise?

Yes. Such demutualisations are likely to be catalysts for deciding what to do with any orphan assets, so policyholders could get free shares and special bonuses.