FSA's radical plan to clean up with-profits industry

The City watchdog yesterday unveiled a radical action plan to overhaul the rules surrounding with-profits investments, which have come to be one of the most criticised features of the financial services industry.

Under the proposals, which will come into force in the next two years, insurers will be forced to remove much of the mystery surrounding with-profits, so that investors will be able to judge for the first time whether their company is being broadly fair in the sums they pay out in bonuses every year.

The Financial Services Authority is also cracking down on the behaviour of directors of insurance companies, to try to force them to run with-profits funds in a way which takes into account the interests of customers as well as shareholders at all times.

Sir Howard Davies, chairman of the FSA, said: "Many of the features that have allowed with-profits investments to deliver superior returns in the past are precisely the features that give rise to concerns about the lack of transparency and poor consumer understanding. So, reform will need to achieve an appropriate balance between the two."

The FSA has ordered insurers to publish a type of manifesto, that will state clearly how they determine bonuses. This will give customers a better idea about how much "smoothing" a company applies to their investment.

Smoothing is the process by which insurers keep some of their total investment return back from policyholders in good years so that they can pay out more in bad years. At the moment, companies are not obliged to give any details of how decisions about smoothing are made and only a very few life offices give out details. Those that do include Norwich Union, part of CGNU, and Standard Life.

The manifesto, which will be called the Principles and Practices of Financial Management, will also require companies to set out the circumstances in which they will apply a penalty on policyholders cashing in their policies early. Again, this practice is ad hoc at the moment and insurers do not have to publish details of their policy.

The FSA is also keen to insert more checks and balances on the boards of life offices and has ruled that companies' appointed actuaries will no longer be responsible for deciding bonuses.

This duty will instead be passed to the board as a whole, which is focused on shareholders' interests. But the board will have to consult a new committee, made up of independent board directors and other experts, whose mandate will be to champion policyholders' interests.

Not all relevant parties were happy with the FSA's plans. The Consumers' Association attacked them as "pathetic and naïve", saying they did not go far enough to ensure more transparency.

The FSA's proposals come ahead of a major review of the life and savings industry by Ron Sandler. Mr Sandler is also expected to attack the opacity of with-profits policies and suggest that much more simple products be designed for the mass market, with more specialist products available for more sophisticated investors.