By Chris O'Brien, Senior Fellow, Nottingham University Business School
The FSA said it would consult on the subject, after the concession it gave to the industry led to considerable opposition.
However, FCA has declined to consult, and has also indicated it will not pursue related issues regarding tax on new business and the adequacy of bonuses on pension policies: this inaction raises questions about its ability to protect consumers.
Background
The issue is who pays the ‘tax on shareholders’ transfers', which is based on the shareholders’ share of distributed surplus and applied to pension business, at the usual corporation tax rate for companies; and to life assurance business, at the excess of the corporation tax rate over the basic rate. Actuaries have had different views on who pays this tax.
Before 2005 some insurers paid the tax by a deduction from asset shares, so that bonuses were lower than otherwise: effectively, policyholders paid 90% of the tax. The FSA then banned this practice.
Some insurers have paid the tax from the inherited estate: in 2005 the FSA allowed this to continue if it was their past practice and explained in the Principles and Practices of Financial Management.
However, It is argued that this tax should be borne by shareholders, not policyholders (O'Brien, 2012): it is payable at the rate applicable to companies, and on the surplus distributed to shareholders. Some insurers do charge the tax to shareholders, who receive a 10% (say) share of distributed share of surplus minus this tax.
But policyholders lose out from reduced expectations of distributions from the inherited estate if that bears the tax, so this doesn’t look right. Reliance on the PPFM also appears mis-placed as it was not usually provided to policyholders and PPFMs were not introduced until after many contracts commenced.
Indeed, the FSA admitted in CP04/14 that its decision to allow the tax to be borne by the inherited estate was ‘a concession’.
Issue 1 – the promised consultation that FCA has abandoned
In CP 11/5, the FSA recognised that its concession attracted a considerable level of opposition (the Treasury Committee had previously asked for a consultation by 2008), and said it would review the position in a forthcoming Solvency II consultation. However, CP 12/13 failed to consider this, despite FSA's Business Plan 2012/13 commenting that it would ensure that with-profits firms managed conflicts of interest appropriately.
It is arguably convenient for any new rules following the consultation to start at the same time as Solvency II, as this has a number of tax consequences. However, the delay in Solvency II should not be a barrier to consulting now and making changes later if required.
Issue 2 – a problem for new business
A particular problem arises for new with-profits business, which FCA rules say should only be written if there is likely to be no adverse effect on the interests of with-profits policyholders: accompanying guidance refers to lines of business being expected to be financially self-supporting.
So new business cannot give policyholders benefits that can be met only by drawing down from the inherited estate.
But if an insurer writes new business with the inherited estate paying tax on shareholders' transfers, the inherited estate is also depleted and the policy not self-supporting. The issue for FCA is whether its rules permit this: if so, it seems to be allowing shareholders but not policyholders to benefit from the inherited estate.
Issue 3 – adequate bonuses on pension policies?
Last, consider how insurers described their pension policies: Iqbal (1990) commented that firms' documents or their salesmen often used expressions such as, "Your money is invested in a tax-free fund", "The fund is free of tax on income and gains", "Tax free" and "Tax exempt".
This suggests that many firms are committed to a tax-free return, implying that bonuses will be based using asset shares without tax on shareholders’ transfers deducted. But several insurers did deduct tax before 2005.
With-profits pension policyholders reaching retirement who expect a tax-free return may raise concerns if they receive less because of tax deductions made in the past. The issue for FCA is to investigate on behalf of such policyholders (and past retirees may also express concerns).
Summary
The FCA has now confirmed that it is not planning any work on these three issues. It is not consulting, despite having agreed it would. It has declined to say whether its rules permit tax on shareholders’ transfers to be charged to the inherited estate on new business. And it has declined to review whether bonuses on pension policies are consistent with insurers’ representations. While actuaries can help advise insurers on the fairness of with-profits practices, policyholders may feel let down by the regulator’s inaction.
References
Iqbal, M. (1990). Reasonable expectations. Policyholders and shareholders. Paper presented to the CILA seminar, Birmingham.
O’Brien, C. (2012). ‘Equity between with-profits policyholders and shareholders’, British Actuarial Journal, 17(2), 435-474.
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