Financial Services Bill

Baroness Drake Excerpts

Wednesday 25th July 2012 Lords Chamber

[Lord Flight]

My Lords, the focus of the insurance objective is rightly on policyholder protection. I do not really understand why the drafting includes those who “may become policyholders”. If they do become policyholders, they will surely be covered automatically. If they do not become policyholders, they will not be covered. I am not aware of any other area of financial services where there is any focus on future potential customers. I have a very simple question: why does this include those who “may become policyholders”? What is the logic, if any, behind this inclusion?

[Baroness Drake]

My Lords, I shall speak to Amendment 141 in my name. The PRA is the prudential regulator of the insurance companies. It has an insurance objective, which will include a requirement to contribute to securing an appropriate degree of protection for policyholders, understandably reflecting the correlation in the insurance sector between the management of risk and the consumer outcome, especially in with-profits policies. The PRA has no explicit consumer protection remit. The FCA does.

The Treasury has, as far as I can see, recognised the need for the PRA to seek advice from the FCA in achieving the balance between the interest of the policyholder and the prudential strength of the company when it comes to with-profits policies. While I understand that the responsibility for that balance should remain with the PRA, it is intended that these matters will be covered by a memorandum of understanding between the PRA and the FCA. However, that memorandum of understanding has to be compatible with the PRA’s view of how to advance its prudential objective. That is where I remain concerned, because this leaves the PRA with a very wide discretion as to what is an appropriate degree of protection for with-profits policyholders.

Unless I am misinterpreting the government amendment in this group, which I will have to wait to hear, the effect of that amendment is to strengthen or give even greater clarity to the fact that it is the PRA which holds the ultimate authority for determining that balance between the prudential strength of the company and the interest of the policyholder. Given that, I believe that it would be desirable if these matters were not left to a memorandum of understanding alone, but that the Bill should guide the approach of the PRA with respect to the regulation of with-profits policies by providing a set of principles which this amendment seeks to set out. Perhaps I may set out my reasons.

The PRA’s focus will be on the prudential regulation of firms, and the stability of the financial system. It will not have the culture to proactively protect consumers who hold with-profits policies, and yet the regulatory framework of with-profits policies has been subject to sustained criticism from the Treasury Select Committee, observers, academics—large numbers of people. However, with-profits policies are still a significant consumer issue. There are around 25 million policies, worth about £330 billion. These policies typically state that the policyholder will share in the profits from the fund, which are distributed to the policyholder in the form of bonuses. The policyholder’s contract normally states that they receive 90% of the profits from the fund, and the shareholders receive 10%.

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[Lord Sassoon]

My Lords, let me first speak to government Amendment 140E. When considering the regulation of discretionary payments in with-profits business there is no easy split between prudential and conduct issues. The Bill deals with this by giving the PRA sole responsibility for issues relating to discretionary payments. The FCA remains responsible for all other conduct regulation. However, under the Bill as drafted, use of “includes” in new Section 3F(1) could be interpreted to suggest that the PRA is responsible for other elements of conduct regulation as well. This amendment simply clarifies the drafting, by removing the implication that the PRA could be responsible for other conduct issues.

I turn to the non-government amendments in this group. Amendment 128BH would remove the reference to those “who may become policyholders” from the PRA’s insurance objectives. However, I can assure my noble friend that the inclusion of this reference to future policyholders is both deliberate and important. It is there for completely different reasons from those advanced by the noble Baroness, Lady Hayter, with whom I agree in rejecting the amendment but for much narrower and more technical reasons related to the nature of a with-profits fund.

Let me give an example of what we are thinking about here. If one considers the scenario where the PRA is considering whether a with-profits insurer should be permitted to make a very large distribution to its policyholders, and if the PRA is only required to consider the interests of current policyholders, it might be inclined to allow the distribution. However, that might leave insufficient assets in the fund to ensure that policyholders coming into the fund—if it is operating on a going-concern basis—obtain fair and adequate payments from the fund.

I should reassure my noble friend that the reference to those becoming policyholders does not require the PRA to go out in some proactive way to protect those who have no current plan to take out a contract of insurance, but who might at some point decide to do so. The PRA is only obliged to provide an appropriate degree of protection and what is appropriate will depend on the facts of the case. In this case, it is the needs of a person who is about to sign on the dotted line for a with-profits policy who needs to be assured by the regulator that the fund to which they are about to subscribe is appropriately strong according to the rules. This provision allows for that.

Amendment 141 would require the PRA to regulate with-profits funds on the basis that the fund should be managed for the purpose of distributing profits to policyholders, as opposed to any other purpose. This is an important issue and I welcome the opportunity to set out broadly how with-profits will be regulated under the new system. It might be worth just pointing out to the noble Baroness, Lady Drake, that new Section 3F—the “With-profits insurance policies” section on page 31 of the Bill—makes it quite clear that the PRA must secure an appropriate degree of protection for policyholders. That is very clear. It is different from the looser wording, to which she referred, about the insurance objective “contributing” to securing protection. It is clear that the language in new Section 3F for with-profits is stronger than in new Section 2C on the insurance objective. That is an important background to the consideration of this amendment, and a point to which the noble Baroness drew attention.

When regulating a with-profits firm, the regulator is concerned with ensuring that the firm recognises a proper balance between the different interests in the fund. These interests include one that is highlighted in this amendment—the interests of with-profits policyholders to the distribution of profits made by the fund. However, there are other legitimate interests in a with-profits fund. They include the interests of the members of the insurer in the case, for example, of a mutual. In a proprietary firm, the shareholders also have an interest in the profits to be distributed. There are also considerations to be balanced between different types of policyholder. I do not suggest for a minute that the noble Baroness seeks to disapply all these other interests in the with-profits fund. Maybe she does—no, I see that she does not. I am glad about that as we would be fundamentally rewriting the law. That would be the effect of the amendment.

I am grateful to the noble Baroness for bringing up this issue. I must say that a balance needs to be struck between the interests of current policyholders, who will be keen to see all available funds distributed, if they are distributed to them, and the interests of future policyholders, which we have discussed, who will pay the price of excessive generosity to previous generations of policyholders. There is also the overriding concern to ensure that the fund remains solvent and able to make distributions.

As I said, under the Bill, the PRA is required to secure an appropriate degree of protection for with-profits policyholders in new Section 3F, and it will have to take all of these factors into account. Although the factors to be taken into consideration are complex, in essence the objective of regulation remains the same for with-profits as for any other type of business. The objective fundamentally is to ensure the firm’s safety and soundness, while ensuring its proper conduct, including the fair treatment of consumers. In asking the Committee in due course to support the Government’s amendment, I ask my noble friend Lord Flight to withdraw his amendment.

[Baroness Drake]

There is an issue that I am not sure the Minister has addressed. The PRA will be focused on prudential regulation, so its approach on how discretion should be applied on with-profits policies could be influenced by a preoccupation with the prudential responsibility, and through that focus may become unfair in how it has balanced the consumer’s interests.

[Lord Sassoon]

My Lords, I do not believe that to be the case but it might be helpful if I write to the noble Baroness, copying in the Committee, with a fuller explanation of how that will be taken care of.