To:Anita Flannigan

Conduct Policy Division

Financial Services Authority

25 The North Colonnade

CanaryWharf

London

E14 5HS

9 February 2011

Dear Anita,

AFM Response toCP11,1 C.8 RDR exemption for certain Holloway contracts

  1. I am writing in response to this consultation paper, on behalf of the Association of Financial Mutuals. The objectives we seek from our response are to:
  • Provide our support for the proposal to develop an exemption from certain aspects of the RDR for some Holloway contracts;
  • Highlight the effect of the exemption as currently proposed and explored alternatives.
  1. The Association of Financial Mutuals (AFM) was established on 1 January 2010, as a result of a merger between the Association of Mutual Insurers and the Association of Friendly Societies. Financial Mutuals are member-owned organisations, and the nature of their ownership, and the consequently lower prices, higher returns or better service that typically result, make mutuals accessible and attractive to consumers.
  1. AFM currently has 57 members and represents mutual insurers and friendly societies in the UK. Between them, these organisations manage the savings, protection and healthcare needs of 20 million people, and have total funds under management of over £80 billion.
  1. The Retail Distribution Review provides a vital opportunity, not just in relation to the functioning of the charging system and the professionalism and status of the adviser, but also to maintaining confidence in the UK investment sector. Consumers need and deserve certainty and clarity when buying financial products, both about the nature of the product and where relevant, the nature of the advice. It many circumstances this certainty and clarity is served by maximising consistency in the market, so that products of a similar nature are sold/ advised upon in a similar fashion.
  1. In this respect, as we have discussed with FSA previously, Holloway is sold as first and foremost a protection product, and in direct competition only with protection products. As currently constituted therefore the RDR increases the cost of and reduces the supply of advice for Holloway. We are therefore very grateful to FSA for identifying this market anomaly, and for exploring the possibility of an exemption for Holloway contracts where there is a low level of excess surplus available to policyholders. We agree that this reflects the nature of Holloway.
  1. Of course the surplus described above is generated, in part or in whole, as a margin to allow for potentially worsening future morbidity- all income protection providers allow for this on a prudential basis- the difference with Holloway is that any accrued surplus is returned to policyholders as bonuses.
  1. Proprietary insurers that offer income protection also include a cushion for worsening morbidity in their premiums; and they also return the excess surplus to the company’s owners (as dividends). So the Holloway concept is not different, other than the fact that the owners of a mutual are not external shareholders, but members.
  1. FSA’s compulsion with describing Holloway as a retail investment, and regulating under COBS is problematic- we remain convinced that (exempted) Holloway contracts could just as satisfactorily be regulated under ICOBS. FSA will recall that it has never properly explained why it did not consider the alternative of reclassifying exempted Holloways as ICOBS- we believe this would have done more to remove the competitive disadvantage Holloways have against alternative income protection products.
  1. We have also discussed with FSA that, for the exemption to be workable, relevant Holloway contracts would also need to be exempt from the requirements of PRIPS (Packaged Retail Investment Products). FSA has confirmed that its response to the PRIPS consultation will recommend that whilst with profits is in scope, it will also seek an exemption for exempted Holloway from PRIPS. This is critical for the exemption to be workable.
  1. The consultation proposes that Holloways below a defined threshold benefit from exemption from the adviser charging and professionalism requirements in the Retail Distribution Review (RDR). As regards each of these:
  1. Exemption from adviser charging means advisers can continue to be remunerated by commission, and as per the 2010 consultation on pure protection, this includes where the Holloway contract is sold alongside an investment product;
  2. Exemption from adviser charging means the provider will be able to continue to issue disclosure documents in current form, and according to the existing COBS rulebook, and this will avoid the provider increasing consumer prices to cover new costs;
  3. Exemption from adviser charging means that consumers will be able to compare the price and features of different income protection products on equal terms;
  4. Exemption from the professional qualifications requirements has the following impact on distribution channels for Holloway:

Nature of Adviser / Pre-RDR / Post-RDR / Notes
Level IV qualified independent investment advisers / Can sell Holloway / Can sell Holloway / Likely to fall in number/ focus on wealthy
COBS authorised Protection only independent advisers / Can sell Holloway / Can sell Holloway / Unclear how many of these in market pre/ post RDR
COBS authorised advisers in vertically integrated Holloway / Can sell Holloway / Can sell Holloway / Small presence now/ main growth prospect?
Mortgage brokers / Cannot sell Holloway / Cannot sell Holloway / Can sell IP pre/ post RDR
ICOBS only authorised protection advisers / Cannot sell Holloway / Cannot sell Holloway / Can sell IP pre/post RDR
Directly marketed / Holloway permitted / Holloway permitted / Not a big market now/ UCITS impact?
  1. So the proposed exemption removes the professionalism criteria for vertically integrated firms where the contract falls meets the conditions of the exemption. For those relying on independent distribution, the effect is limited, unless a significant number of currently COBS authorised investment advisers opt not to become Level IV qualified but remain in the IFA market as pure protection advisers. We do not think there will be great demand for this, but would welcome any evidence FSA has collected on this.
  1. So the overall effect is that with fewer IFAs who are more focused on wealthy clients, the supply of independent advice to people seeking a Holloway contract will reduce. The proposed exemption is therefore a welcome, albeit limited development. But that does not take away from our support for this initiative, which avoids widening the competitive disadvantage any further.
  1. Our answers to the specific consultations are attached. Wewould be pleased to discuss further any of the issues raised by our response.

Yours sincerely,

Martin Shaw

Chief Executive

Association of Financial Mutuals

Answers to specific questions

Q8.1: Do you agree that Holloway policies with a small investment element should be exempt from the RDR Adviser Charging and Professionalism requirements? If not, please give your reasons and provide any supporting evidence.

We agree; an exemption will ensure there remains diversity in the market for income protection, by not adding further to the unlevel playing field for Holloways versus traditional income protection providers.

As we infer in the paragraphs above, we consider the term “small investment element” to be a misleading description of Holloway. Holloway premiums include a margin over morbidity premiums to allow for a capital build-up should the morbidity experience in future change.

Where FSA agrees with the principle that a policy that is sold as predominantly a protection contract should be exempt from RDR, it might also be argued that similar treatment should be afforded to some Whole of Life contracts. We have not explored this in any detail.

Q8.2: If your answer to Q8.1 is ‘Yes’, please say which option you support for defining ‘small investment element’:

(a) our proposed threshold of a projected maturity value of 20% or less of total premiums, based on the mid-rate projection used by the Holloway provider; or

(b) a different solution.

Answer: b

FSA’s analysis indicated around 70% of sales currently fall within the proposed 20% threshold. That would appear an appropriate objective. However, the amount of excess premium in any individual Holloway contract will vary according to factors such as age and term as well as investment performance, and the profile of consumers may vary over time within the same provider’s book.

We suggest therefore that it would be more appropriate to set a threshold of 25%, and to include an additional tolerance margin of 5% above that on a temporary basis, to remove the risk that some providers/ contracts dip in and out of threshold status. The tolerance would prevent instability caused by a product or range dropping in and out of exemption with regularity. We consider that the Board of the Holloway should be responsible for regularly reviewing the trend in surplus, and for taking appropriate action- which might for example include re-pricing the product, distributing the surplus, or accepting the exemption no longer applies.

Q8.3: If your answer to Q8.2 is (b), please give your reasons and explain how you think we should define ‘small investment element’.

We are as stated above content with the methodology proposed in the consultation; we suggest the threshold is increased to 25% with a 5% operating margin that the Board of the Holloway.

We do though believe FSA needs to define the working of the threshold more explicitly:

  • the threshold should be set for the average of all policies rather than based on the projection of an individual contract;
  • there should be a regular review period, such that if the profile of contracts changes over time the provider would need to confirm they still meet the threshold: we suggest a three year review with reporting to the regulator, coupled with regular internal review by the Board that it is operating within the tolerance level;
  • the provider will need to confirm that a particular product has been granted an exemption from adviser charging requirements, but not the detail of the exemption on each occasion;
  • it should not be necessary for an adviser to explain the nature of the exemption to the consumer.

Q8.4: Do you have any other comments on the draft rules in Appendix 8?

As per the comments above, the draft rules describe the nature of the threshold but not the basis by which the firm maintains, reviews or reports that it has met the conditions of the exemption.

We consider the exemption should be applied for all contracts of a specified nature. Otherwise it will be incumbent on the provider and adviser to assess each proposal individually and identify which are exempt and which are not; this can only be done by running parallel disclosure systems which will undermine the purpose of the exemption, and prevent the adviser providing appropriate charging disclosure at the start of the process. Premiums and the excess surplus will vary according to factors like age and time to maturity.

Q8.5: Do you have any comments on the cost benefit analysis?

Within the cost-benefit case the main benefit ascribed to consumers is that the proposal maintains product variety in the marketplace. We would go further than that- due to a combination of reasons the exemption would help enable the availability of a wider range of products that better meet the needs of consumers, including those that might otherwise be disenfranchised by proprietary insurers:

  • Holloway contracts are recognised as offering similar or lower premiums than traditional income protection, with the potential for a limited return of excess premiums;
  • they provide day-one cover for people without employer cover;
  • have underwriting terms which generally do not include rating, and which tend to differentiate less by age or gender; and
  • are available to the self-employed and to manual workers who are otherwise priced out of the market.

AFM Response to CP11/1, C.81 of 5

February 2011