business non plan profit

Non-profit mutuals: a viable option ? Sen Nagarajan, KPMG David Ford, Royal Liver Assurance 12th November 2007 Contents Current environment Purpose of mutual companies Alternatives A Case Study Matters to consider Current environment 1 Current environment – business levels Total new business 16,000 14,000 12,000 10,000 8,000 6,000 4,000 2,000 0 1995 2000 Year 2005 Total new business (APE £m) Year With-profits Non-profit APE (£m) 1995 2000 2005 898 443 141 13,691 11,949 13,717 With-profits (Life and pensions) Non-profit (Life and pensions) Sales of new with-profits business as measured by APE have fallen by 93% in the 10 years since 1995 (73% for pension business) Source: Company FSA returns from Synthesis Life Current environment – business levels Percentage of new with-profits policies % new with-profits policies (APE) 12% 10% 8% 6% 4% 2% 0% 1995 2000 Year Life and pensions Life only Pensions only 2005 Proportion of new with-profits business (based on APE) Year Life Pensions Combined 1995 2000 2005 10% 7% 1% 4% 2% 1% 6% 4% 1% With-profits has declined from 10% of all new APE to 1% for life business and from 4% to 1% for pension business Source: Company FSA returns from Synthesis Life Current environment - regulation Under FSA requirements, if mutuals do nothing in the light of disappearing with-profits sales, they may inadvertently become closed funds A firm may need to declare itself closed to new business and submit a run off plan if it no longer effects any new business (whether with-profits and non profit) COB 6.12.95 (COBS 20.2.54 R) states “…a firm will be taken to have ceased to effect new contracts of insurance in a with-profits fund (1) when any decision by the governing body to cease to effect new contracts of insurance takes effect; or (2) Where no such decision is made, when the firm is no longer: (a) actively seeking to effect new contracts…in that fund, or (b) effecting new contracts of insurance in that fund except by increment.” Even if it no longer sells new with-profits policies it must discuss with the FSA to determine if it is closed to new business COB 6.12.97 (COBS 20.2.55 R) states that a firm should contact the FSA to discuss whether it has ceased to sell new business if it is “no longer effecting a material volume of new with-profits policies in a particular with-profits fund…” 2 Current environment - regulation In addition companies cannot continue to write significant amounts of non-profit business when with-profits business tails off: COB 6.12.105 (COBS 20.2.60 G (1)) requires that a firm should take reasonable steps to ensure that the economic value emerging from the non-profit business written in a with-profits fund is available for distribution during the life-time of the with-profits business COB 6.12.106 (COBS 20.2.60 G (2)) states that a firm may use alternative arrangements to write new non-profit insurance business …but can this alternative include a non-profit mutual structure? …what process can be used to obtain with-profit policyholder agreement? Current environment - regulation Changing from an open to a closed with-profits fund will be an onerous exercise: COB 6.12.94 (COBS 20.2.53 R) requires the company to inform the policyholders and the FSA and provide run off plans upon ceasing to offer new contracts Policyholders and FSA to be advised within 28 days of decision Detailed runoff plan to be with FSA within 3 months Other relevant rules include COB 6.12.73 (COBS 20.2.28 R) new policies can only be effected if these are unlikely to have a material impact on existing with-profits policyholders COB 6.12.89 to 93 (COBS 20.2.39 R et seq.) state that firms cannot enter into a material transaction if is not in the existing with-profits policyholders’ interests Purpose of mutual companies 3 Purpose of mutual companies So why do mutual insurance companies exist? What will their purpose be in the absence of with-profits business? How will they provide/maintain capital? How will they share their success with policyholders/“members”? Purpose of mutual companies A short (simplified) history lesson: Mutuals formed - sell non profit contracts Share surplus through bonus mechanism “Codification” of participation rights Decline of with-profits business Surplus emerges - what to do with it? 1800’s 1900’s Pressure to codify leads to separation of with-profits contracts from risk-taking 2000+ Purpose of mutual companies What will their purpose be in the absence of with-profits business? Some mutuals (e.g. building societies) exist in the absence of an explicit profit sharing mechanism with stakeholders Hence looking to provide a service to members At a better price than a proprietary? At a better (more appropriate) service standard than a proprietary? Allowing some element of ‘participation’ in the business other than ‘with-profits’? Where proprietary would not offer such a service? Last point may include mutuals acting for affinity groups 4 Purpose of mutual companies How will they provide/maintain capital? Assuming capital is already present… Can increase capital through retention of profits Ability to increase available capital more limited for a mutual than a proprietary company Some ability to raise regulatory capital – e.g. through issue of subordinated debt Purpose of mutual companies How will they share their success with policyholders/“members”? Many alternatives could be considered – e.g.: Dividends or other reward schemes Product pricing Pricing for new products only Variable annual management charges Reviewable premiums Allocation of additional units Other benefits through affinity arrangements Purpose of mutual companies How will they share their success with policyholders/“members”? There may be difficulties with some of the alternatives: When does participation start to become ‘with-profits’ and hence require PPFMs, associated governance? Will policyholders value the participation? How can you dialogue with policyholders about level of potential benefits through participation, whilst complying with TCF? Are these mechanisms truly about participation or not – supermarket loyalty cards ‘share benefits’ but doesn’t mean the supermarket is a mutual! In any event, ‘participation’ is not likely to involve policyholders sharing in the capital risks of the venture to anything like the extent that was the case for with-profits under previous reserving requirements 5 Alternatives What are the alternatives? Continue to maintain status quo Close to new business Convert to a plc Become a non-profit mutual Maintain status quo Steps Simply continue as now Advantages Easiest option (at least in the short to medium term) Position of the fund is unchanged Disadvantages Increasing proportion of non-profit business relative to with-profits business The risks to with-profits policyholders could increase In the long run COB rule requirements will force the mutual to decide one way or another – may be better to plan for change rather than react later 6 Close to new business Steps Notify the FSA and policyholders and submit a run off plan with in the required time frame May need to develop a proposal to deal with the inherited estate Prepare communications to policyholders Advantages No need to change fund structure No requirement for additional capital Capital distributed to existing policyholders Disadvantages Managing risk and bonus rates for remaining policyholders Tontine effects likely Rising unit costs Managing business- eg retaining key staff in runoff Convert to plc / other demutualisation Steps Policyholder communications Decide on the allocation of the inherited estate Go through the listing process Advantages Can access capital from share markets to fund new business Disadvantages Costly and difficult, scale is important Smaller companies more likely to seek to be taken over Shareholders will require a return on their capital Some element of control is lost over the strategic direction of the company Become a non-profit mutual Steps Follow the requirements of the PPFM and company articles of association Communications to policyholders The fund may be partitioned Entitlements to the inherited estate will need to be defined Advantages Continue to write new non-profit business without breaching COB rules (provided appropriate structure is in place) Disadvantages Access to capital for future nonprofit business may be limited Lack of clarity over regulatory requirements for transition? Getting apportionment of capital right is difficult/contentious 7 A Case Study …or, how does a with-profits mutual become a non profit mutual? Review of mutuality Project Scope A strategic review of an insurer’s current position as a mutual long-term business insurer One potential option considered was conversion to a non-profit mutual Review of mutuality Why? A number of external factors such as: Decline in with-profits business Observing an increase in the ratio of “customers” to “members” Mutual structure may not readily fit with the product and distribution strategies Increasing sales of newer style protection and savings products Distribution moving away from traditional channels Organisation still believing that mutuality is a key component of fulfilling customers’ long term needs 8 Review of mutuality How? Considered the firm’s current position, mission and objectives: Also considered the legal requirements Developed and evaluated options Potential solutions evaluated taking into account of How to respond to changes in operating environment while pursuing goals Sustainability - Options considered from the point of implementation and future ongoing operations Membership and participation opportunities Competitor analysis Matters to consider Matters to consider Technical Financial position PPFM Memorandum and Articles of Association Legislation/regulation Strategic Mission Statement Demand for Products Building membership 9 Matters to consider: financial position Current position A typical mutual will have a with-profits fund with an estate Both with-profits and non-profit business is sold in this fund With-profits policyholders are entitled to estate only if a distribution is made Fund may continue with no distributions being made A mutual with a withprofits fund With-profits and non profit liabilities Estate Matters to consider: financial position Proposed position With-profit policy holders are transferred to a new with-profits sub fund which is closed A new sub fund is created for new non-profit policies New with-profits policies may also be sold, with benefits being internally reinsured to the with-profits sub fund Existing non-profit policies may transfer to either new open sub fund or closed with-profits sub fund Possible structure for a non-profit mutual Closed withprofits sub fund Estate Open non-profit sub fund Estate Matters to consider: financial position Will this benefit existing with-profits policyholders? By transferring them to a closed with-profits fund the access to the estate is more certain Under current structure policyholders may not receive any of the estate if distributions are not made Some of the estate maybe distributed immediately The resources required to carry out this transition are significant May need separate consideration of position on dissolution The split of the estate is likely to be contentious 10 Matters to consider: PPFM Notification requirements and ability to alter PPFM Existing rules on distribution of profits/estate Strategic investments – linked to asset shares? Overriding requirements eg existing Schemes of Transfer – can these be amended as needed? Matters to consider: memorandum and articles of association Rules around closing or setting up new funds Voting rights Conversion process Membership for new non-profit customers Matters to consider: legislation / regulation COB rules Closure plans Reattribution plans Fund restructure (application via FSA) Notification procedures – to regulators, policyholders (including eg overseas) Appointment of independent experts (Independent actuary, policyholder advocate) – are these required explicitly, or good TCF anyway? 11 Matters to consider: mission statement Types of products that company is looking to manufacture Types of distribution channels Does ‘mutuality’ matter? What is ‘mutuality’ component of offering? Matters to consider: demand for products Relates to mission statement and corporate strategy Is there a market for the proposed product range? Can the benefits of a mutual provide features that potential policyholders will value? Matters to consider: building membership Nature of ‘membership’/mutuality Voting rights Enhancements to policies Rights on dissolution / takeover… Rights to vary by class of policy – eg withprofits, non-profit? 12 Contents Current environment Purpose of mutual companies Alternatives A Case Study Matters to consider Disclaimer 1. The views and opinions expressed herein are those of the authors and do not necessarily represent the views and opinions of their employers 2. The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation. Non-profit mutuals: a viable option ? Sen Nagarajan, KPMG David Ford, Royal Liver Assurance 12th November 2007 13