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Volume 229: debated on Thursday 22 July 1993

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To ask the Chancellor of the Exchequer what conclusions he has reached on the report by the Director General of Fair Trading on the marketing and sale of investment-linked insurance products.

The Director General of Fair Trading (DGFT) reported to my predecessor in March about the rules on marketing and sale of investment-linked life insurance products1, made last July by the Securities and Investments Board (SIB) and the Life Assurance and Unit Trust Regulatory Organisation (LAUTRO). These rules had been drawn up in response to the then Secretary of State for Trade and Industry in December 1990, who asked for changes in the rules to meet the concerns raised in the report of April 1990 by the previous DGFT.

1 The marketing and sale of investment-linked insurance products. The rules of the Securities and Investments Board and the Life Assurance and Unit Trust Regulatory Organisation. A report by the Director General of Fair Trading to the Chancellor of the Exchequer, March 1993.

In his report under the Financial Services Act 1986 (FSA), the DGFT was of the opinion that four aspects of the new rules were likely to have significantly anti-competitive effects. Under the FSA, the Treasury must consider whether the rules are likely to have significant anti-competitive effects and, if it considers that they do, whether those effects are greater than necessary for investor protection.

In April, the Treasury invited comments on the DGFT's report as well as on his separate report under the Fair Trading Act 19732 . Many hon. Members have written to me about the reports, and a large number of written submissions have been received from interested parties, many of which have been discussed in detail with officials. I have taken account of the views and arguments put during this consultation process in reaching my conclusions.

I endorse the director general's finding that four aspects of the rules have or are likely to have significantly anti-competitive effects. I do not find that these effects are necessary to protect investors. The Treasury is therefore directing SIB to develop a new approach to the regulation of the marketing of life insurance products through rules to rectify the deficiencies identified. My reasons, and the changes the Treasury now requires, are set out below.

2 "Fair Trading and Life Insurance Savings Products: A Report by the Director General of Fair Trading", March 1993.

There has been a good deal of justified criticism concerning the proportion of long-term policies surrendered early and the low surrender values of policies surrendered in the early years. The relevant SIB rules are designed to improve regulation and to help the investor by requiring life offices both to disclose surrender values for the first five years of life policies and to indicate the point at which the surrender value may equal or exceed the amount paid by the investor if the crossover point falls outside the first five years. The rules prevent life offices disclosing surrender values for a longer period.

The DGFT has welcomed the rule changes in so far as they give the investor more information about the long-term and illiquid nature of these investments and about likely surrender values in the early years. However, the DGFT concludes that the absence of information about surrender values in the later years of the policy limits the ability of investors to make properly informed choices among the products of different life offices and between life products and other investments; and hence is likely to restrict and distort competition to a significant extent.

SIB and LAUTRO have concentrated on better disclosure of surrender values in the early years where the major concerns have arisen. Surrender values, however, do vary considerably between life offices in the later years and I agree with the DGFT that lack of information is likely significantly to restrict and distort competition. I have also taken into account other factors relevant to investor protection; in particular, the risk that disclosure of likely cash surrender values for each year of a policy could appear to offer guaranteed returns and could be in serious danger of overloading the investor with a huge array of figures. Any profile of figures which appeared to offer guaranteed returns would have investor disadvantages in so far as it altered life offices' investment behaviour and thus ultimately reduced the returns delivered or raised the cost of a given return; equally, a detailed array of figures, added to all the other quantitative information, could overload investors with complex and confusing details and thereby defeat the object of disclosure. I have examined these arguments and options and concluded that, through fuller disclosure of the implications of early surrender on the value of policies, it should be possible to remove the anti-competitive effect of non-disclosure of surrender values in later years in a way which avoids the danger of appearing to give guarantees and which does not overload the investor.

The Treasury is therefore directing SIB to develop a new approach and to bring forward rules which will provide a clear and quantified account of the effect of life offices' intended surrender value practices on the value of the policy if cashed in early beyond the initial five years, without implying guaranteed projections or overloading the investor with figures. The new requirements should provide, in plain terms, a clear description of the effect on surrender values throughout the duration of the policy.

While own charges—the charges currently levied by the particular life office—are required to be used in the calculations of likely surrender values during the first five years of a policy, SIB's and LAUTRO's rules require that illustrations of projected future returns on policies use standard—approximately average—assumptions about the charges levied by life offices. Illustrations are not mandated by the regulators but are a strong marketing tool. Requiring the use of standard charges prevents life offices from producing illustrations which demonstrate the relative merits of their products, thus restricting their ability to compete with others in the market. Use of own charges should also bring downward pressure on costs. I therefore agree with the DGFT that the requirement to use standard charges in illustrations is likely significantly to restrict and distort competition among life offices. Investor protection considerations also argue in favour of use of own charges. Use of standard charges can be misleading to investors by implying that charges do not affect performance when, in reality, charges of life offices to not alter rapidly and do influence total returns. In their joint submission to the Treasury commenting on the DGFT's report SIB, LAUTRO and the Financial Intermediaries, Managers and Brokers Regulatory Organisation accept that own charges ought now to be used in illustrations.

The Treasury is therefore directing SIB to bring forward rules which will require policy illustrations to use the life offices' own recent charges. This information should make clear to investors the full impact of product costs throughout the duration of the policy.

Within the independent financial adviser sector, individual firms are allowed to and do rebate commission to investors. The final price to the investor can therefore take account of the costs of distribution, with the more efficient advisers being able to offer keener prices. Cost competitiveness is allowed to reign. In marked contrast, SIB/LAUTRO rules have the effect of preventing price competition for a life office's products between its tied channels and outlets. There is no direct rule preventing the rebating of commission by tied agents to their customers. But the best advice rule has been found in practice to prevent differential pricing because it would prevent a tied agent advising the purchase of a particular product if the product were available more cheaply through another tied outlet.

The DGFT has concluded that rules which prevent some intermediaries from passing through to investors the benefits of cost differentials and efficiencies and which in practice require cross subsidisation between tied outlets are significantly anti-competitive. There has been no real attempt in the representations I have received to argue that the practice is anything other than anti-competitive and I agree with the DGFT's finding. The weight of the representations on this issue has been that the anti-competitive effects of the best advice rule are outweighed by investor protection benefits which also result from the best advice rule; in particular that an investor should be able to expect that if (s)he is buying a life office product through a tied channel, the same product could not be secured more cheaply through another tied outlet.

I have considered all the countervailing investor protection arguments very carefully, but I do not find them sufficiently convincing to outweigh the competitive disadvantages or even in their own right. I can see no good reason why price competition between tied agents and outlets should not be compatible with the preservation of best advice as well as suitability, just as it is with IFAs. Introducing competition within the tied channels will, on the contrary, result in benefits to the investor.

The Treasury is therefore directing SIB to adapt the best advice regime to allow differential pricing in the tied sector. As with IFAs, best advice would continue to pertain for the product and value for money/price within the range of products and prices offered by the particular tied outlet.

SIB and LAUTRO rules require commission, in cash terms, to be disclosed by independent financial advisers if requested by the investor—so-called "soft" disclosure. No such requirement applies to other intermediaries such as tied agents and company representatives. Whether or not the amount of commission is requested by investors, it is disclosed automatically by the life office no later than the start of the cooling-off period, but is expressed as a percentage of premiums to be paid.

The DGFT has concluded that these rules are likely to distort competition among IFAs and between them and other intermediaries to a significant extent. His reasoning rests mainly on the argument that the IFA sector is a market, separate from the tied agent and direct sales force sectors, in which commission is the price for the advice which the investor receives. He therefore calls for the early automatic disclosure of commission, in actual cash amounts, to the investor, only by IFAs.

I have considered carefully the enormous number of representations about the structure of the life insurance-linked investment market. Polarisation has introduced dichotomies into the marketplace and there are significant differences between the roles of IFAs on the one hand and the tied agents and company representatives on the other. But they are not two completely distinct and separate markets. Their roles and functions overlap and they are in competition with each other for much of the same business. Tied agents and life offices' direct sales forces are also in the business of giving advice, although their advice is restricted to the investment decision and to the choice of product within the range of a given life office. Similarly, commission cannot be regarded simply as the price of advice. I have concluded that to require early automatic disclosure of commission only by IFAs would distort the market further and would be likely to result in a significant reduction in competition by encouraging IFAs to become tied. IFAs offer a valuable range of choice and advice to investors as well as providing an essential element of competition within the industry: it is important that the IFA distribution channel is not disadvantaged in relation to the other distribution channels by the commission disclosure regime.

The current rule on commission disclosure nevertheless remains a very serious concern in an industry where sales practices are often dominated and perceived to be dominated by the payment of commission. Up-front commissions are of significant size and vary substantially both for similar products between life offices and between different products supplied by the same life office. Especially where the investor is not fully aware of the level of commission received, there is a serious risk of advice being biased by the level of commission received. This risk of bias exists in both the tied and independent sectors. Where commission is not paid, the structure of remuneration and incentives can also create a risk of bias. The current rule discriminates unfairly between IFAs on the one hand and tied agents and company representatives on the other, to the former's disadvantage. By requiring "soft" disclosure only, the current rule also allows products to compete in practice other than on the basis of their price, quality and suitability. I have assessed the evidence and have concluded that the current rule is likely to have the effect of significantly distorting and restricting competition between life offices, distribution channels and products.

In order not to distort the marketplace, it will be necessary to require automatic disclosure of commission in cash terms at an early stage by all distribution channels or broadly equivalent information in the cases of direct sales forces and bancassurance where commission is not paid. This, of course, should also enhance investor protection in that it will enable investors more easily to judge the extent to which the advice they receive could be biased. I have, however, had to consider carefully whether the likely quality and comparability of the information will be such as to be informative to the investor. I believe that it should be. But the construction of measures for all distribution channels which are meaningful, not open to manipulation and cost effective, requires detailed and expert consideration and a combination of definition and oversight by the regulatory bodies.

Accordingly, the Treasury is directing SIB to develop proposals for fuller disclosure of commission, as specified above, and the nearest equivalent for distribution channels where commission is not paid or forms only a small element of remuneration. In developing these proposals, I know that SIB will wish to work closely with the industry and other regulatory bodies and I look particularly to the industry to respond constructively to this remit. I am also asking SIB to see that the new regime on disclosure of commission and equivalents is firmly enforced.

The regulation of the sale and marketing of life insurance policies has been the subject of lengthy—too lengthy—debate. The arguments on each of the points raised by the DGFT are complex, but it is now time to draw the debate to a rapid close so that both firms and regulators can settle down in a stable regime to plan with confidence. This must be in the best long-term interest of investors and the industry alike. Disclosure of more information to their clients, with proper explanation, should hold no fears for advisers, be they IFAs, tied agents or direct sales forces. Indeed, greater transparency should help increase consumer confidence in the life insurance industry and promote healthy competition in the market for long-term savings products.

The Treasury is therefore directing SIB to bring forward by the end of 1993 detailed new draft rules as described above, or in the case of commission disclosure detailed proposals for how commission and equivalents should be measured. To ensure that they are effective and durable, it is important that the new arrangements are consumer tested before they are introduced. I am also asking SIB to consider adjustments to supervision to secure compliance with the spirit as well as the letter of the new regime and to make an assessment of the potential cost of compliance to ensure that the burdens on business are no more than necessary to deliver fair competition and investor protection.

To ask the Chancellor of the Exchequer when he will publish his proposals to amend the tax system to allow for reserving in insurance business; and if he will make a statement.

In his Budget speech my right hon. Friend the Member for Kingston upon Thames (Mr. Lamont) referred to representations made by the insurance industry and acknowledged that there may be a case for allowing tax relief on certain types of equalisation reserves covering occasional, exceptional losses. Such reserves would have to be within the regulatory framework for the industry. The Inland Revenue and the Department of Trade and Industry will next week be jointly issuing the consultation document which we promised. This looks at the issues in greater detail and invites comments on a number of matters by 29 October 1993.As my right hon. Friend said in his Budget speech, tax-deductible equalisation reserves would be a major departure for the British tax system. If there is a consensus that equalisation reserves for particular types of insurance business should become a regulatory requirement, and practical methods of isolating the business in question and of calculating the reserve can be found, we would need to consider carefully whether the introduction of a regulatory requirement, accompanied by tax relief, should be financed by compensating changes elsewhere. Given the overall fiscal position, I am clear that it would not be appropriate for the Exchequer to suffer a net cost from the introduction of such a scheme.