Legacy contracts pose problem for providers

Legacy contracts pose problem for providers

Two professional services firms have warned providers about the potential impact of the Financial Conduct Authority’s forthcoming review of long-standing insurance contracts.

The thematic review into fair treatment of legacy insurance customers began last Spring, with its botched pre-briefing causing billions of pounds to be wiped off the value of several UK insurers, amidst suggestions that it would investigate the level of profits made from funds closed to new business.

At the time, the FCA confirmed that the review is looking at a representative sample of firms, but not individually reviewing 30m policies - as had been suggested - or looking at removing exit fees from those policies, providing they were compliant at the time.

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The regulator told FTAdviser this week that the work is still ongoing, but conclusions are not imminent.

However, PwC’s conduct risk director Matt Browne warned that companies should be braced for possible changes to exit and surrender charges.

“These fees act as an important safeguard for insurers on older-style policies, recovering the initial costs when contracts were first set-up. The question of whether the FCA believes exit charges are excessive, locking customers into policies unfairly, still remains unanswered.”

He also suggested that the regulator is likely to challenge the quality of communications insurers provide to their long-standing customers. “If the FCA does demand a change in communications, implementing a major overhaul of IT systems will come at a price.

“Savvy firms will take the opportunity to become more innovative, using data analytics coupled with behavioural science to help provide the right customer outcomes,” added Mr Browne.

Jason Whyte, insurance director at EY, told FTAdviser that the big problem with these ‘heritage’ policies is that the life and pensions environment has changed dramatically since they were taken out.

“How do you reconcile contracts that were designed under conditions of high inflation, a long bull market and complex fee structures with today’s environment of low inflation, uncertain growth and simple, transparent fees?”

He gave the example of pension contracts that customers signed up to in the 1980s and early 1990s being priced assuming that customers would hold them to maturity and then buy an annuity.

Income drawdown was only introduced in 1995 and only became a practical and popular mass market option with this year’s at-retirement reforms, causing headaches for providers with customers having to move from their old contracts to a new one that allows access, often triggering exit charges in the process.

“Some insurers are opting to waive the charges, recognising that customers are more likely to leave any remaining funds with them if they feel they’ve been treated fairly; but it’s a thorny problem.

By waiving the charges and allowing customers to move to what is often a lower margin product, they take a hit on the embedded value of their heritage book, which is calculated based on assumptions about the retention and pricing of these policies.”