Many mutual companies combine their with-profits business with other business lines, typically annuities, in a common fund in order to reduce their capital requirements through risk diversification. Under the LTGA's technical specifications, insurers would need to place a ring-fence around the assets backing the non-with-profit policies in order to utilise Solvency II's matching adjustment. This, mutual insurers argue, would cancel out the diversification benefit and undermine the usefulness of a common fund structure to mutuals.
Conditions on the application of all five versions of the matching adjustment contained in the LTGA technical specifications require ring-fenced funds to be managed separately from the rest of the business of an undertaking "without any possibility of transfer".
While the European Insurance and Occupational Pensions Authority (EIOPA) which is running the LTGA, claims that the ring-fencing provisions are preliminary and apply for LTGA purposes only, mutuals remain unhappy. David Gulland, chief risk officer at mutual insurer MGM Advantage, based in Worthing, says this rigid approach does not take into account how mutual insurers undertake risk management. By pooling the diverse risks attached to both non-with-profit and with-profit business in one fund, mutuals can afford to hold less reserve capital to protect their policyholders, he says.
If the ring-fencing provisions are maintained companies will have to make a judgement on whether the matching adjustment – aimed at reducing the balance sheet volatility arising from spread movements on assets held to maturity to back certain long-term products – or diversification benefit is of greater value to them.
Years of negotiations between mutual companies and the FSA bore fruit earlier this year with the regulator's recognition that providers had a right to deploy the inherited estates bound up in their common fund to service non-with-profit business.
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