Both the FCA and the Prudential Regulation Authority (PRA) last week published statements in response to the FSA Consultation Paper 12/38: Mutuality and with-profits: a way forward, which suggested a way for with-profits mutuals to create a ‘members’ fund’ in which to write or continue to write non-profits business. This issue, and in particular how a small to medium sized mutual could create such a fund without a formal scheme of arrangement, has been under discussion for a number of years now. It would appear to have come to something of a landing point.


The problem for mutuals who are no longer writing significant amounts of with-profits business is that the FCA’s Conduct of Business rules (COBS) effectively require them to go into run-off and to plan for the distribution of their assets over the life of the existing with-profits policies. This is clearly not desirable as many mutuals provide (or at least could potentially provide) other types of insurance policies. Many mutual firms have therefore challenged the FCA rules on the grounds that the FSA/FCA interpretation of the COBS requirements does not reflect the reality of how mutuals operate. Many mutuals have sought to show that just because all of their surplus sits in one fund which supports the with-profits business, it does not mean either that other policyholders (or members) have not benefited from distributions from the fund or that all of the fund’s assets should go to the with-profits policyholders on the occurrence of a distribution/winding-up. These arguments have tended to be based on the constitution and operational model of the individual mutual and their practices to date.


Given the differences in the interpretation of the COBS requirements between the FSA and many of the mutuals, in December 2012 the FSA consulted on what is in effect a compromise position. This compromise was designed to offer small and medium sized mutuals a way of creating a members’ fund in which they could continue to write non-profits business. The FSA’s proposal was to allow mutuals to apply for a waiver from the relevant COBS rules. This waiver application would need to explain why the proposals being put forward by the mutual were fair to with-profits policyholders and should be supported by an opinion from an independent expert. The responses to CP12/38 raised two fundamental issues:

  1. whether a waiver was an appropriate way to achieve a permanent variation of policyholder rights; and
  2. how the mutual members’ fund, being a purely notional fund for the purposes of a regulatory rule waiver, would be categorised under Solvency II provisions on ring-fenced funds.

The FCA’s Policy Statement PS14/5 seeks to answer the first question raised by CP12/38 while the PRA’s Supervisory Statement SS1/14 seeks to answer the second question.


The FCA has confirmed that a rule waiver will technically be revocable but has stated that by necessity its long-term nature would be considered as part of the application process.

The FCA has also provided feedback on the original consultation, a summary of its view of the legal position on the rights and interests of policyholders and the text for additional guidance to be added as COBS 20.2 60-61. This guidance sets out the applicable process (in addition to the normal requirements of an application for a rule waiver in section 138A of FSMA). This can be summarised in high level terms as requirements to demonstrate the viability of the proposed non-profits business, the engagement of policyholders and that the waiver would be ‘fair’ to, in particular, the with-profits policyholders. In addition, the firm’s proposals would need to demonstrate that the exercise would not amount to a reattribution, complies with the firm’s constitution and is supported by a report from an ‘approved’ independent expert. The mutual will be required to provide a comparison with a proprietary company to demonstrate that the mutual policyholders will not be at a disadvantage when compared to policyholders of a proprietary with-profits company. In addition, the mutual will need to provide an explanation of the support obligations the mutual members’ fund will undertake in relation to the with-profits business and supply details of how policyholder compensation or redress can be paid. Finally, the proposals must demonstrate “how and the extent to which continuing membership rights will benefit with-profits policyholders and other policyholders”.

The FCA makes the point that it expects the independent expert’s views of the existing rights of with-profits policyholders to be supported by independent legal advice and any uncertainty in relation to the legal position should be taken into account by the independent expert. The FCA points out that each application will be dealt with on a case by case basis.


The main point of interest from the PRA paper, other than to confirm the need for both regulators to be involved in the application process, concerns the applicability of Solvency II ring-fenced fund requirements. These broadly require a notional capital requirement to be applied to ring-fenced funds and require that capital in such funds should not to be available to support any other business undertaken by the insurer. The definition of ring-fenced funds is likely to catch with-profits funds with the result that it is not clear how the mutual member’s fund will be treated under Solvency II. The PRA makes the point that Solvency II is a maximum harmonising directive so it will be unable to provide an exemption from its requirements. The PRA appears to consider that the with-profits fund and the mutual members’ fund could each be ring-fenced (i.e. because the mutual members’ funds would presumably be restricted by obligations in relation to the with-profits fund). The other alternative is that for Solvency II purposes, the two funds could be categorised as part of the same ring-fenced fund (due to the notional nature of the split resulting from the waiver).

Our comments

Both the PRA and the FCA statements appear to provide a framework for such notional splitting of a mutual’s common fund. The approach appears to encourage mutuals to make use of this facility to create a way forward and it is hoped that it can work in practice. However, it is fair to say that the uncertainties raised when the FSA’s paper was issued do not appear to have been fully resolved. There are still doubts as to the legal status of a process that potentially compromises policyholder rights under the existing COBS rules and the status of the waiver for Solvency II purposes. For many larger mutuals, given that they will need to incur the expense of an independent expert and potentially lawyers to advise that independent expert anyway, they may gain more from a formal scheme of arrangement to separate their common fund.

View PS14/5: Response to CP12/38 – Mutuality and with-profits funds: a way forward, 3 April 2014

View SS1/14: Mutuality and with-profits funds: a way forward, 3 April 2014