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The Actuary The magazine of the Institute & Faculty of Actuaries

Closed life funds

Closed funds have a high profile in
the UK life insurance industry. Is
closure a suitable way for some
firms to respond to adverse market
conditions? Why have specialist groups
started buying closed funds? And what are the
implications for policyholders?
Our research examined the development of
closed life insurance firms in the UK from 1995
to 2004. The study covers all UK-authorised
long-term insurers (excluding pure reinsurers)
and significant friendly societies.
How many closed funds are there?
At the end of 1994 there were 49 closed firms.
There were 67 cases of firms closing over the
period to 2004. However, many of the closing
firms subsequently transferred their business to
another insurer, and some reopened. The outcome
is that the number of closed firms only
increased by five to 54. On the other hand, the
number of open firms fell from 197 to 134. The
assets in closed firms increased from £6bn in
1994 to £139bn in 2004, the latter figure being
13% of the industry total of £1,065bn.
In the first half of our period, 199599, there
were 27 closures (and only 10 of the firms had
with-profits liabilities), whereas in 200004 the
number of closures was 40 (of which 23 had
with-profits liabilities).
At the end of 2004, two of the ‘closed fund
consolidators’, Resolution plc and Pearl Group
Ltd, owned 12 and 7 closed firms respectively
(ie 19 of the 54 in total), with £39bn and £28bn
assets respectively.
Are closed firms different from
open ones?
We found that closed firms tend to be smaller,
financially weaker, and have a higher proportion
of with-profits liabilities. They also tend to
have relatively high lapse/surrender rates and
a high maintenance expense ratio (maintenance
expenses as a proportion of regular premiums
plus 10% of single premiums).
Some large with-profits life insurers have
closed in recent years. We can compare the 21
open and 17 closed firms that issued a realistic
with-profits balance sheet in accordance with
FSA rules at the end of 2004. The closed firms
tend to be relatively small, have lower solvency
ratios, and have a lower risk capital margin as a
proportion of their liabilities. This is consistent
with some of the closed firms emphasising the
need to reduce the risks to which they are
exposed (‘de-risking’).
What types of firms close?
We examined the characteristics of firms that
closed, two years before closure. We then compared
these characteristics with similar firms
that did not close. We found that closure is
more likely if the firm:
°ª is proprietary as distinct
from mutual (***)
°ª has low solvency (***)
°ª has a low proportion of
linked business (*)
°ª has a low level of new business
°ª has a high acquisition cost
ratio (**)
°ª has a high maintenance
expense ratio (**).
(The more asterisks, the higher
level of statistical significance.)
What happened after closure?
We compared 24 firms that closed (‘closers’)
with similar firms that did not close (‘matches’).
Our analysis is restricted to firms that were in
operation three years before and three years
after closure. We found that:
°? the solvency ratio of closers tends to improve
after closure;
°? in the second and third years after closure,
the equity allocation of closers increases
whereas for matches it falls (for with-profits);
°? the lapse/surrender ratio for closers is
markedly higher in the year after closure, and
while it then drops, it is still higher than for
the matches in the second and third years
after closure; and
°? the maintenance expense ratio of closers is
markedly higher in the year after closure and
although it declines somewhat thereafter, the
excess of expenses of closers over matches
remains higher than pre-closure.
The analysis of consequences of closure cannot
include firms that closed recently including
some of the purchases of with-profits funds
by the consolidators although there is some
evidence of maintenance expenses decreasing,
and of new approaches to equity investment.
What are the implications for
Without the need to attract new customers
there have been questions raised about how
closed funds treat their existing policyholders.
The FSA has introduced new rules for, and is
reviewing the practices of, closed firms. Our
report discusses a number of issues relevant to
with-profits policyholders, including the challenge
that closed firms face to demonstrate the
fairness of their payouts, the operation of management
services agreements and the proportion
of surplus allocated to shareholders.
The new closed fund consolidators can focus
on the operation of the existing business, and
this may enable them to achieve efficiency savings
to provide a good return to their shareholders.
However, it is early days, and there are
still plenty of challenges to be faced.
We are grateful to ABN Amro for funding the