Compliance Note Update

Prepared by Patrick McIntosh - Chairman

With Profit Bonds

February 2004

Such extraordinary events in the market place forced me to detail some important facts for members of KMG and for our compliance files.

MGM
One of my constant themes to clients has been the lack of transparency and the complete inability to understand or clarify what may be the real position of With Profit Funds going forward.

In the case of MGM they arbitrarily decided to impose MVAs on regular withdrawals towards the end of 2003. Despite our remonstrations to the contrary in respect of Key Feature documents, which they clearly issued to us at the time the contracts were sold suggesting that MVAs could not be imposed on income withdrawals, they now claim that they issued different Key Feature documents which did state this fact, and we are in dispute with them.

MVAs for MGM were some of the highest in the industry at approximately 25%, and were, in our opinion, significant.

Approximately 18 months ago I met with the Chief Actuary of MGM who explained to me that he did not feel that MGM had the same liabilities to Guaranteed Annuity Rates and pension mis-selling, and nor did he really feel that endowment mis-selling was likely to be of considerable concern to him, such that whilst the assets did not meet his liabilities within the fund at that time, he felt relatively positive about the future.

I was thus very surprised when their MVAs became larger than everybody else's, and presumed when they then started imposing MVAs on withdrawals, that in fact their liabilities had become substantially larger and their investment strategy moved against them dramatically.

All historic information on free asset ratios and solvency margins etc for MGM looked bad but not impossible, but one had to assume that the up-to-date actions, which of course come out well ahead of published information, clearly indicated a deteriorating situation.

We discovered on the 19th February, without MGM advising us, that they had suddenly reduced their MVAs from 25% to 5% on Life, With Profit Bonds, and 10% on Pension Funds. How can this be? Have their funds suddenly recovered? Have their liabilities disappeared? How can they move in such diverse directions in such a short space of time when a With Profit Fund is supposed to be a steady long-term smoothed product?

However one looks at this situation it is entirely bizarre and provides no confidence to IFAs or the market place, that any of these actuaries or managements of large With Profit Funds really have any control or understanding over what they are trying to manage.

The Market in General
Clearly the announcements in the Financial Times regarding Standard Life must leave one to conclude that bonuses going forward for Standard Life will be significantly less attractive than they have in the past. More importantly it will take a significantly longer period of time for them to recover their solvency margin, as they will not benefit from equity revaluation as markets move ahead with such a small proportion of the fund now invested therein. Clearly they have lost out by selling at the low end of the market in March 2003, and subsequent to that time with the market still well below its peak of 2000 and now purchasing assets that may produce reasonable income flows and produce protection against inflation, can hardly enable Standard Life to recover their position, reduce their MVAs, or improve bonus positions, especially whilst they may have such substantial liabilities in all directions.

The concerns regarding the Penrose Enquiry and the fact that the report has not been published must lead IFAs and the public to suggest that there are some grave issues that need to be addressed. One must presume that when the report is published it may well destabilise the market dramatically, such that there could be the effect of a run on With Profit Funds. One rational explanation for Government referring the report to the fraud office is because there could be some suggestion of deliberate mal-administration. I cannot believe that Government and the FSA would wish to increase the concerns in the public's mind at this very sensitive time unless they were absolutely convinced of the dilemmas that have been revealed in the Penrose Enquiry.

This note is being sent to the FSA simply to demonstrate to them how difficult it is for an IFA to give sensible advice and/or for the public to make a rational decision about whether to sell their With Profit Funds or stay. Another nail in the coffin was an article in Money Mail on Wednesday 18th February encouraging all With Profit Bond holders to bail out whilst they still can!

I welcome the FSA's comments and response to the above.