Prudential pre-empts Sandler with new fund

Prudential, Britain's biggest with-profit provider, is to launch a fund that will separate assets owned by shareholders and policyholders ahead of a Government review into the sector that is expected to force insurers to restructure products this way.

The insurance group is expected to launch the fund in the autumn, just after Ron Sandler reports his findings following an independent investigation into with-profits. Mr Sandler is likely to say that the current structure of with-profits funds is unfair to policyholders.

Most with-profits funds are constructed so that they contain 90 per cent policyholder money and 10 per cent of shareholder money. Returns to shareholders are determined by how much is paid in bonuses to policyholders. This has raised fears at the Financial Services Authority and with the Government that the board faces a conflict of interest between policyholders and shareholders.

Mr Sandler and other critics of with-profits are also not happy with the fact that policyholders' capital, in effect, funds new business. Yet new business growth holds no obvious benefit to current policyholders while it is a key factor that affects share prices and so is of great importance for shareholders.

Prudential's fund will still contain shareholder and policyholder money. But it will break the link between bonuses and shareholder returns. Instead of one depending on the other, bonuses will be based on a straightforward assessment of investment performance minus fees for managing the money.

Mark Wood, the head of Prudential's UK arm, said: "There is merit in moving away from the 90-10 model and even in these markets we would not find it difficult to capitalise a new fund."

Prudential, which has £70bn of with-profits assets under management, has earmarked £125m of shareholder capital to get the new fund off the ground.

It is in the process of raising this money by merging its Scottish Amicable fund with another Prudential fund.

The move releases £125m of capital that was used to underpin the solvency of the Scottish Amicable fund and is not needed because there is sufficient capital in the second fund to meet solvency requirements.

The move by Prudential comes after it emerged that Scottish Widows has launched a new with-profit bond with a more transparent structure. The new bond, called Flexible Options does not mix policyholder and shareholder money and makes charges much easier to understand.

Scottish Widows, a mutual organisation that was bought by Lloyds TSB two years ago, has not managed any funds that contain 90 per cent of policyholder money and 10 per cent of shareholder cash.

But other insurers still have to come up with a plan for how they could unravel the 90-10 division within their existing with-profits funds, if Mr Sandler strongly encourages insurers to divide their existing books as well as new business. This will be a thorny problem for Prudential and its rivals, as they will have to divide large "orphan assets" estates, which are made up of shareholder and policyholder money. The task is difficult because there is no established procedure for deciding how the money should be divided.