NORWICH UNION, Britain’s biggest insurer, has raided policyholders’ funds to the tune of nearly £300m to plug a hole in its pension fund and pay for past mis-selling.

The move will mean lower payouts for 1.1m policyholders as the insurer prepares to unlock £5 billion of surplus assets in its with-profits funds.

The figures, unearthed by consumer group Which?, reveal that the company has reserved £83m of its surplus assets to cover a deficit in its staff pension scheme. Another £182m has been set aside to pay for endowment and pension mis-selling – meaning policyholders are being forced to pay for the industry’s mistakes.

MPs and consumer groups say this is typical of the way that insurers sneakily cream off the funds of policyholders for their own benefit, even though many customers continue to suffer appalling returns.

Vince Cable, the Liberal Democrats’ Treasury spokesman, said: “The Financial Services Authority perpetuates rules which give preference to shareholders over policyholders and allow such appalling abuses as penalties for pensions mis-selling to be taken from policyholders’ inherited estates. Companies like Norwich Union and Prudential are managing, under the cloak of complexity, to deprive their policyholders of large sums.”

Consumer groups say that business expenses should come out of shareholders’ pockets and not be allowed to deplete policyholders’ funds. Angry investors agree, pointing out they have diligently paid into Norwich Union’s with-profits funds for years only to suffer disappointing returns.

A typical maturing £50-a-month, 25-year Commercial Union policy will pay out £40,737 this year, including a special bonus from the inherited estate. This is 7% down on the £43,697 equivalent plan last year.

If less of the money were used to pay for business costs, more could be used to boost policy payouts, argues Dominic Lindley at Which?

He said: “The rules institutionalise unfairness by allowing Norwich Union to use the inherited estate to pay shareholders’ tax bills, subsidise new business, pay for mis-selling and prop up the Norwich Union staff pension scheme. Every pound used for these purposes reduces the amount available to distribute to policyholders.”

The cash raid has been exposed as Norwich Union nears the end of at times acrimonious negotiations over how it carves up about £5 billion of excess capital in its with-profits fund.

This has built up because insurers have discretion about how much of the investment returns generated by the fund are handed to policyholders each year.

With-profits funds are supposed to smooth the ups and downs of the stock market by holding back some of their returns in good years and adding them back during periods of poor performance.

Although insurers claim that over the life of a policy you get back all the investment returns, in practice companies have held back too much money, short-changing previous policyholders and resulting in billion-pound surpluses.

Norwich Union wants to get its hands on a large chunk of the cash to finance a range of business expenses. Analysts at the investment bank KBW estimate this will benefit shareholders in Aviva, which owns Norwich Union, to the tune of £500m.

In return, it intends to offer compensation to 1.1m endowment, pension and bond policyholders for waiving their rights to the money.

For more than a year Aviva has been in negotiations with Clare Spottiswoode, who has been appointed to represent customers in the carve-up. It announced last month that it would pay about £2.1 billion of the excess capital to policyholders as a special bonus over the next three years.

Norwich Union has still to decide what it will do with the remaining £2.6 billion, however. It has two options – distribution or reattribution. If the surplus assets are distributed, or paid out in full, insurers are obliged by rules laid down by the City regulator to pay 90% to policyholders and only 10% to shareholders.

However, the bosses at Norwich Union favour a “reattribution” of the cash – in other words, asking policyholders to give up all rights to future payouts from the inherited estate in return for a windfall. With reattribution, there are no rules on how much policyholders should get and as a result shareholders are expected to be the big winners.

The extent of the shareholders’ coup is expected to become clear in the next few weeks as the negotiations reach their climax, with big implications for other listed life firms. Prudential, Britain’s second-biggest insurer, is considering whether to give the green light to a similar plan for its £9 billion inherited estate. It has kept its plans on hold while Norwich Union and Spottiswoode battle over their plans.

Aviva originally hoped to have agreed a deal by last autumn. However, the process has been seriously delayed as the company has clashed with Spottiswoode over how much of the money should be used for the benefit of shareholders.

Norwich Union said that its use of the with-profits fund to pay for business expenses was within the rules.

John Lister, chief actuary at Norwich Union, said: “The assets don’t belong to the policyholders, but to the company.”

ENDOWMENT SHORTFALL ANGER

GLEN MACKENZIE, from Etwall in Derbyshire, will qualify for a windfall and special bonus from Norwich Union if it pushes ahead with its plans, but he thinks the money would have been better spent wiping out his endowment shortfall.

Glen and wife Janine, pictured with children Shona and Rorie, took out three endowments with NU to pay their mortgage. Returns have not matched what they were promised and they face a combined shortfall of £6,000.

Glen, 46, an engineering consultant, believes any excess assets should be used to boost returns rather than go into the pockets of shareholders or be used to cover NU’s business expenses.

He said: ‘This money was built up using policyholders’ funds, so most of it should rightfully go to customers, not siphoned off for the shareholders’ benefit.’

WHAT’S NORWICH UP TO?

— NU is carving up £5 billion of excess assets in its with-profits funds between policyholders and shareholders.

— About 1.1m policyholders in the Commercial Union Life Assurance or CGNU Life funds on November 21, 2006, could get a windfall – but critics say it won’t be enough.

— A deal could be announced in weeks, with payments this summer. However, that timetable could change.

— Qualifying with-profits policyholders will be able to vote on any proposed deal.

— People who had CU Life and CGNU with-profits policies in force on January 1 are also getting a special bonus.

Times Recommends

• How to sell your home in a downturn
• How to boost your spending power
• Unemployment benefits explained