Insurer Prudential has announced it will not be returning any of its £8.7 billion of surplus funds to policyholders and shareholders.

The group said an "extensive assessment" had concluded that maintaining the current operating model for its with-profits fund was in the best long-term interest of current and future policyholders and shareholders.

It said having a strong inherited estate gave the group greater investment flexibility, allowing it to have greater exposure to higher risk assets that potentially offered higher returns.

But the group's decision not to reattribute its inherited estate is likely to cause controversy, coming just a week after the influential Treasury Select Committee published a damning report on company's use of these funds.

The inherited estate refers to surplus cash that has built up in a with-profits fund over the years, due to the practice of holding back some returns in good years to pay out in bad ones.

But the Treasury Select Committee criticised insurers for using the money to pay shareholders' tax bills, subsidise new business and pay compensation claims, adding that the Financial Services Authority was failing to protect the interests of policyholders.

Prudential defended its decision, saying the whole of the inherited estate was required as working capital for the with-profits fund to enable it to continue with its current investment strategy, as well as to provide security and ongoing financial strength for the fund.

It added that at £8.7 billion, the inherited estate represented just 11% of the fund's total size of £79.1 billion at the end of December.

Nick Prettejohn, chief executive of Prudential UK & Europe, said: "Our with-profits fund has been consistently the top performing life fund in the UK for the past one, three, five and 10 years.

"Our overriding priority is to maintain the long-term financial security of the with-profits fund and to continue delivering strong performance for the benefit of our policyholders."

But the group's decision is still likely to disappoint policyholders, who could have received up to 90% of any of the inherited estate that was reattributed, with the remaining 10% going to shareholders.

Consumer group Which? said Prudential's decision made it even more important that the FSA tightened its regulations on with-profits funds and it called of an independent assessment to be carried out on the Prudential fund.

Chief executive Peter Vicary-Smith said: "We believe there must be a rigorous and independent assessment of Prudential's inherited estate to determine whether any of this money should be considered an 'excess surplus'.

"If so, it should be distributed immediately to policyholders on a 90:10 basis."

Copyright © PA Business 2008