TENTH REPORT |
The Treasury Committee has agreed to the
EQUITABLE LIFE AND THE LIFE ASSURANCE
AN INTERIM REPORT
Summary of Conclusions and Recommendations
(a) We would like
the Financial Services Authority (FSA), Faculty and Institute
of Actuaries (F&IA) and Institute of Chartered Accountants
of England and Wales (ICAEW) to take on board the points we make
in this Report in the context of their own inquiries, so that
the Equitable Life affair can be properly and fully explained
and to help the Committee continue the investigation (paragraph
(b) We could not form
a firm conclusion as to whether rapid institutional change coupled
with continuity in staff did or did not contribute to the Equitable
Life affair. The Committee will wish to return to this issue (paragraph
(c) The F&IA report
should consider whether the actuarial guidance provided by the
F&IA was appropriate at the time, and whether such general
advice was suitable. It should also consider the extent to which
the F&IA's opinion was based on the prudential insurance regulator's
view (paragraph 17).
(d) Equitable Life's
risky decision in 1993 not to build up a reserve to cover the
cost of Guaranteed Annuity Rate (GAR) liabilities was a crucial
turning point. We return later in this Report to the level of
information given to policyholders and potential policyholders
(e) The relationship
between firms' Appointed Actuaries and management boards, and
with the body of policyholders, is in need of review, in the light
of the Equitable Life affair (paragraph 20).
(f) It is unclear
to us why the issue of GAR liabilities and reserving was not considered
by the prudential insurance regulator at least by 1993, rather
than only in 1998. We believe that the current inquiries should
pursue this closely (paragraph 21).
(g) We ask the FSA
to consider whether cash reserves only need to be accumulated
when required by the economic circumstancesor whether there
are other circumstances in which cash reserves may be required
(h) We ask the FSA
to reconsider whether it was right to accept the reinsurance contract
given its terms, and whether it was prudent to allow such a contract
to have accounted for half of the Equitable Life's statutory reserves
(i) Equitable Life
demonstrated that the information provided to policyholders, through
the statutory accounts, and to the regulator, through the regulatory
return, differed substantially in their treatment of the GAR liabilities
and the consequential reserving that had been undertaken. As a
result, policyholders were not able easily to establish the true
position of the company. We ask both the FSA and the ICAEW to
consider whether statutory accounts and regulatory returns should
draw upon the same information and assumptions wherever possible,
in order to improve transparency. In addition, the FSA should
consider whether a life office's reserving policy should be made
clear to policyholders, either in statutory accounts or in some
other way (paragraph 31).
(j) We do not believe
that the auditing arrangements for the statutory accounts and,
in particular, the regulatory returns of life offices were adequate.
In their memorandum to us, Ernst and Young set out the judgments
that they made concerning disclosure. We ask the FSA to consider
the justification for the auditors' judgments and whether there
are implications for future reporting practices by auditors generally
(k) Equitable Life
failed to explain to their policyholders the full implication
of Lord Woolf's judgment. The FSA should therefore consider whether
the assessment made by Equitable Life, and indeed by themselves,
of whether the eventual House of Lords ruling could have been
predicted, was justified, especially given Lord Woolf's judgment
(l) We welcome the
FSA's review of Equitable Life's selling practices after the Court
of Appeal decision and we ask the FSA to review the Equitable
Life's practices when pension policyholders gave up rights to
guaranteed annuity rates (paragraph 42).
(m) We welcome the
announcement of an FSA review of management discretion in the
with-profits business. We recommend that the FSA analyse the extent
to which financial services, in particular life assurance, rely
on managerial absolute discretion (paragraph 46).
(n) It is important
that the role of regulator since 1993, when Equitable Life began
to operate a policy of terminal bonus differentiation, should
be analysed in order for the regulatory lessons to be properly
learnt, for policyholders to fully understand the history of the
affair and for Parliament to undertake its scrutiny of this topic
properly and fully. The Committee will await the FSA's report.
It will want to examine what it has to say on the regulatory background
to the Equitable Life affair between 1993 and 1999, and then decide
how to proceed (paragraph 50).
(o) We welcome the
announcement that the FSA inquiry will have access to Government
Actuary's Department (GAD) files and personnel. In our recent
report on GAD, we recommended that GAD should publish a regular
report to Parliament on the life assurance sector, so that public
attention can be drawn to trends and issues of concern. We recommend
that the FSA inquiry make suggestions as to how this could best
be achieved and how better public information about the condition
of individual life assurers can be published, on the basis of
the actuarial advice received by the FSA (paragraph 53).
1. On 20 July 2000, the House of Lords ruled against
the policy of Equitable Life Assurance Society of applying differential
terminal bonuses between groups of with-profits policyholders
depending on whether the Guaranteed Annuity Rate option (GAR)
in their contract was exercised.
Immediately following the ruling, the board of Equitable Life
announced it was having to put the Society up for sale; on 8 December
2000, when the last interested party pulled out of negotiations,
Equitable Life announced it was closing to new business. Equitable
Life subsequently (5 February 2001) reached agreement with Halifax
Group plc in regard to the sale of part of the company. We return
to this arrangement in paragraph 54.
2. As these events potentially affect over half a
we announced, on 16 January 2001, our intention to undertake an
inquiry "to examine the regulatory environment and the management
of risk in the life assurance sector following the Equitable Life
3. We took evidence on 15 February from representatives
of Equitable Life and the Financial Services Authority (FSA).
We also took the opportunity of the Chancellor of the Exchequer's
appearance in front of the Committee during our inquiry into the
2001 Budget to ask him some questions about the Government's regulation
of life assurance firms prior to 1999. Our Sub-committee's inquiry
into the Government Actuary's Department (GAD)
also touched on the Equitable Life affair and we refer to the
evidence it took at appropriate points in this Report.
CURRENT INQUIRIES INTO THE EQUITABLE LIFE AFFAIR
4. There are a number of other ongoing investigations
into the events surrounding Equitable Life: the Actuarial Profession
(the Faculty and Institute of Actuaries (F&IA)) announced
on 21 December 2000 that it would establish a "Committee
of Inquiry" to consider the affair, focussing on the issue
of professional guidance,
which it is hoped will report during the spring; the FSA issued
a press notice on 22 December 2000 saying that its board had agreed
that the organisation's executive management should undertake
an internal investigation of its regulation of Equitable Lifethe
report is intended to be completed in summer 2001 and sent to
HM Treasury before being published;
and the Institute of Chartered Accountants in England and Wales
(ICAEW) have announced that they will be "looking into the
role" of its members in relation to Equitable Life.
We refer further to the FSA's inquiry later in our Report (paragraph
AIM OF THIS REPORT
5. This report is intended to be an interim
assessment, based on the written and oral evidence taken by us
to date. We felt that it was important for us to set out the background
to the Equitable Life case and the key factors explaining its
recent problems, to help inform the House and to suggest questions
which the other inquiries need to address. We would like the
FSA, F&IA and ICAEW to take on board the points we make in
this Report in the context of their own inquiries, so that the
Equitable Life affair can be properly and fully explained and
to help the Committee continue the investigation.
6. The structure of the report follows a chronological
approach to events. The complicated regulatory environment is
explained in the first instance, to allow the Equitable Life's
policy of differential terminal bonuses and the consequences of
this approach to be put in the context of the applicable regulatory
regime over the period from 1993 to December 2000. This is followed
by an examination of the issue of guaranteed annuity rate options
(GARs), the Equitable Life's response of giving different terminal
bonuses depending on how a policyholder took his or her pension,
and the Equitable Life's reserving policy. The consequences of
the Equitable Life's approach to terminal bonus provision, leading
to a representative action by Mr Hyman, and the ensuing judicial
process is then considered. We examine the scope of the FSA's
inquiry. The Report ends with a review of the deal between Equitable
Life and the Halifax Group, and the outlook for with-profits policyholders.
Regulation of the Life Assurance Sector
7. Regulation of the life assurance industry, including
Equitable Life, is currently undertaken under two separate statutory
regimes. One type of regulation is conduct of business,
under the Financial Services Act 1986: this relates primarily
to how companies deal with their customers, for example, advertising
and advice given to consumers at the point of sale. This regulation
remains the legal responsibility of the Personal Investment Authority
although under a service level agreement the work has been carried
out, under contract, by staff of the FSA since 1 June 1998.
These arrangements were set up in preparation for the implementation
of the Financial Services and Markets Act (FSMA), when responsibility
for conduct of regulation will transfer to the FSA, and the PIA
will be wound up. We return to the information given to new investors
by Equitable Life during 1999 and 2000 in paragraph 41.
8. The other type of regulation is prudential
supervision: this relates to whether life assurance companies
(or life offices, as they are also known) can meet their liabilities.
In regard to prudential supervision, there have been three different
regulators since the early 1980s. Until the end of 1998, responsibility
was held by the Department of Trade and Industry (DTI). In May
1997, the incoming Government decided that prudential supervision
of insurance companies should be transferred to the proposed new
single financial regulator. In anticipation of this transfer,
responsibility, including Ministerial responsibility, moved to
HM Treasury on 5 January 1998.
On 1 January 1999, the FSA became responsible for prudential insurance
regulation, although ministerial responsibility continued to rest
with HM Treasury.
At the time of the transfer of prudential insurance regulation
to the FSA, however, the FSMA had yet to receive Royal Assent,
and it is still to be implemented in regard to insurance regulation.
9. Until the FSMA is implemented, the transfer to
the FSA of HM Treasury's role in prudential insurance regulation
has been achieved by contracting out.
This has meant that the majority, but not all, of the Treasury's
powers under the Insurance Companies Act 1982 have become exercisable
by the FSAthe FSA is responsible only for the day-to-day
task of prudential insurance regulation,
and remains accountable to HM Treasury for prudential insurance
supervision until the FSMA is implemented.
10. Through this period of change, however, there
has been a measure of continuity in the staff involved in prudential
insurance regulation. Mr Martin Roberts was appointed Director
of HM Treasury's Insurance Directorate in February 1998, and was
subsequently transferred to the FSA in January 1999 and continued
in the same role with his new employer.
Other members of Mr Roberts' directorate at HM Treasury also transferred
to the FSA when the contracting out of prudential insurance regulation
came into effect in January 1999, including Mr Roger Allen, who
continued in his post as Deputy Director of the Insurance Directorate,
with responsibility for the Life Assurance sector. Mr Allen had
worked in the Insurance Directorate of the DTI and then the Treasury
since 1993. Additionally, the legal advisers (previously part
of the Treasury Solicitors) were transferred to the FSA. GAD,
which provides advice on the supervision of insurance companies
to the prudential insurance regulator, reported directly to the
FSA. Sir Howard Davies, Chairman and Chief Executive of the FSA,
said, referring to the staff, that "there has been, therefore,
a high degree of continuity of approach [towards prudential insurance
regulation] through 1998, 1999 and 2000".
We could not form a firm conclusion as to whether rapid institutional
change coupled with continuity in staff did or did not contribute
to the Equitable Life affair. The Committee will wish to return
to this issue.
The issue of Guaranteed Annuity Rate options and
the response of Equitable Life
11. As a mutual, Equitable Life has no shareholders;
instead, holders of "participating policies" are the
"members", or owners, of Equitable Life. These members
share in the profitability of the company through their participating
policiesin other words, "with-profits" policies.
The key feature of with-profits policies, in contrast to unit-linked
ones, is that they allow the insurer to smooth the returns to
policyholders over the life of the contract. Policyholders earn
a "reversionary" bonus every year during the life of
the policy, which cannot be taken away. The level of the reversionary
bonus is intended to be broadly stable from year to year, despite
underlying market conditions. In addition, if the maturity date
of the policy is reached, or if the policyholder dies, a "terminal"
bonus is paid. This bonus is usually decided only at the time
of payment. The lack of certainty means that the terminal bonus
does not have to be backed by reserves.
12. Guaranteed Annuity Rate options (GARs) provide
a fixed rate at which the policyholder is entitled to obtain an
annuity based on the repayment value of his or her investment.
GARs were a feature of pension contracts issued by Equitable Life
between 1957 and July 1988. Their inclusion in policies was at
no charge to the policyholder, and Equitable Life said that they
were not used as a "major marketing tool", adding that
it was standard market practice to include a GAR provision.
Until 1975, the interest rate underlying the guarantee was 4 per
cent; after 1975 until 1988, a period of high inflation, the rate
was increased to 7 per cent.
GARs were not included in policies sold after 1988, although contracts
sold with GARs remained valid and such policies could still be
13. A policyholder does not have to take the GAR
option when seeking an annuity. The other options are to purchase
an annuity from the life assurer at the current annuity rate,
or purchase an annuity with another provider.
However, the inclusion of a GAR within a with profits policy created
added certainty for the policyholder, as Mr Headdon, then Chief
Executive of Equitable Life, explained: "All with-profits
policies provide a certain minimum level of guaranteed benefit
... Typically it is a minimum cash sum that is payable at some
future date. These contracts [i.e with profits with a GAR included]
were unusual in that, as well as providing a minimum cash benefit,
they also provided a minimum level of income".
The increasing worth of GARs during the 1990s
14. During the period when Equitable Life included
GARs in with-profits policies, current annuity rates were above
the GAR, and therefore policyholders tended not to choose to take
the GAR option. However, as UK inflation fell, so expectations
of future interest rates declined as reflected in the yield on
long-dated UK government bonds (gilts), and therefore annuity
rates. Sir Howard Davies explained that "there is roughly
a break-even point at somewhere between 8 and 8½ per cent
on long-term gilt rates where these [GAR] policies trigger significantly
higher annuities than you would otherwise have got [if you took
the current annuity rate]".
At the end of 1993, current annuity rates had declined to the
extent that they were below the the GARs held by those who had
purchased Equitable Life with-profit policies between 1975 and
July 1988. Although current annuity rates rose in 1994, in 1995
they had once again fallen below GARs and this situation has since
persisted. Between 1995 and 1998, the gap between GARs and current
annuity rates widened (and has since stabilised around 1998 levels),
with the effect that the value of the GAR to policyholders has
The response of Equitable Life: to pay different
15. In response to the fall in interest rates, Equitable
Life's policy was "to adopt a 'differential final bonus practice'
to equalise, so far as possible, the benefits taken by policyholders
in GAR form with those benefits in cash form".
Mr Headdon said that the board of Equitable Life had considered
in the 1980s the scenario of GARs exceeding current annuity rates.
The conclusion was that different terminal bonuses should be paid
to those who exercised the GAR "consistent with the type
of bonus approach that we have described to our members".
This strategy was implemented at the end of 1993, when GARs exceeded
current annuity rates. Because the lowest terminal bonus for benefits
taken in GAR form is zero, there would be occasions where, even
allowing for zero terminal bonus, the benefits that are in GAR
form exceed those that are taken at the current annuity rate.
To cover for such circumstances, Equitable Life made a provision
of £200 million in their statutory accounts.
A consequence of this approach was to discourage policyholders
from exercising their GAR. Mr Cazalet argued that the policy of
terminal bonus differentation was undertaken "with the intention
of seeing to it that practically none of its customers would opt
to take the annuity on the terms guaranteed in their contracts".
16. Sir Howard explained that Equitable Life were
"not an unusual/unique company" in their approach to
addressing the problem.
Indeed, the life offices that did adopt this approach to the GAR
issue appeared, in the view of Mr Cazalet, to have "the explicit
backing of the Insurance Directorate of HM Treasury".
In a letter to all managing directors of life offices, Mr Roberts,
then as HM Treasury's Director of Insurance, wrote on 18 December
"It would appear possible, depending on the
particular circumstances relating to the contract, that any terminal
bonus added at maturity may be somewhat lower than for contracts
without such options or guarantees [GARs] ... [This] is the Treasury's
considered view, and is without prejudice to any decision of the
courts which may affect it".
The F&IA explained that the letter "confirmed
HM Treasury's view at that time ... that, in appropriate circumstances,
any final bonus added at maturity for contracts containing Guaranteed
Annuity Rates might be lower than for contracts which did not
contain Guaranteed Annuity Rates".
Mr Headdon told the Committee that when Equitable Life introduced
differential terminal bonuses, it had not sought advice from the
prudential insurance regulator.
But Mr Peter Martin, Vice-President of Equitable Life, explained
that, in the view of Equitable Life, the letter from Mr Roberts
"confirmed in a modest way that what we were doing [since
1993 by differentiating terminal bonuses] was not out of order".
17. In addition, the F&IA issued a statement
in regard to GARs in March 1999, from which an extract is reproduced
"The policyholder is likely to receive the full
value of the funds built up to support the policy, regardless
of whether they take a cash option or pension option under their
policy. The final bonus rates for individual policies will be
set so that the accumulated fund equals the cost of the annuity
provided. The 'guarantee' may seem to be lost, but the position
is no different from the position of the past under older policies
with a guaranteed conversion the other wayfrom pension
to cash. The guarantee will still bite if final bonus rates fall
The statement was amended in October 2000. The
F&IA report should consider whether the actuarial guidance
provided by the F&IA was appropriate at the time, and whether
such general advice was suitable. It should also consider the
extent to which the F&IA's opinion was based on the prudential
insurance regulator's view.
18. While Equitable Life apparently had regulatory
approval for its approach to the issue of GARs, the Annuity Bureau
told us that "this risk [from GARs] is usually managed by
setting reserves aside to meet the potential costs and/or reassuring
part of the expected liabilities".
Mr Cazalet confirmed that: "With a couple of minor exceptions,
all other life offices chose to take their [GAR] hits squarely
on the chin, using their excess capital to meet the cost of their
The lack of reserves
19. Equitable Life has been a mutual organisation
since its inception, and operated on a philosophy of "full
and fair" distribution of its profits to "with-profits"
policyholders. This had the effect of increasing the returns to
such policyholders; and this was reflected in Equitable Life's
superior performance relative to other life offices.
However, the consequence of this policy was that, unlike other
life offices, including many with mutual status, Equitable Life
did not accumulate any substantial reserves (alternatively referred
to as an "inherited" or "orphan" estate).
Equitable Life explained: "if part of the surplus otherwise
available for distribution to policyholders was set aside for
future emergencies, this would have been at the expense of policyholders
whose policies were in force or maturing when those surpluses
Mr Headdon said that policyholders were "not explicitly"
told that the policy of full and fair distribution was at the
expense of creating "a reserve fund that could meet some
Mr Headdon admitted to the Committee that if reserves had been
accumulated from 1993 onwards, then Equitable Life could have
responded to the subsequent House of Lords ruling "in a less
dramatic and worrying way", and the problems that afflicted
Equitable Life in the light of that ruling would probably not
Equitable Life's risky decision in 1993 not to build up a reserve
to cover the cost of GAR liabilities was a crucial turning point.
We return later in this Report to the level of information given
to policyholders and potential policyholders.
The role of the appointed actuary
20. The role of the appointed actuary is set out
in the Insurance Companies Act 1982 and includes determining the
value of the company's liabilities, so that they can be balanced
off against the assets in order to calculate the "mathematical
reserves". An important part of this calculation is the "potential
effects of guarantees and options under the Company's policies
... [and] any reinsurance arrangements".
The appointed actuary should also advise the board of their interpretation
of what policyholders' reasonable expectations (PRE)
are, including the treatment of with-profits policyholders through
The F&IA describe the Appointed Actuary system as "central
to the financial soundness of life companies in the UK".
Mr Headdon was the finance director and the appointed actuary
of Equitable Life during the period August 1997 to December 2000.
The F&IA have said that the arrangements that were in place
at Equitable Life are regarded as "desirable in many ways",
as the appointed actuary has close contact with the board. However,
the F&IA warned that "it is important that the Board
should be clear about when the individual is giving advice formally
as the Appointed Actuary and when he or she is acting in another
Mr Deakin told us that he had no concerns about an appointed actuary
also having an executive role or a directorship within a company,
except, as a general rule, being the managing director.
The relationship between firms' Appointed Actuaries and management
boards, and with the body of policyholders, is in need of review,
in the light of the Equitable Life affair.
GAD Review of regulatory reserving for GARs
21. Mr Cazalet noted that during the 1990s, as the
potential GAR liabilities increased, so life offices made extra
provisions but did so "ad hoc and subject to a great
deal of actuarial discretion".
Sir Howard explained that the prudential insurance regulator became
concerned about the level of reserves held by life offices in
regard to GARs in 1997, when long-dated gilt yields started to
decline sharply, thereby increasing the benefit of exercising
a GAR, and so increasing the costs of life offices.
In 1998, the regulator (HM Treasury) asked the Government Actuary's
Department to undertake a survey of life offices. It is unclear
to us why the issue of GAR liabilities and reserving was not considered
by the prudential insurance regulator at least by 1993, rather
than only in 1998. We believe that the current inquiries should
pursue this closely.
22. Sir Howard said the GAD survey followed three
lines of inquiry in regard to GARs: "one, how many have you
got and how significant are they in terms of your fund, two, how
are you dealing with the bonusing arrangements and, three, how
are you reserving for them".
The results of the survey showed that some life offices were adjusting
the terminal bonus, while others were setting aside reserves for
this provision. However, Sir Howard said that Equitable Life "stood
out" because "it had, one, a lot of them [GARs] because
they had sold more of these policies than most people because
they are predominantly a pensions house and they made a strong
marketing effort in these between 1957 and 1988, secondly, they
were particularly flexible policies and, thirdly, they did not
have this carried forward 'free estate' [i.e reserves], which
again had been a strong part of their overall marketing".
Mr Roberts said that the GAD survey had led the prudential insurance
regulator to become "acutely aware that the Equitable was
in a very much more exposed position than anyone else".
The extent of the concern is reflected in an internal briefing
document regarding Equitable Life from Mr Allen to Mr Michael
Foot (Managing Director and Head of Financial Services of the
FSA), dated 5 November 1998: "Our primary concern is over
the company's ability to reserve adequately for these guarantees
[i.e GARs]. The information received to date is unconvincing,
and raises serious questions about the company's solvency".
(It is worth noting that the review, and its conclusions, were
based on the law as it then stood in regard to differentiation
of terminal bonuses between groups of policyholders; it did not
consider provision for the subsequent ruling of the House of Lords.)
Sir Howard said that alarm bells started ringing at the FSA as
a result of the briefing document sent to Mr Foot.
23. In a general response to the findings of the
GAD survey, the Government Actuary, in conjunction with the FSA,
issued guidance to life offices that the level of reserving expected
for GAR contracts
should be based on a "prudent" assessment
of the extent to which GARs were taken.
Mr Cazalet explained that the GAD "indicated" that life
offices should "reserve on the basis that substantially all
of the benefits were taken in guaranteed annuity form,
irrespective of actual experience".
The advice from GAD was an attempt to create a more uniform approach
to the issue of reserving for GARs.
24. As a result of the findings of the GAD survey
in regard to Equitable Life, the prudential insurance regulator
entered into what Sir Howard described as a "lively debate"
with Equitable Life. Even though Equitable Life's approach to
terminal bonus differentiation was "not unreasonable",
Sir Howard explained that the prudential insurance regulator "did
not think that their reserving approach was necessarily appropriate."
Sir Howard explained that the "lively debate" with Equitable
Life at one stage led to a threat by Equitable Life to take the
prudential insurance regulator, which at that time was HM Treasury,
to judicial review.
The prudential insurance regulator's legal advisers were, however,
able to convince their Equitable Life counterparts that their
approach was appropriate; as a consequence Equitable Life put
in place the reserve in their 1998 regulatory return,
by purchasing a re-insurance contract, an issue which we return
to in paragraph 27. Sir Howard said that Equitable Life only accepted
that it had to put in place regulatory reserves when the FSA told
them it was stating a requirement, rather than giving advice.
The response of Equitable Life to the GAD review
of regulatory reserves
25. Equitable Life faced an exposure of £1.59
billion from its GAR policies, based on the prudent assumptions
of the new GAD guidance. Whereas the GAD guidance assumed a very
high take-up of GARs, Equitable Life had previously set its reserves
on an assumption of the prevailing, and expected, very low take-up
In response to the requirement to meet its regulatory reserving
obligations for GARs, Equitable Life chose not to accumulate cash
reserves to cover the whole of the provision. For Equitable Life,
such an approach would have run counter to its policy of "full
and fair" distribution of profits to its policyholders. Mr
Headdon explained that to create reserves "there is no magic
external source of money that can be brought in. The money can
only come from policyholders in one shape or form".
26. The approach undertaken by Equitable Life was
approved by the FSA: Sir Howard explained that "[in the absence
of] the House of Lords judgment, we are not in economic circumstances
which would have created the need for these reserves to be available
in cash form".
However, this perhaps misses the point: reserves should not be
accumulated at the time when the economic circumstances necessitate,
as there is not always sufficient time to react to economic circumstances.
In addition, while economic circumstances are one reason for accumulating
reserves, as was demonstrated in the case of Equitable Life, there
are other eventualities that can arise with, or without, warning
that necessitate drawing on cash reserves. We ask the FSA to
consider whether cash reserves only need to be accumulated when
required by the economic circumstancesor whether there
are other circumstances in which cash reserves may be required.
Sir Howard also argued that "by that time [late 1998] the
only alternative in terms of creating cash [reserves] for everything
would have been to pay no bonus whatsoevereffectively to
do in 1999 what the company had to do as a result of the House
of Lords [ruling] in the year 2000and it did not seem to
us to be at that point ... reasonable to insist on that".
Purchase of a Reinsurance Contract
27. Faced with the need to find sufficient reserves,
Equitable Life sought to fund some £800 million, or about
half, of the necessary regulatory reserves through a reinsurance
contract purchased at the end of 1998.
The terms of the reinsurance policy stipulated that the cost of
any claim was recouped by the reinsurer, by taking in future years
any surplus in excess of that needed to support the regulatory
reserves; in effect, the reinsurance policy would spread the cost
of meeting the GAR liabilities over a number of years.
The terms of the reinsurance contract were specifically intended
to insure Equitable Life against "extreme economic conditions
... [when] the cushion of surplus assets over and above the contractual
liabilities might no longer be available to pay out the guaranteed
However, it did not cover against any other eventuality, as Mr
Headdon explained: "The reinsurance was against the economic
exposure of the Society in the circumstances envisaged by the
statutory returns. It was not and never purported to be an insurance
against a change of legal ruling" on bonuses (see paragraph
28. Equitable Life told us that the reinsurance treaty
was negotiated after full discussion with GAD and "was accepted
by them for the purpose intended".
Although the reinsurance contract provided only limited cover,
Sir Howard said that the FSA, which had access to the terms of
the reinsurance contract,
had also "accepted it". Sir Howard explained that the
FSA "thought that ... some kind of provisioning should be
put in place and a reinsurance policy to do that was, we thought,
... in the circumstances ... a reasonable response to this particular
We ask the FSA to reconsider whether it was right to accept
the reinsurance contract given its terms, and whether it was prudent
to allow such a contract to have accounted for half of the Equitable
Life's statutory reserves.
The reporting of the regulatory reserving requirement
29. Equitable Life, like other life offices, is required
by statute to produce two sets of financial reports:
- the statutory (or annual) accounts,
as required by the Companies Act 1985, which are intended for
policyholders. The accounts should present a "true and fair"
view of the state of affairs of the company as at the end of the
financial year, and the profit or loss for the financial year.
Ernst and Young note that the term "true and fair" is
undefined, but, they add, "for working purposes ... this
does not mean wholly accurate", although a judgement is required
to ensure the accounts do not present a materially misleading
picture of the company's state of affairs.
These accounts provide information on the overall performance
of the company.
- the regulatory return,
as required by the Insurance Companies Act 1982, is submitted
annually to the prudential insurance regulator, although others
can obtain a copy on request. The return is significantly longer
and more detailed than the statutory accounts. The regulatory
return is intended to provide the regulator with a wide range
of information to facilitate its monitoring functions.
30. The provisions that Equitable Life had put in
place, including the reinsurance contract, were intended to meet
the £1.59 billion GAR liability as required by the regulator
and GAD. Therefore, the provisions were included in the Equitable
Life's regulatory returns for 1998 and 1999 (i.e after the introduction
of the new GAD approach to calculating GAR liabilities). Ernst
and Young explained that: "the method of valuation of assets
and liabilities in regulatory returns is prescribed by the Insurance
Companies Regulations of 1994, and requires the use of detailed
rules, the application of which is more pessimistic than the prudently
realistic basis used for statutory accounts".
However, no reference was made in the statutory accounts to the
figure of £1.59 billion, or the measures (including the reinsurance
contract) that had been taken in regard to it. This was because
Equitable Life did not share the view of GAD in regard to the
take-up rate of GARs: Equitable Life argued that for the statutory
reserves to be fully called upon "would have required there
to be not just a significantly adverse set of conditions, but
for these conditions to prevail throughout the whole period during
which retirement benefits would be drawn".
Equitable Life therefore based the statutory accounts on its own
assumptions of the take-up rate. In the statutory accounts, Equitable
Life made a provision of £200 million in order to reflect
the additional cost of the GARs and viewed this as a prudent approach,
given that, on the basis of actual take-up of GARs up to 1999,
it was estimated that it would incur a cost of £50 million.
Mr Sclater, the then President of Equitable Life, explained that
Equitable Life had "tried to present in our [statutory] accounts
for that year ... a true and fair view of what we believed the
circumstance of the Society to be".
Professor Richard Dale, of Southampton University, argued that
the statutory accounts provided to policyholders were "a
dangerously misleading set of accounts" which "proved
to be virtually meaningless".
31. While there was a disparity between the GAR liability
reported in the statutory accounts and the regulatory return,
Sir Howard argued that the regulatory return was in the public
domain and could be considered by analysts and rating agencies,
but admitted that the FSA have no control over the contents of
the statutory accounts.
The FSA have recognised that the present reporting requirements
of life offices "may not provide readily accessible information
to policyholders and other users".
It suggests that the statutory accounts of life offices move towards
the format of statutory accounts undertaken by non-insurance companies;
this would result in the inclusion of insurance liabilities in
the narrative description of uncertainties and provision being
made for both legal and constructive liabilities. The FSA told
us that they are "actively participating" in international
work to create a new accounting standard for the insurance sector
based on this approach.
Equitable Life demonstrated that the information provided to
policyholders, through the statutory accounts, and to the regulator,
through the regulatory return, differed substantially in their
treatment of the GAR liabilities and the consequential reserving
that had been undertaken. As a result, policyholders were not
able easily to establish the true position of the company. We
ask both the FSA and the ICAEW to consider whether statutory accounts
and regulatory returns should draw upon the same information and
assumptions wherever possible, in order to improve transparency.
In addition, the FSA should consider whether a life office's reserving
policy should be made clear to policyholders, either in statutory
accounts or in some other way.
32. The directors of Equitable Life had responsibility
for drawing up the statutory accounts while Ernst and Young, as
auditors, were responsible for forming an independent opinion
of Equitable Life's statutory accounts, and for determining that
the statutory accounts gave a true and fair view of the company's
finances, and were free from material misstatements.
However, only specific parts of the regulatory return are subject
to an independent assessment by the auditors;
for Equitable Life's 1999 regulatory return, Ernst and Young's
audit covered only 28 of its 420 pages. The areas of the regulatory
return that the auditors were not required to examine included
the estimation of the reserves in regard to the estimation of
the GAR liability based on the regulator's assumptions. The auditors
have a duty to report on whether the particular parts of the regulatory
return subject to audit have been "properly prepared",
rather than provide a "true and fair view".
We do not believe that the auditing arrangements for the statutory
accounts and, in particular, the regulatory returns of life offices
were adequate. In their memorandum to us,
Ernst and Young set out the judgments that they made concerning
disclosure. We ask the FSA to consider the justification for the
auditors' judgments and whether there are implications for future
reporting practices by auditors generally.
33. Although Equitable Life adopted its differential
bonus policy in 1993, it appears that complaints about it to the
PIA Ombudsman did not emerge until late in 1998.
Mr Martin explained that representative action, where one decision
would apply to all GAR policyholders, was better than "death
by a thousand cuts" from many ombudsman's hearings.
This prompted Equitable Life to seek "guidance from the courts"
as to whether its practice was lawful, in order to avoid a situation
where the ombudsman ruled against Equitable Life in a case which
could lead to overwhelming pressure to follow the same treatment
for all cases, even if the case in question had distinctive features.
A representation order was duly made by the court: the Society
was appointed to represent the non-GAR policyholders and Mr Alan
David Hyman, separately advised, was appointed by the Court to
represent the GAR policyholders.
THE PROCESS OF THE REPRESENTATIVE ACTION THROUGH
34. The case went before the High Court, the Court
of Appeal and finally the House of Lords. The High Court verdict,
handed down by the Rt Hon Sir Richard Scott on 9 September 1999,
backed Equitable Life, although Mr Hyman was granted leave to
appeal. The Court of Appeal ruling, delivered on 21 January 2000,
was split 2-1 in favour of Mr Hyman, although the majority differed
in their opinion. While Lord Woolf (then Master of the Rolls)
accepted the appeal unconditionally, Lord Justice Waller proposed
that Equitable Life was entitled to ring-fence the GAR policyholders
(i.e. to calculate their terminal bonus levels separately from
non-GAR policyholders). Lord Justice Morritt, however, rejected
the appeal. Leave was granted for Equitable Life to appeal to
the House of Lords. The House of Lords' five judges ruled unanimously
in favour of Mr Hyman on 20 July 2000, thereby determining that
Equitable Life's policy of paying different terminal bonuses,
dependent on whether a policyholder exercised their GAR, was unlawful.
The House of Lords also ruled out the option of ring-fencing the
GAR policyholders. The ruling meant that Equitable Life had to
pay the same terminal bonus to all with-profits policyholders,
irrespective of whether they were entitled to a GAR or not and,
if so, whether they took up the guarantee.
DID THE HOUSE OF LORDS RULING DIFFER FROM THE COURT
35. Following the verdict against Equitable Life
by the Court of Appeal, Equitable Life made an assessment of the
potential costs it faced if it lost the House of Lords ruling:
"if the approach of Lord Justice Morritt to the analysis
of the GAR policyholder's contract, or that of Lord Justice Waller
to ring-fencing, had been upheld in the House of Lords, the cost
to the Society would be no more than £50 million, for which
there were adequate reserves".
Equitable Life's interpretation of the Court of Appeal decision
was that "a GAR policyholder should receive the same proportionate
final bonus irrespective of the form of benefits selected. The
Court did not however rule that the Society could not differentiate
between GAR and non-GAR [with-profits policy]holders in this respect".
They added that "the House of Lords' ruling took matters
one stage beyond this by saying that the Society could not apply
a different bonus policy to GAR and non-GAR [policy]holders".
Mr Headdon admitted that Equitable Life did not expect the House
of Lords decision, and considered it, in the light of the legal
advice that Equitable Life had received, to be a "very remote
36. The FSA's interpretation of the Court of Appeal's
verdict was that Equitable Life "could not pay different
levels of [terminal] bonus according to whether or not a guaranteed
annuity was taken up. But it did not rule out the possibility
that different levels of bonus could be awarded to different types
of policyholder [i.e the ring fencing argument]". The FSA
concurred with Equitable Life in that the House of Lords ruling
"went further than merely upholding the Court of Appeal judgement.
It ruled that when setting final bonuses the Equitable was not
entitled to differentiate between policyholders depending on whether
or not their policies contained GARs, or on the form in which
benefits were taken".
37. However, this interpretation of the judgements
has been challenged in evidence to us by Mr Stephen J. Suttle,
a barrister of 1 Brick Court, Temple and an Equitable Life with-profits
GAR policyholder. He contended that: "the House of Lords
upheld the approach in the Court of Appeal of the senior of the
two majority judges, the [then] Master of the Rolls Lord Woolf
... and did not accept the less draconian approach suggested by
the other majority judge (Waller LJ) and described as the 'ring-fencing
We also note that Lord Steyn, in his House of Lords ruling (which
the four other House of Lords judges agreed with), said that his
verdict was "in substantial agreement with Lord Woolf".
Equitable Life failed to explain to their policyholders the
full implication of Lord Woolf's judgment. The FSA should therefore
consider whether the assessment made by Equitable Life, and indeed
by themselves, of whether the eventual House of Lords ruling could
have been predicted, was justified, especially given Lord Woolf's
THE IMPLICATIONS OF THE RULING OF THE HOUSE OF LORDS
38. The House of Lords ruling meant that Equitable
Life faced a estimated liability of £1.5 billion. However,
Mr Cazalet warned that "the true total, being based on ever-changing
mortality and interest rate factors, is highly volatile".
Mr Sclater also said that the liability could increase if GAR
policyholders continued to pay additional contributions to their
39. Equitable Life, in their written evidence, question
the House of Lords decision. In particular, they point out that
the decision to protect the value of the guarantee resulted in
the necessary funds being taken largely from the later, non-GAR
policyholders. Equitable claim that this could not have been an
unintended consequence of the ruling, as the point was made "repeatedly"
to the Lords by their counsel.
40. In response to the liability that had arisen,
Equitable Life announced that it would exclude the first seven
months of the year from the 2000 reversionary bonus for all with-profits
policyholdersEquitable Life said that it hoped to restore
the lost bonuses once a buyer was found. In addition, for those
with-profits annuities already in payment the growth would be
adjusted downwards. All other Equitable Life policies were unaffected.
The ruling also meant that Equitable Life had to increase its
statutory reserves, so diminishing the capital strength of the
company and meaning that, in order to maintain its solvency, the
company would have to invest in less risky assets, such as gilts,
which also tend to provide lower returns.
As a result, the board of Equitable Life announced immediately
after the House of Lords ruling that the Society was having to
put itself up for sale.
INFORMATION TO POLICYHOLDERS FOLLOWING THE COURT
OF APPEAL VERDICT
41. After the Court of Appeal verdict, the FSA discussed
with the Society a range of scenarios based on possible House
of Lords rulings. Although the FSA believe that the eventual House
of Lords ruling was different from that of the Court of Appeal
(see paragraph 35), the possibility of such a ruling being delivered
by the Lords was considered to be high enough to merit discussions
of its implications with Equitable Life. The FSA were unable to
disclose the precise date that these discussions took place, however.
Equitable Life predicted that, under the scenario which eventually
transpired, take-up of GARs would increase, at the expense of
non-GAR with-profits policyholders, and additional reserves would
It told the FSA that it would meet these liabilities by announcing
it was putting itself up for sale, and withholding the reversionary
bonus for the first seven months of 2000, the tactics that it
eventually employed when the House of Lords ruled. The FSA considered
that this response was "consistent with the regulations and
appropriate in the circumstances", although it pointed out
that the approach was the decision of the Equitable Life.
42. However, policyholders were not privy to the
detailed planning that the Equitable Life and FSA had undertaken.
This may have been because they were planning for what was considered
to be, in the view of Equitable Life at least, a "very remote
In a letter to all policyholders following the Court of Appeal
verdict, Equitable Life said that "there would be no significant
costs imposed on the Society if the Court of Appeal's decision
were upheld in the House of Lords"this
was based on Equitable Life's assumption of the cost and the Court
of Appeal's verdict (see paragraph 35). Mr Sclater explained that,
while no specific warnings were given in regard to the possibilities
that Equitable Life and the FSA were contemplating arising from
the House of Lords ruling, "from late 1998 onwards I think
our financial circumstances were debated very widely in the newspapers".
Indeed, the day after the Court of Appeal ruling, the Daily Telegraph
reported that: "about 90,000 policyholders with Equitable
Life may share £1.5 billion after a Court of Appeal ruling
However, Mr Martin ridiculed the article as a basis for assessing
the financial position of Equitable Life, and Mr Headdon added
that the article "misrepresented" the Court of Appeal's
Mr Sclater said that, after the House of Lords ruling, "any
new policyholder taking out a policy was particularly asked to
clarify the fact that he or she was aware of the circumstances
in which the Society then was".
However, Sir Howard explained that the FSA "have received
complaints about the selling of policies in the year 2000, both
before the House of Lords and after, and we are carrying out a
review of those selling practices during that period to see whether
there is a case for action on misselling and whether there are
investors who have been missold".
We welcome the FSA's review of Equitable Life's selling practices
after the Court of Appeal decision and we ask the FSA to review
the Equitable Life's practices when pension policyholders gave
up rights to guaranteed annuity rates.
The issue of management discretion and the complexity
of the contracts
43. Perhaps one of the most surprising facts of the
Equitable Life case is that in order to determine what should,
in theory, have been a straightforward matter ended up proceeding
though the three highest courts in the land and being put before
nine of the country's most senior judges. The complexity of the
policy and of the Equitable Life's Articles of Association, which
govern the relationship between the Society and its members, were
highlighted by the fact that they were open to such wide interpretation
as demonstrated by the verdicts produced during the representative
44. It may not be surprising that Equitable Life's
reliance upon "absolute discretion" is also called into
question in relation to another aspect of Equitable Life's control
of with-profits policies. When the closure to new business was
announced on 8 December 2000, Equitable Life also increased the
market value adjuster (MVA), commonly referred to as the exit
penalty, from five per cent on the with-profits fund to ten per
cent. Following complaints from those Equitable Life policyholders
affected, the Office of Fair Trading (OFT) undertook an investigation.
The OFT's view was that while the ten per cent penalty in itself
was not unfair, a view with which the FSA concurred,
it was unfair to impose the MVA simply by using "absolute
Equitable Life has since further raised the MVA to 15 per cent
on 16 March 2001.
45. It would appear that "absolute discretion"
was used by Equitable Life as a universal justification for implementing
changes to policyholders' reasonable expectations in the absence
of contractual or other justification. More precisely defined
contracts would have allowed policyholders to know what to expect,
and would have increased transparency. Further, as was proved
during the representative action of Equitable Life's policy of
bonus differentiation, and the recent OFT inquiry, reliance on
absolute discretion rather than contract specificity would seem
to be risky.
46. Sir Howard, in a speech on 23 February 2001,
said that an FSA review of the with-profits business would include
"the extent of the discretion available to management over
the operation of with-profits funds, and how that discretion is
We welcome the announcement of an FSA review of management discretion
in the with-profits business. We recommend that the FSA analyse
the extent to which financial services, in particular life assurance,
rely on managerial absolute discretion.
The FSA inquiry
47. On 22 December 2000, the Board of the FSA requested
the executive management to provide a report on the regulation
of Equitable Life. In anticipation of the formal announcement
by the FSA, Miss Melanie Johnson MP, Economic Secretary to the
Treasury, told the House that the report would "cover the
FSA's actions as a prudential regulator and in carrying out its
functions under the Financial Services Act 1986 ... The Treasury
will publish the conclusions of the review".
The FSA clarified the review in its press release, stating that
the report would cover: "the FSA's discharge of the functions
(under the Insurance Companies Act 1982) which it undertakes as
delegate for HM Treasury; and the ... [PIA's] discharge of its
functions as a recognised self regulating organisation (under
the Financial Services Act 1986)". The report will be a full
account of the prudential regulation of Equitable Life from 1
January 1999 to 8 December 2000, analysing the course of supervisory
work over that period when the FSA was the regulator. The role
of HM Treasury and DTI will be covered only to the extent that
the report will "describe" the "background and
events leading up to the FSA assumption of responsibility ...
on 1 January 1999".
Sir Howard explained that the remit of the report was decided
in discussion with HM Treasury. Although the Treasury was initially
uncertain of the merits of including reference to the pre-1999
situation in the FSA report, Sir Howard told the Committee that
in their dialogue with HM Treasury: "we [the FSA] said we
cannot sensibly review our own inheritance and what we did unless
we described the background up to the point at which we took it
48. Miss Johnson told the Sub-committee that "the
[FSA] report is down to cover the background to the events prior
to 1 January 1999 and, clearly, issues can be brought into consideration
in that background".
The limited range of the "issues" which the FSA will
be able to consider was revealed during the questioning of the
FSA witnesses. Mr Roberts was unable to tell the Committee what
involvement there had been with Ministers.
Sir Howard explained that the Committee's questioning of Mr Roberts
in this instance had entered into "unchartered constitutional
and explained that "there are constraints on former civil
servants, about revealing advice to ministers and debates with
ministers and precise ministerial involvement in that matter".
He added that the FSA report will "give a description of
that process [before 1 January 1999] without commenting on the
merits of it".
49. The Chancellor advocated that the Treasury and
our Committee should "await ... the report of the FSA and
then we can draw conclusions once we have seen what the report
However, the Financial Services Consumer Panel
told the Committee that the lack of an inquiry into the role of
the prudential insurance regulators before 1999 is a "serious
gap in the scrutiny of the events that led up to Equitable Life's
closure to new business". The view of the Panel was that
the FSA Report would therefore be "an incomplete analysis
of the causes of the Equitable Life crisis, and that important
lessons therefore might be missed".
50. It is important that the role of regulator
since 1993, when Equitable Life began to operate a policy of terminal
bonus differentiation, should be analysed in order for the regulatory
lessons to be properly learnt, for policyholders to fully understand
the history of the affair and for Parliament to undertake its
scrutiny of this topic properly and fully. The Committee will
await the FSA's report. It will want to examine what it has to
say on the regulatory background to the Equitable Life affair
between 1993 and 1999, and then decide how to proceed.
51. The FSA report will be produced by a team led
by Mr Ronnie Baird, the FSA's director of internal audit, who
will be supported with legal and accountancy advice from Norton
Rose and PricewaterhouseCoopers respectively.
Sir Howard explained that the FSA had previously "set up
an internal audit and a quality insurance function which was partly
in place in order to deal with questions where people raise issues
about our regulatory effectiveness",
and told the Committee that Mr Baird had previously undertaken
other internal FSA investigations of a "very sharp-pencilled
Sir Howard added that, in his opinion: "I believe that [the
FSA report] will give an independent view of the events that took
place ... I think this will be a scrupulous and independent investigation
of those activities [by FSA]".
The role of the Government Actuary's Department
52. In order to complete a full account of the regulation
of Equitable Life, there is a need to consider also the actuarial
advice given to the prudential insurance regulator: GAD has performed
this function since the early 1960s.
A confidential report on each insurer is sent to the FSA, setting
out the result of this analysis (although not necessarily to suggest
what regulatory action should be taken).
53. The Government Actuary, Mr Daykin, was unable
to tell the Sub-committee about GAD's analyses of Equitable Life's
financial position: he said that it was "a matter of client
confidentiality", and that he was bound by the professional
code of conduct of the F&IA. Mr Daykin noted that it was "of
course ... open to the client if they wish to disclose information".
The client was defined as the prudential insurance regulator
by Mr Daykin. Mr Daykin said that GAD had, at that time, no formal
role in the FSA's inquiry.
In a letter to Sir Michael Spicer MP, Chairman of the Sub-committee,
Miss Johnson said that the FSA review "will include an examination
of GAD's files and interviews with relevant GAD staff".
At present, advice given to the regulator is not published. Sir
Howard argued that, because GAD's analyses are based on the regulatory
return (see paragraph 29), publication would not be the best way
to improve the quality of information given the public. We
welcome the announcement that the FSA inquiry will have access
to GAD files and personnel. In our recent report on GAD, we recommended
that GAD should publish a regular report to Parliament on the
life assurance sector, so that public attention can be drawn to
trends and issues of concern. We recommend that the FSA inquiry
make suggestions as to how this could best be achieved and how
better public information about the condition of individual life
assurers can be published, on the basis of the actuarial advice
received by the FSA.
The future for Equitable Life policyholders
54. On 5 February 2001, the Halifax Group plc announced
that it had agreed to buy Equitable Life's operating assets, salesforce
and non-profit and unit-linked business. Equitable Life will consist
only of the with-profits fund, the fund management and administration
of which will be conducted by Clerical Medical, part of the Halifax
Group. However, Equitable Life will remain a mutual organisation
owned by its members. The deal is worth a minimum of £500
million, which will support the with-profits fund. If agreement
can be reached between the GAR and non-GAR policyholders to cap
the liability arising from the outcome of the representative action
(see paragraph 38), a further £250 million will be paid unconditionally.
In addition, if the performance of the Equitable Life's saleforce
meets new sales and profitability targets in 2003 and 2004, a
further £250 million will be paid by Halifax Group. The deal
will, however, not restore the seven months of lost reversionary
bonuses to with-profits policyholders as originally hoped (see
paragraph 40). The Halifax Group deal followed the sale by Equitable
Life of the Permanent Insurance Company on 22 December 2000 for
55. Mr Headdon described the deal as a "good
result for policyholders",
adding before the Committee that the new money coming into fund
"will help to strengthen it and improve investment freedom
and, compared to a closed fund situation, we have secured costeffective
administration for policyholders going forward".
Sir Howard said that following the deal "the prospects have
become somewhat better"
for policyholders, although a return towards normality "does
depend heavily on the result of the vote" of policyholders
on whether to accept a settlement to cap the GAR liability.
56. Although Sir Howard saw advantages to policyholders
accepting a settlement, he did not wish to advocate to policyholders
whether or not to accept any deal. The FSA will, however, offer
a view on the "fairness of that deal" when the terms
are negotiated, highlighting the pros and cons of the deal and
allowing individual policyholders to make up their own minds.
term Guaranteed Annuity Rate option (GAR) is interchangeable with:
Guaranteed Annuity Rate; and Guaranteed Annuity Option (GAO).
It is explained in paragraph 12. Back
3 In addition
to with-profits pension policyholders, of whom there are about
90,000 with guaranteed annuity rates and 370,000 without (Q 16),
there are over 200,000 non-pension with-profits policyholders. Back
Committee, Press Notice, No. 3 (2000-01), 16 January 2001. Back
Report, Session 2000-01, The Government Actuary's Department,
HC 236 (hereafter GAD Report). Back
2, paras 15.1, 15.2. Back
Services Authority, News Release, "Equitable Life: FSA Report",
FSA/PN/163/2000, 22 December 2000. Back
8 Q 159. Back
Life auditors face probe by peers", Financial Times,
12 December 2000. Back
PIA is a "self-regulatory organisation" recognised by
the FSA under the Financial Services Act 1986. It replaced the
Life Assurance and Unit Trust Regulatory Organisation (LAUTRO),
which had had this responsibility from 29 April 1988 to 18 July
p 23 para 8; Appendix 6. Back
6. The staff transfers to the Treasury were made "pending
the onward transfer of supervision to the FSA". Back
decision to contract out prudential insurance regulation to the
FSA was an early step towards the integration of financial regulation
and the benefits of a single regulatory culture, to the maximum
extent possible under existing law prior to Parliament's consideration
of the Financial Services and Markets Bill (see Appendix 6). Back
Financial Services and Markets Bill received Royal Assent on 14
June 2000. Back
the Deregulation and Contracting Out Act 1994. Back
of the functions transferred to the FSA were those carried out
under the Insurance Companies Act 1982, although a small number
were under other Acts. HM Treasury, however, retained the following
provisions: powers to make subordinate legislation; certain activities
that affect the liberty of individuals, and; the power to raise
fees. These arrangements will remain in place until the FSMA
is implemented (Appendix 6). Back
p 23, para 6. Back
18 Q 159. Back
19 Q 159. Back
addition, Equitable Life had sold other types of policies, namely
non-profits and unit-linked. However, these were not affected
by the issue of Guaranteed Annuity Rates, and therefore are not
considered in any significant detail in this report. Those holding
such policies are not members of the Society. Back
21 Q 56. Back
exchange for tax concessions on pension contributions, Inland
Revenue rules require policyholders to purchase an annuity with
most of the proceeds of the pension contract. Back
p 1. Back
interest rates quoted are not the same as the actual annuity rates,
which are higher because there is an element of return of capital
depending on the expected remaining life of the policyholder,
but they are the rates to be compared to current market interest
rates in order to determine whether a guarantee is worth taking
p 1. Back
26 Q 24. Back
27 Q 226. Back
graph, ev p 30; Appendix 5. Back
p 2. Back
30 Q 5. Back
31 Q 39;
although the provision was for £200 million, Equitable Life
said that their expectation was that the liability would be only
£50m (see paragraph 30). Back
33 Q 203.
See also Mr Roberts (Q 224). Back
from Mr Martin Roberts, HM Treasury, 18 December 1998 (quoted
in Appendix 5). Back
2, para 10.3. Back
37 Q 28-9. Back
38 Q 35. Back
2, para 11.3. Back
1, para 2.5. The terms "reinsurance" and "reassurance"
are interchangeable. Back
p 1. The Equitable's policy on reserves is set out in detail
in an extract from a discussion on the subject in the memorandum
from the F&IA (Appendix 2 paras 12.1-12.2). Back
44 Q 62. Back
45 Q 57-60. Back
Role of the Appointed Actuary in the United Kingdom,
The Actuarial Profession, May 2000, p 6 (hereafter Appointed
Insurance Companies Act 1982 states the requirement that provision
is make for policyholders' reasonable expectations (PRE), and
not just contractual liabilities. However, the Act does not define
PRE, and therefore interpretation is the judgment of the Appointed
Actuary, and, in some cases, the Courts. The F&IA believe
that the PRE of policyholders should be influenced by: "the
fair treatment of policyholders vis à vis shareholders
(where applicable); any statements by the company as to its bonus
philosophy and the entitlement of policyholders to share in a
profit, for example, in its articles of association or in company
literature; the history and past practice of the company; general
practice within the life insurance industry; and fair treatment
amongst different groups and generations of policyholders".
See Appendix 2, sections 6 and 7. Back
Actuary, p 7. Back
Actuary, p 8. Back
Actuary, p 5. Back
Report, Q 28. Back
53 Q 226. Back
54 Q 226. Back
55 Q 226. Back
56 Q 244. Back
Report, 19 December 2000,
col 48WH. Back
58 Q 169. Back
p 24, para 14. Back
Cazalet explained that prudent assessment was an assumption that
80 per cent of policyholders with pensions savings contracts incorporating
GARs would be likely to exercise such options (Appendix 5). Back
from Mr Daykin to all appointed actuaries, 13 January 1999, para
footnote 59. Back
64 Q 227. Back
65 Q 169,
261. Sir Howard explained that although HM Treasury was the prudential
insurance regulator at the time of the threatened judicial review
by Equitable Life, this threat was made only two weeks before
prudential insurance regulation transferred to the FSA, and therefore
the case would have concerned Equitable Life and the FSA (Q 261). Back
66 Q 169. Back
67 Q 170-1. Back
68 Q 86. Back
69 Q 64. Back
70 Q 179. Back
71 Q 176. Back
4, para 4.7. In an article in March 2000, Mr Cazalet explained
that the effect of the reinsurance contract was to allow Equitable
Life to meet the requirements of the GAD's guidance yet, in terms
of their balance sheet, "release part of the £1.5bn
reserves for final bonus back to the free assets (i.e back from
the liability to the asset side of the balance sheet), thereby
arriving at what Equitable regards as being a presentation closer
to the true underlying position" (Life 2000, Cazalet
Financial Consulting, March 2000, in Appendix 5). Back
73 Q 133-4. Back
74 Q 196. Back
75 Q 94. Back
p 5. See also Appendix 15. Back
77 Q 96. Back
78 Q 174. Back
4, paras 2.1-2.9. Back
4, para 2.3. Ernst & Young are Equitable Life's auditors. Back
4, para 2.9. Back
4, para 2.9. Back
4, para 2.7. Back
p 2. Back
86 Q 75. Back
88 Q 193. Back
89 Q 194. Back
p 45, para 6. Back
p 45, para 6. Back
4, para 3.1. Back
accordance with the Insurance Companies (Accounts and Statements)
Regulations 1996. Back
4, para 3.2. Back
p 2, p 45 paras 8-11. Back
97 Q 46. Back
p 2. Back
p 3. Back
p 3. Back
p 24, para 18. Back
of Lords judgement: Equitable Life Assurance Society v. Hyman,
Opinions of the Lords of Appeal for Judgement in the Cause Equitable
Life Assurance Society v. Hyman, 20 July 2000. Back
p 4. Back
p 24, para 20. Back
to policyholders, Equitable Life, 1 February 2000 (see Appendix
hit by £1.5 bn bonus ruling", Daily Telegraph,
22 January 2000. Back
Appendix 16. Back
In the Court of Appeal Lord Woolf said that Article 65, on the
declaration of a bonus or cash payment, is "in very wide
terms". Lord Woolf noted that the only obligation is for
the Directors of Equitable Life to declare a bonus at least once
every three years; "subject to this the directors' powers
are expressed in the widest of terms. They have an 'absolute
discretion' and their decision is to be 'final and conclusive'".
However, Lord Woolf argued that, in his view, "even a discretion
expressed in these wide terms is not unlimited", specifying
breach of contract and the just and fair exercise of the Directors'
powers as the boundaries (Lord Woolf, Court of Appeal judgement,
The Equitable Life Assurance Society and Alan David Hyman, Judgment
as approved by the Court, Case No: 1999/1025/3, 21 January 2000,
paras 13 and 15-6). In contrast, Lord Justice Morritt, who denied
the appeal, believed that there was "no ground on which the
exercise of discretion given to the Directors of the Society by
Article 65 so as to declare differential bonuses can be successfully
challenged (Lord Justice Morritt, Court of Appeal judgement, The
Equitable Life Assurance Society and Alan David Hyman, Judgment
as approved by the Court, Case No: 1999/1025/3, 21 January 2000,
para 111). Back
probes Equitable Penalties", Sunday Telegraph, 31
December 2000. Back
p 26 para 33. Back
faces OFT threat over exit penalty", Financial Times,
27 February 2001. Back
Future Regulation of With-Profits Business", Speech to the
The Institute of Welsh Affairs, Cardiff, 23 February 2001, para
Report, 19 December 2000,
col 56-7 WH. Back
Services Authority, News Release, "Equitable Life: FSA Report",
FSA/PN/163/2000, 22 December 2000. Back
Report, Q 117. Back
of Evidence, 20 March 2001, The 2001 Budget, HC (2000-01)
326-i to iii, Q 433. Back
Financial Services Consumer Panel was set up by the FSA in 1998
and is being given a statutory basis by section 10 of the Financial
Services and Markets Act 2000. Back
191, 241. Back
task requires GAD to analyse the financial returns of insurance
companies, including the valuation reports by appointed actuaries,
in order to assess the current financial position of the insurer
and also consider the effects of any adverse features or trends
as disclosed in the returns. GAD issues advice to all insurers
on the parameters to be adopted for the purpose of "resilience
testing": this generic advice does not have any mandatory
status but is provided to show the general standard of testing
that GAD would expect to see included in the regulatory returns
to the FSA. This standard is intended "both to protect consumers
and to promote market confidence". GAD is also often called
to advise upon a range of other financial matters, such as restructuring,
that affect individual insurers (see also GAD Report, Ev
p 11-12, paras 2, 9-10, 13). Back
Report Q 20-21; this is accompanied
by a copy of any correspondence with the company's actuary resulting
from the scrutiny of the returns (GAD Report, Ev p 11,
para 9). Back
Report Q 15, 16. Back
Report Q 17. Back
Report Q 31. Back
Report, Appendix 8. Back
Life Assurance Society, Press Release, 5 February 2001, p 2. Back