Members Notes of a meeting between ELAS and five Society members from EMAG membership held at ELAS London Office on 14^th August 2000 to address topics raised in section 1 of letter Mr Holding to Mr Nash dated 9^th August.

Attendees

Mr Alistair Dunbar ELAS Senior Manager – Public Relations
Mr Vic Otter ELAS Senior Manager – Customer Liaison Department
Mr Clive Holding (Primarily WP annuitant)
Mr Adrian Howard-Jones (Primarily GARP holder)
Mr Tom Lake (Primarily WP fund holder) 
Mr Keith Martin (Primarily GARP holder)
Mr Bernard Reed (Primarily WP annuitant)

The meeting commenced at 10.00am. Attendees introduced themselves and ELAS representatives explained their reporting structure

Mr Dunbar reports via Mr N. Webb to Mr D. Anderson AGM who in turn reports to Mr Nash via General Manager Mr J. Weller.

Mr Otter reports as part of Corporate Complaints to Mr C. Mathews AGM who reports via Mr Chris Headdon General Manager Finance and Appointed Actuary, to Mr Nash.

Mr Dunbar tabled agenda as follows to combine together related items from the 9 topics in section 1 of Mr Holding’s letter dated 9^th Aug. The proposal was agreed and it was further confirmed that the other 4 sections of the letter would be responded to by letter.

Agenda

Legal Position (5,6,7)

Impact on financial position (2,3)

The way forward (4)

The sale process (9)

Other (1,8)

N.B. These notes give the attending members' best understanding and recollection of the meeting.

1. Mr Dunbar introduced his discussion of the legal situation by summarising the findings of the HOL. The decisions were more adverse than had been anticipated by ELAS. The HOL had rejected the ELAS appeal by finding that the ELAS’s very broad powers under the contract did not include the right to overturn the benefits of a guarantee given in the contract, or to determine different pensionable sums depending upon which way the elective rights under the contract were exercised. Beyond that the HOL had also indicated that the Equitable were not entitled to differentiate (or ’ring fence’) between policies with a GAR benefit and those without when it came to the allocation of bonuses.

   Mr Dunbar indicated that ELAS believed that the HOL decision represented the final feasible step in the legal process and that the avenues for further appeal did not exist.

2. It was proposed by EMAG that there was a difference in the nature of the two decisions. The first had been the subject of the appeal, indeed this had been tried in three levels of court and must be considered closed. The opinion on ‘ring fencing’ however did not appear to be a part of the appeal, but dealt with a suggestion made by Lord Justice Waller in the Court of Appeal. The decision appeared to have far reaching implications for the administration of ‘profits’ distributions between policies which required higher levels of secure funding than other types of policy.

3. Mr Dunbar was of the opinion that the decision was particular to the the situation of policies with or without the GAR option, but EMAG suggested that there was nothing in the presentation of LJ Waller’s argument in the Court of Appeal, and LJ Steyns refutation in the HOL which did not make this general to all policies benfiting from the ‘with profits’ pool.

4. EMAG was of the opinion that the grounds for overturning the ‘ring fencing’ principle were not cogent, not practicable and not commercial. The ‘ring fencing’ decision, not the subject of the appeal, was the most damaging part of the overall ruling. EMAG requested that ELAS should consider two questions.

5. Could ELAS seek counsel's opinion to determine whether the decision on ‘ring fencing’ uld not be challenged? ACTION ELAS

6. Could ELAS advise on the overall impact of the ‘ring fencing’ decision on the attribution of profits to different types of policy. For example in the case of policies with a gaurenteed growth level were they entitled to deduct the value of this gaurentee from profits attributed? ACTION ELAS

Where numerical figures are given in this section it was understood that these were approximations.

1. There are in total 650,000 individuals who hold policies directly in ELAS. Within that total, the number of people who hold with profits policies, but no GAR policies, is 350,000. A further 50,000 hold both types of policies. In addition, 50,000 hold only GAR policies. (ELAS agreed to provide the number of people and policies and the value of the liabilities in each category described in Alan Nash's letter of 2/8/00).

   ACTION ELAS

2. There are also over 500,000 individuals who are members of company pension schemes and thereby the beneficiaries of with profits policies. They are represented, for voting purposes, by the trustees of their individual schemes. The first named trustee in each scheme has 10 votes provided that the combined value of the underlying policies exceeds £10,000.

3. One effect of the House of Lords ruling is that ELAS must accept as a liablity the requirement to pay the difference between the guaranteed rate and the currently lower market rate on all GAR policies. At present the value of the additional liability is £1 billion.

4. In calculating a figure of £1 billion, ELAS has assumed that all holders of GAR policies will eventually take up the option on maturity to be paid at the guaranteed rate, which is currently higher than the market rate for annuities. In practice, some policyholders will not take up the option but no estimate of this has been included in the calculation. The calculation also assumes that all holders of GAR policies will pay in the maximum amount permitted by Inland Revenue rules for the entire term of their policies. Again, in practice, some proportion of the policyholders may not do this.

5. £1 billion of the final bonuses that would otherwise have been allocated to with profit policies has been sequestered from their holders and allocated to the GAR policies. The effect of the order £1 billion transfer to the GAR policies is to ensure that, after covering the extra cost of their guarantees, their allocation of final bonus will be the proportionately the same as for non-GAR policies.

6. EMAG insisted that an independent actuarial valuation be obtained to confirm the £1 billion figure. (ELAS subsequently informed EMAG that, as part of the sale process, it is a government requirement that the valuations be scrutinised by an independent actuary).

7. Even before the House of Lords decision, new government regulations had required ELAS to assume, in calculating its guaranteed liabilities, to treat its obligations to the holders of GAR policies conservatively. That had already increased ELAS's liabilities by £1.6 billion. The House of Lords decision requires that ELAS uses the even more conservative assumptions in paragraph 4 above, adding the further sum of £1 billion to its liabilities.

8. Government regulations require ELAS to be reasonably certain of meeting this increased amount of guaranteed liabilities, regardless of likely variations in the values of its investments. There are two tests. The first is a simple solvency calculation to show that the current value of assets is at least equal to the total of liabilities. The second test is to show the resilience of the Society's financial position, i.e. whether solvency would still be maintained if adverse conditions in the financial and property markets reduced the value of its assets. Hence, it would not be permissible to hold any equities, which are volatile, unless the current value of assets was so much greater than liabilities that the Society would still be solvent even if the equity market declined by 25%. With its present range of assets, ELAS cannot pass the resilience test. The only sure way of covering ELAS's liabilities in the long term is to invest entirely in gilts and thereby immunise holders of guaranteed policies against market risk. Over a period of many years, returns on gilts have been far less than on equities. Hence, the more conservative investment policy forced on ELAS would reduce the eventual returns to holders of with profits policies and place the Society in a weak competitive position compared to other life offices.

9. EMAG contributed the following observations: Returns on gilts are artificially low. They are in short supply to the government's budget surpluses and ability to repay the national debt rather than increase it by issuing new gilts. The demand for gilts has been boosted by the government's requirement that pension schemes meet the resilience test. Hence, the gap between the guaranteed and the market annuity rates is even greater than it otherwise would have been.

10. The value of the total funds managed by ELAS is £33 billion. The value of the assets now covering the GAR and non-GAR with-profits policies is £25 billion. To provide sufficient additional capital to remain resilient with its presently high proportion of its assets in equities, ELAS requires an injection of new funds. That will enable it to maintain its previous investment freedom. In addition, ELAS wishes to obtain a further £1 billion to replace the funds sequestered from bonuses. The bonuses would then be restored to previously planned levels.

11. If the capital were raised from existing holders of with profit policies, it could be done by sequestering their final bonuses for a further extended period. However, the government regulators would not allow ELAS such a long period in which to cover its guaranteed liabilities.

12. In the opinion of the investment bankers advising ELAS, it is not feasible to raise all the required capital by way of some form of investment by the existing policyholders of which there are 650,00 in total. EMAG estimates that the investment would represent many thousands of pounds per head. Many, probably the majority, could not afford to pay so much.

13. What is less clear is whether ELAS could remain mutual through a mix of measures. The aim would be to raise the amount required within a time-scale that would be acceptable to the government regulators. They are already willing to allow ELAS until spring next year to raise the money through the sale of the business. As an alternative, EMAG needs to know whether it is possible to sequester bonuses for a further 9 months (£1.5 billion); issue new shares to raise on average £750 per policyholder (£0.5 billion); sell off the unit trust management operation, various subsidiaries and any other inessential assets that are currently undervalued in the balance sheet to raise the remainder.

The Group were advised of the alternative courses of action considered by Directors namely.

1. Do nothing.

   In the light of the statutory rules on Life Companies relating to Investment Freedom, whilst the “solvency” criteria could be seen to be satisfied “achieving resilience” brought about a constraint on investment freedom . It is necessary for a geared proportion of existing higher yielding forms of investment assets (such as equities and/or property) to be transferred to gilts.This strengthening of the balance sheet requires a significant immediate injection of capital which is not available to the Society as currently constituted.

2. Sell subsidiaries to raise immediate capital. The disposal of subsidiaries such as Permanent Insurance Ltd and / or the Unit Trust business or other perhaps undervalued assets in the balance sheet would not in themselves raise sufficient funds. In any event the strength of EL is the interrelation of the various component parts, such as support services, marketing, administration etc with each part of the business. In this way economies of scale could be achieved and costs kept down to a level that are the envy of the industry.

3. Raise immediate capital from existing members. The directors have been advised by Schroeders (the merchant bank handling the sale) that they deem it unlikely that all the members would be prepared to put up immediate capital, in addition to the reduction to their “with profit” fund already suffered. This has to be “new” money and it is felt that the process and probable time delay would be counterproductive.

   The group pressed for more specific detail as to the level of any cash call recognising the difficulty of assessment and changes that could occur in the future i.e. the UK entering the Euro. Information was not forthcoming at this time but suffice it to say that group members gained the impression that even a sum close to individual annual premiums for last year might not be sufficient.

4. Sell the business. Advice received by Directors had been that a sale of the integrated business would be attractive to a wide range of potential purchasers and that a price could be achieved to increase the assets of the business to firstly restore resilience to the balance sheet, secondly to repay individual “with profit” funds and thirdly to provide a potential surplus in the form of a comparatively small windfall payment to members at the date of the ruling.

The group closely questioned the representatives of EL on each option and, whilst as full and frank answers as were possible to give were given, there was unhappiness within the group that the Society might not necessarily be able to demonstrate to the EGM of members that it had fully tested its background assumptions and strategic thinking. For instance a mixture of options might be considered with a sale of part linked to a less onerous cash call on members to stay mutual; alternatively the company might be split with the well respected sales side being used to sell other financial products within a separate entity.

It is considered that based upon current feelings Directors could be unsuccessful in obtaining approval to their proposals. Thus EL were requested to consider the strategy that they would adopt in the event of failure to achieve the necessary votes perhaps by a proposal to invest within a new and separate Society.

It is not the responsibility of the Group to advise the Directors and management on how to run the business, to submit proposals for consideration nor to act as an initial vetting procedure. However as members we are entitled to be reassured at the EGM that internal procedures are such that the proposals have been stringently tested and questioned either by independent advisers who are not remunerated on a “success related” fee or by a distinctly separate group within the company which would have a free rein to consider new options.

SALE PROCESS

(This item also addressed topic 9 from section 1 of EMAG letter toELAS dated 9 Aug namely the consequences of a majority voting aginst the board's decision to sell )

1. An information memorandum was in preparation and would be available shortly under terms of confidentiality to prospective buyers. This could of course include some of the society's current competitors. ELAS did not feel that this memorandum would be appropriate for an advisor appointed by a group of members even if working under similar terms.

2. Exercise of due diligence by prospective buyers would be carried out during the autumn with the aim of having the favoured buyer known by Christmas.

3. A proposal to members would go out early in 2001. ELAS agreed that this should describe the consequences of yes and no votes and that the options considered should be set out.

An EGM would be held in spring 2001 to vote on the proposal. A 75% vote would be required to carry the proposal.

4. Purchase by another mutual society could not result in continued mutuality. Only merger with another mutual could achieve that and that seemed unlikely

5. An independent actuary's report would be required on the proposal demonstrating that the existing rights of members were not compromised. This would require High Court approval. A likely position might be for the new owners to take 10% of the profits of the with-profits funds. The actuary would be paid by ELAS.

6. The members present felt that their interests could only be protected by a vigorous construction of alternatives. They did not want to be presented with a fait accompli which could not be challenged. They requested that ELAS establish separate internal activities to explore and prepare the best alternative scenario (such as red and blue teams). Some members were willing to contemplate a split of the Society. There might even be a suitable bidding process by which the members could express their valuations of different courses of action.

OTHER

(This item addressed topics 1 and 8 from section 1 of EMAG letter to ELAS dated 9 Aug namely “The number of contracts, contract holders and values in various categories”

And

“Discouragement of ‘carpet-baggers’ by channelling ALL ‘windfalls’ direct to WP funds)

As the information was not available in the meeting ELAS agreed to respond later on the number of contracts, contract holders and values in the categories identified in Mr Nash’s letter to all policyholders dated 2 Aug 2000. ACTION ELAS

ELAS was not able subsequently to supply these figures.

ELAS stated that they saw no conflict in windfall payments to influence the membership in favour of a sale furthermore it might be an element required by the potential buyer to ensure the success of the sale process. EMAG members stated that the interests of long term equality are likely to be better served by directing all excesses from the sale (after the requirement to resolve resilience and 7 months lost bonus) direct into the WP fund.