Equitable Members Action Group and The Equitable Life Assurance Society at 55
Basinghall Street, London

Present: Equitable Members Action Group:

Adrian Howard-Jones
Tom Lake
Jeremy Lever, QC
Vincent Nolan

The Equitable Life Assurance Society:
Alistair Dunbar, Senior Manager, Media Relations
Chris Headdon, Finance Director and Appointed Actuary
Alan Nash, Managing Director and Actuary
Peter Wilmot, Company Secretary
Jennie Page, non-executive director

Elizabeth Gloster, QC

Cindy Leslie, Partner, Denton Wilde Sapte

The meeting commenced at 10.30 a.m.

Alan Nash welcomed those present. He indicated that he would be happy to arrange further such meetings, if these would prove helpful.

EMAG had sent a letter dated 11 November 2000 to Alan Nash, and this was used as an agenda for the meeting.

1) Legal

Adrian Howard-Jones commented on the first item in the letter, which stated that EMAG 'was conscious that the ruling of the Courts when taken together with the discretionary management practices of the Society created a situation of unfairness towards the 'non-GAR' policyholders'.

AH-J commented that from 1998, policies were issued not containing GARs. At that time, interest rates remained high and ELAS took a practical approach and decided to administer GAR and non-GAR policies in a similar manner. By 1993, he commented that GAR policies needed to be invested in secure funds with less investment freedom, with the result that GAR policies contributed less profit to the with-profits fund than non-GAR policies. He went on to state that it was not now possible to fund the contractual obligations under GAR policies from contributions to GAR policies alone.

AH-J added that EMAG's view was that GAR and non-GAR policies were never the same; as non-GAR policies allowed the Society greater investment freedom. He added that ELAS had stressed that the Society had one with-profits fund. While he accepted that this seemed sensible, he commented that each sector of the fund did not benefit to the same extent, for example, ELAS applies different treatment depending on size of fund, level of guarantees, etc..

AH-J commented that the existence of GARs in a contract was bound to affect the way in which the funds could be invested and that non-GAR policies were not constrained in this way. He drew a distinction between the participation in the with-profits fund of the two types of contract, stating that GAR policies formed part of a 'secure investment area' while non-GAR policies formed a 'free discretionary pool'. He stated that GAR policies with 'a guaranteed cap' would always be expected to have less potential than non-GAR policies and added that the injustice to non-GAR policyholders had started in 1988.

Alan Nash responded to these comments. He stated that AH-J was correct to state that the GAR series of policies ended in 1988 and that a new series of contracts was issued. However, he stated that it was not right to consider these as highly different policies which needed to be invested in different ways. He added that the with-profits fund had a wide range of types of policy. It was the Appointed Actuary's responsibility to ensure that bonuses allotted gave a fair return to each type of policy. He added that ELAS had never run the fund as 'two funds' but that it had always been run as a common fund. AH-J's contentions might have been right had the Society been aware of the House of Lords' judgment at the relevant time, but the Society had been running the fund on the basis that differential final bonuses were appropriate.

Adrian Howard-Jones reiterated his view that non-GAR policyholders had been disadvantaged as they had received lower returns due to investment restrictions on the fund created by the need to have different investment strategies to reflect the guarantees under GAR policies. He added that to manage both GAR and non-GAR policies in the same way was irrational. He commented that the injustice started in 1988 and had continued since and that the House of Lords' judgment was irrelevant to this.

Chris Headdon then commented and agreed with Alan Nash's analysis that non-GAR policyholders had not been disadvantaged, up to the time of the House of Lords' judgment, as the differential bonus approach had equalised the benefits under GAR and non-GAR policies. He explained that from the late 1980s to the early 1990s, the financial conditions were such that GARs had little value. The position changed in 1993, but by then all GAR policies were at least five years old and had built up large final bonuses, which provided 'headroom' to allow for the guarantees by way of differential final bonus. For the period 1993 to 1998, as a result of the differential final bonus approach, there had been no impact on other policyholders. The position had changed 'at the margins' in 1998 and, even applying the differential final bonus approach, some GAR policies could receive marginally more than their asset share. In this situation, the Society might have considered that, going forward, lower bonuses might have been appropriate for GAR policies. However, the House of Lords' judgment had changed the position and did not allow for this approach.

Adrian Howard-Jones commented that ELAS was not bound to administer the non-GAR policies in the way that it did and reiterated his view that not to discriminate between different types of policy was irrational. Alan Nash said that it would have been possible for ELAS to have operated in a different way and to have applied different investment strategies towards the contracts. However, he commented that ELAS had considered that using the differential bonus approach had been the preferable way of approaching the matter, in order to provide an attractive investment mix for both GAR and non-GAR policies. AN added that, without the knowledge of the House of Lords' judgment, that approach could not be regarded as being irrational.

Chris Headdon added that each with-profits life office runs its fund in its own way and that it would be possible to run separate groups of policy within the with-profits funds. ELAS had never taken this approach, nor had it led policyholders to believe that it would do so.

Jeremy Lever summarised EMAG's contention that 'shares of the common fund enjoyed by particular policyholders should have reflected the economic characteristics of each policyholder's contract with the Society'. He then commented further on the legal position and stated that there were three issues, namely:

(i) is the door open to non-GAR policyholders to question in the Courts the diminution of 'their proportion of the cake' (ii) whether there was any hope that non-GAR policyholders could get some relief for that loss of their share (iii) whether, if the door is still open and there is any possibility of recovery, it would be appropriate to pursue the point or whether such action was inappropriate as it would interfere with other initiatives by ELAS (i.e. the sale process).

JL added that non-GAR policyholders had suffered loss and that this might be an ongoing and growing loss, for example as a result of further contributions by GAR policyholders. He added that, at no point had anyone on the legal side been exclusively looking at the position of non-GAR policyholders, i.e. putting forward their view if this was different from that of the Board. He commented that both EMAG and ELAS considered it wrong that, because of the House of Lords' judgment, the Board did not have the discretion to take into account the different economic characteristics when setting final bonus.

JL stated that he considered the only way to put the injustice right was to go back to the Courts and contend that it was not practical for ELAS to put the full case on behalf of non-GAR policyholders. He suggested that ELAS sought the further opinion of a QC who had not previously been involved with the case. ELAS and EMAG should agree a set of instructions for Counsel, and Counsel should receive submissions from both ELAS and EMAG. JL stated that if Counsel concluded that JL was wrong or that such an action would be futile, JL would cease argument on the matter. However, he considered that it would be wrong at this stage not to seek advice from someone who had not previously been involved with the Board and who was aware of the difference of opinion between EMAG and ELAS. He added that if EMAG's contentions on behalf of non-GAR policyholders was vindicated then this would reduce the 'black hole' created by GAR policies, and he could see no reason why prospective purchasers of the Society could object to this. Indeed, such reduction in GAR liabilities could be reflected in the sales document.

Vincent Nolan suggested that the proposition be taken in two parts, namely: (i) whether ELAS would be prepared to seek a 'second opinion' (ii) if the second opinion supported EMAG's contention, what action should be taken.

Elizabeth Gloster remarked that she had advised ELAS that the 'door was not open' and that the House of Lords had decided the matter in a situation where a representation order was in place. The matter of 'ringfencing' had been decided by the House of Lords. Although the originating summons did not expressly raise whether ELAS could apply differential bonuses to GAR and non-GAR policies, the actual proceedings had looked at matters far more widely and argument had been put between Leading Counsel for both sides on that matter. The evidence had described the unfair economic consequences of treating GAR and non-GAR policies in the same way. The point had also been made that it would not be equitable to disallow this differential approach, as this would result in a transfer of benefits to GAR policyholders at the expense of non-GAR policyholders and that resultant benefits would not then reflect asset share. The unfairness of such a final bonus system was made clear to the Courts.

EG reiterated that both the lower Courts and the House of Lords were well aware that such a transfer of benefits would result from the decision ultimately given by the House of Lords. ELAS's argument was that differential bonuses and asset share represented fairness between policyholders and that for every £1 by which GAR benefits were inflated, the benefits available to non-GAR policyholders would be decreased by £1. Evidence had also addressed the possibility that, if the Courts found against ELAS, the Board would have to consider 'ringfencing' to avoid such an unfair transfer. In coming to its decision, the House of Lords was therefore fully aware of all the relevant issues, including ringfencing. EG confirmed her view that JL was wrong to state that there was any possibility of seeking any change or further clarification from the House of Lords regarding the matters under question.

Adrian Howard-Jones commented that the Courts had been told that GAR policies had not had any cost penalty or additional premium in respect of the guarantee. There had been no separate representation in the Courts that the Society had been irrational in treating GAR and non-GAR policies in the same way.

Elizabeth Gloster went on to add that the argument as to whether the Board had acted wrongly in respect of non-GAR policies did not affect the matter. The House of Lords had decided the case on the construction of the contractual points.

Alan Nash added that if there had been a reasonable chance of success in further litigation, then the Society would have pursued this. However, the advice given by Counsel to the Board was that this was not the case. He added that if the Society took further advice, as suggested by EMAG, this would have various damaging commercial effects. These would include the withdrawal of potential purchasers of the Society, continuing uncertainty in the market place, a continuing decline in the Society's new business and members of the field force leaving. These, and any other delays in the sales process, would reduce the sale price of the Society and affect the ultimate benefits available to members, including the reinstatement of the lost seven months growth. The Society would be bound to disclose to potential purchasers that it was seeking such a 'second opinion'.

Cindy Leslie concurred with Elizabeth Gloster's earlier comments regarding the basis of the House of Lords' decision. The matter for decision was whether the Society was in breach of contract and, if not, whether the Board had the discretion to decide on bonuses in the manner it had applied. The House of Lords had found against the Society on the first point (i.e. the contractual point). EMAG's argument regarding the 'economic differences' of the GAR and non-GAR contracts was not relevant to the contractual point decided by the House of Lords.

Elizabeth Gloster questioned what point EMAG considered the House of Lords could be asked to consider again. Jeremy Lever stated that this was that the House of Lords could not have intended what had resulted from their decision and that in the litigation the effect on non-GAR policyholders had not been fully explained. Also, the point that the Board had pursued an irrational economic policy had not been argued.

Jennie Page suggested that ELAS provide a written response to the proposition put forward by EMAG. Alan Nash agreed that ELAS would consider the matters raised and give a written response to EMAG within two weeks. He asked that EMAG keep this matter as strictly confidential at this stage

Elizabeth Gloster left the meeting at this point.

2) Property Protection

Adrian Howard-Jones referred to EMAG's letter of 11 November 2000, which stated that EMAG was 'aware that not all of the with-profits fund is irrevocably and contractually nominated in favour of the existing members'. He went on to add that EMAG wished to understand how the present members' non-contractual interest in the fund is to be protected if management and assets of the Society are transferred to new ownership.

AH-J remarked that at EMAG's August meeting with ELAS, EMAG had asked how the non-guaranteed elements would be protected and received no answer. EMAG had asked whether these non-guaranteed elements could be attached to policies and had been told that this was not possible as this would affect solvency requirements.

Chris Headdon explained that where the business of a life office is to be transferred, Court approval for the Scheme must be sought. The Scheme deals with the disposition of existing assets and also includes conditions for running the business going forward. Before the Court will give its approval, the life office's regulators must have confirmed that they approve the Scheme. Also, the Court appoints an Independent Actuary to comment on the Scheme and he considers the interests of existing members. The Court will not approve the Scheme without the Independent Actuary's confirmation that he considers the Scheme deals fairly with the interests of existing members.

CH went on to add that the Society can be considered to have three classes of policy, namely: non-profit contracts, unit-linked contracts and with-profits contracts. Assets belonging to the with-profits fund will be wholly attributable to existing with-profits policies.

Jeremy Lever asked whether a purchaser might seek to take similar action regarding such funds as was currently being proposed by Axa. Chris Headdon replied that this was a different issue and explained that many life offices have funds no t properly attributable to policyholders or shareholders. These are commonly known as 'orphan assets' and these have been built up over time. CH added that ELAS had no such funds and that all of its assets in the with-profits fund were fully attributable to with-profits policyholders. He added that, as Appointed Actuary, he would have to report to the Court as part of the approval process of the Scheme, confirming that he considered the Scheme dealt fairly with existing with-profits policyholders. He stated that he would not sign any such report unless the Scheme provided for the totality of assets under the with-profits fund to go to the existing with-profits policyholders.

Adrian Howard-Jones asked for confirmation that this would be embedded in the continuing principles of the Scheme and commented that it would be helpful to know what the whole of those principles would comprise. Jeremy Lever also expressed the concern that the purchaser might 'pile up the money to make the fund look more attractive for new business'. CH confirmed that the regulators were alive to the issue and that in every demutualisation that had taken place, there had been ring fencing such as CH had described earlier.

Adrian Howard-Jones asked whether, although there was no contractual entitlement, the non-guaranteed elements would be attributed to individual clients. Chris Headdon confirmed that these elements would remain as non-guaranteed final bonus.

Jennie Page suggested that it would be helpful for a note to be prepared covering the issues discussed, with the intention that it could be sent to members prior to the sale. She added that this would be one of a number of issues to communicate to members and suggested that ELAS might ask EMAG to act as a 'guinea pig' to check these communications.

Among matters to be covered in such communications, Adrian Howard-Jones emphasised the need to be satisfied about the protection of the interests of existing members and Jeremy Lever suggested that there should also be an indication from the buyer as to what made the purchase worthwhile.

3) Consideration of alternatives

In its letter of 11 November 2000, EMAG had stated that it was 'concerned that the Society had not explained how the alternatives for the future of the of the 'with-profits fund' and the custodial responsibilities of the Society are to be evaluated'. The letter went on to state that it was EMAG's impression that 'the Society has set itself upon sale as the only course without full consideration of the alternatives'.

Adrian Howard-Jones commented that sale was one possibility but that there were others. EMAG was seeking to be satisfied that the criteria applied by the Board in deciding which course to follow are the same as those which a with-profits policyholder would use.

Alan Nash responded that the sale of the Society was unpalatable to both the Board and the management. ELAS had looked at other alternatives, and had discussed and evaluated these. Alternatives considered included: Merging with another mutual Floating the Society Selling off parts of the operation (e.g. Permanent Insurance Company Limited, Equitable Services and Consultancy Limited, Equitable Investment Fund Managers Limited, the sales force) Closing the fund to new business Asking members to forgo the seven months growth.

AN added that the Board had concluded that the sale of the Society to another organisation was the best way of protecting members' interests i.e. to provide investment freedom and to seek to make good the loss of seven months growth.

AH-J commented that this would only be the best course if the sale price was sufficient to outweigh the other options. AN agreed.

Jeremy Lever asked whether ELAS could give an idea of the magnitude of the problem that made the sale necessary. He asked whether the figure of £1.4 billion often mentioned was the immediate cost of implementing the House of Lords' decision and whether there was, in addition, an ongoing cost (which was unquantifiable as GAR policyholders could pay additional contributions).

Chris Headdon then commented on the effects of the House of Lords' judgment. He explained that as a result of the judgment people taking GAR annuities were entitled to more final bonus than before, which meant that all with-profits policyholders had to take a cut. There was therefore a transfer of economic value from non-GAR policyholders to GAR policyholders. The extent of this transfer depended on a number factors, namely: (i) the proportion of GAR policyholders who actually made use of the GAR (ii) the actual conditions when the GAR policyholders retired (i.e. the relationship between the then current annuity rates and the GARs) (iii) how much the benefits under GAR policies are increased by further contributions made by the policyholders.

CH stated that ELAS had looked at the results of these factors on different ranges of assumptions and that the Board, on CH's advice, had taken a conservative but realistic view. On this view, the transfer of economic value is £1.4 billion. CH confirmed that it included assumptions about future contributions paid by policyholders to GAR policies and included provision for payments to be made in respect of GAR policies which had already terminated. CH added that the figure assumed that future interest rates would be somewhat less than current interest rates.

In response to a question from AH-J, CH stated that a variance in interest rates of 1/2% resulted in a change in the figure of approximately £0.2 billion. Projections done indicated that in most circumstances, the figure would be within £0.3 billion of the figure of £1.4 billion.

Adrian Howard-Jones commented that these figures implied that it was always in the interest of members to sell the Society i.e. if sale is an advantage now, why was it not before?

CH responded that the case could always be put for the sale of a mutual. However, from the way the Society ran its business including the low costs, it was in members interests to continue as a mutual for so long as this was possible. Alan Nash added that the arguments for the Society remaining a mutual had been set out strongly in the Report and Accounts. The position had changed since the House of Lords' judgment. If the Society now tried to 'soldier on' there would be constraints applied by the regulators. This would require the Society to move its investments more from equities to gilts, resulting in poorer future investment returns.

Tom Lake asked how the loss of seven months growth compared with £1.4 billion. CH confirmed that the loss of seven months growth had been equivalent to approximately £1.4 billion value. He confirmed that this value had not been realised in terms of liquidating assets. In response to a question, CH added that it was not necessary for the £1.4 billion transfer of value to be achieved in one step. However, the Board had considered that it was appropriate to do this to ensure fairness. If the adjustment had not been made in one step, this would mean that people could leave the with-profits fund without having contributed their share of this transfer of value.

Jeremy Lever asked whether, if litigation had ended with the Court of Appeal, ELAS would have faced the same regulatory aspects and restrictions on investment policy. Chris Headdon responded that in these circumstances, the Society would have reduced final bonus on GAR policies only and Lord Justice Waller had indicated that such an approach might follow from the Court of Appeal judgment. Such an approach would have resulted in less severe solvency issues and other options, rather than sale of the Society, could have been considered. These could have included a change in the investment policy for GAR policies.

Jeremy Lever asked whether it was the restrictions on investment policy, rather than the £1.4 billion transfer of value, that had 'blown the Society off course'. Alan Nash agreed and added that this was because the regulatory solvency requirements hit much more severely.

Jeremy Lever commented that many GAR policyholders would like to waive the option, in order to see ELAS continue as a mutual. JL asked whether it was worth investigating whether enough policyholders would waive their rights. Alan Nash commented that, while a number of GAR policyholders had expressed this view to him, with GARs currently approximately 20% above current annuity rates, it seemed inconceivable that sufficient GAR policyholders would give up their rights. Tom Lake asked whether ELAS had considered 'buying' the option from the policyholders. AN responded that ELAS had done a limited amount of research and had considered payment of, say, an extra bonus of 10% in order to buy out the GAR provisions. However, the likely result would be that those with a long period before retirement might give up their rights while those close to retirement would decide to retain their GAR. AH-J agreed that he would not consider giving up his own GAR rights.

Tom Lake commented that these issues were poorly understood by members and that a clear explanation would be useful. Alan Nash agreed that ELAS would prepare a note on how the increased reserving requirements arose and why this resulted in investment restrictions.

Vincent Nolan asked whether the investment restrictions would apply to the purchaser, to which Alan Nash commented that this would not be the case provided the purchaser had made available sufficient excess assets (over the solvency requirement). Alan Nash added that the purchaser would need to be able to demonstrate a return to its shareholders; this would not arise from existing members but would be from its ability to obtain future new business.

Adrian Howard-Jones commented that it was reported that not all purchasers were interested in running the Society as a going concern. Alan Nash stated that ELAS was talking to bidders who are interested in the Society as a going concern. He added that it was the intention to sell the Society as a going concern and that ELAS will demonstrate that this is in the best interests of members. Jennie Page added that the Board accepted the need to put sufficient information to members, so that they could make up their minds.

Alan Nash then described the information as to the sale that was planned to be issued. This was a communication to policyholders in December 2000 with information on the preferred bidder, why the sale was proposed and what alternatives had been considered. Approximately one month before the Extraordinary General Meeting, a large pack of information would be issued to members.

Adrian Howard-Jones commented that members can focus on their Annual Statement for the value of their policies. He added that it would be helpful if this could show the value of the policy if the Society was sold and the value if it was not sold.

4) Unfair selling

In its letter of 11 November 2000, EMAG had stated that it was 'concerned by recent advertising campaigns undertaken by the Society which have included policies participating in the 'with-profits' fund'. The letter had gone to state that this was 'of little or no benefit to the existing membership' and that it also introduced 'a risk exposure for complaints of 'unfair selling' that could entail costs 'damaging to existing members'.

Adrian Howard-Jones queried whether this advertising and selling was safe to both new and existing members.

Alan Nash described the consequences of not selling new business. He stated that if there were no advertising and no selling of new business, the sales force would leave. This would mean that purchasers would not be interested in ELAS as the sales force is probably the major single asset driving the price a purchaser will pay. In consequence, advertising and selling the business is in the interests of members.

AH-J commented that it was not necessary to sell with-profits business. AN responded that the advertising was principally in respect of unit-linked business. Where with-profits policies were sold, the Society's representatives were explaining the sales process. The Society's regulators were aware of the position and the Society had obtained legal advice regarding its continuing to trade.

AH-J queried whether new policyholders were aware that they might be subsidising another class of policy. AN explained that a standard leaflet was issued as part of the sale process and that policies were being sold on the same basis as for many years i.e. on contract flexibility and low expenses. ELAS had explained to representatives how they should sell with-profits business. Alan Nash commented that it might be appropriate at a future date to distinguish between the returns allocated for policies taken out before and after a particular date. AN summarised the discussion by stating that continuing to trade was in the interests of members and that the Board had looked at this carefully and had taken advice.

5) Benefits to members or policy beneficiaries

In its letter of 11 November 2000, EMAG had commented that it was aware 'that a significant proportion of those with an interest in the with profits fund' are members of group schemes and are not in themselves members of the Society. In the letter EMAG also commented that it would 'wish to hear how their interest is to be protected throughout the process of sale (including 'windfalls')'.

Adrian Howard-Jones asked how many beneficiaries there were under the group schemes. Alan Nash responded that there were approximately 7,000 group pension scheme arrangements with the Society, under which there were in total approximately 700,000 group scheme members. AN confirmed that in these cases it was the Trustees who were the Society's members and not the individual group scheme members.

In response to a question about how group scheme members interests would be protected, AN commented that if the seven months growth was restored, this would be reflected in the benefits under the group scheme to which the individual scheme members were entitled. If there were to be a 'windfall payment' as part of the sale, this would be likely to be based on size of funds with the Society (unless there were to be some flat rate element to the payment). ELAS had made the point to prospective purchasers that a substantial part of its business was group pensions business and, in order to deal fairly with this, any payment should be related to size of fund.

ELAS confirmed that the maximum number of votes of any member (including Trustees under a group scheme) was 10. An explanation of voting rights would be included in the relevant communication with members.

6) Other matters

Vincent Nolan referred back to the discussion of communication with policyholders and commented on the need for members to be able to follow the evaluation of other options and selection of the preferred bidder. He asked that EMAG be allowed to look at the alternatives considered and ELAS's consideration of the options. Alan Nash commented that the independent actuary who reports to the Court on the Scheme will have information on alternatives and include consideration of these in his report to the Court. Adrian Howard-Jones added that, although there was some meeting of minds, there remained some uncertainty on the principles ELAS was following. Alan Nash responded that there was one overriding principle, applied by him and the Board, and that was to maximise the value for existing members. AH-J remarked that EMAG was happy to accept a best offer for members provided that it could understand the reasoning behind the selection of that offer as best. He added that it would have been better to have an Extraordinary General Meeting setting out the principles of sale, before the sale was put forward.

Vincent Nolan commented on the need to carry members through the sale process and to recognise that there were emotional as well as rational issues for members.

Adrian Howard-Jones commented that past decisions of the Board appeared to have been made 'to get past difficulties rather than to deal with them head on'. He stated that he considered there was no justification for the Society's 'sleight of hand' in respect of GARs. Alan Nash responded that clearly this was Mr Howard-Jones' view but that others had different views. He added that he was deeply sorry that the Society was needing to take its current steps but that he could see no particular actions that could have been taken to have avoided them.

Alan Nash commented that, if it would be helpful, he would be happy to have a further meeting with EMAG in the few weeks time.

Tom Lake commented that as regards the 'legal' issue, EMAG would await the arrival of ELASs response (which had been promised for within two weeks of the meeting). Regarding the rest of the meeting, he commented that EMAG would feel able to make a report to its members, but would provide a copy to ELAS before publication. Vincent Nolan suggested that EMAG drop the item regarding 'unfair selling' from any report made.

The meeting ended at 2.30 p.m.

PWW

The Equitable Life Assurance Society: Regulated by the Personal Investment Authority A member of the Association of the British Insurers Registered in England No 37038

Registered Office: City Place House, 55 Basinghall Street, London EC2V 5DR United Kingdom

The Equitable group comprises: The Equitable Life Assurance Society, Equitable Investment Fund Managers Limited, University Life Assurance Society

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