8 July '03 - Letter from Tom Lake of EMAG to his MP regarding Equitable Life and the Ombudsmans report

Dear Jane,

As you may know, the Parliamentary Ombudsman has now reported on the representative complaint of `Mr P', published her report finding no maladministration by the prudential regulator (FSA on behalf of the Treasury) and announced that she will not be looking at any further cases in this connection.

I find this conclusion unacceptable; in the paragraphs below I detail the deficiencies that I perceive in the investigation and the way in which these have led to the conclusion mentioned.

In the last few days Mr Alistair Carmichael MP asked the Leader of the Commons for a debate on the Equitable Life affair - the response was warm, so I very much hope that a debate will take place before the summer recess.

The Argument

Firstly - a brief summary of the clear argument which the Ombudsman has ducked.

• The regulator accepted and the Ombudsman equally recognised the regulator's duty under the 1982 Insurance Act to protect the policyholders against the risk that the policyholder's reasonable expectations (PRE) might not be fulfilled.
  
  
• Unusually for long-term insurers Equitable Life gave its policyholders an annual valuation of their policies - e.g. In 1999 and earlier the term `value of benefits' was used to describe this valuation. (The evidence given by the FSA and other officers to the Ombudsman tendentiously describes these communications as bonus notices - a misrespresentation which the Ombudsman swallowed without apparent second thought.)
  
  
• These valuations included both the guaranteed part, a liability of the Society against which their Solvency had to be tested so that it could be guaranteed into the long-term future, and the non-guaranteed part, which, according to the Society's rules and long practice should have represented the remainder of the members asset share at the time of valuation.
  
  
• The valuations formed and still form the basis for contractual payouts by Equitable Life. They gave a very real expectation to the policyholders of the payout they might expect at the time of valuation.
  
  
• The very explicit expectation given to the policyholders of Equitable Life meant that the regulator had more work to do in the case of Equitable Life than in the case of other societies, namely to inquire as to the adequacy of the assets to meet the total of these expectations. There was additional information that the regulator should have obtained from Equitable Life and an additional criterion of adequacy to be applied.
  
  
• The report by accountants Burgess Hodgson, commissioned by Equitable Members' Action Group (EMAG) and mentioned in EDM 1337 shows that the Equitable Life failed to meet this criterion throughout much of the 1990s, often irrespective of the Guaranteed Interest Rate issue
  
  
• The failure of the regulator to recognise the annual valuations and to take any measures to check them against Equitable Life's assets is a clear dereliction of their responsibilities under the 1982 Insurance Acts.

The ombudsman does not mention the annual valuations or the Burgess Hodgson report and did not take any evidence from policyholders or policyholders' representatives apart from policyholders' initial and usually brief statements of complaint. Perhaps it is not surprising that she came up with a one-sided view of matters which entirely cleared the regulator.

In the Ombudsman's report whenever PRE is mentioned it is only in relation to whether the expectations are CHANGED by the GAR (guaranteed annuity rate) decisions in the Courts. Amazingly, neither the officers nor the supposedly impartial Ombudsman ever stopped to consider whether the society could meet the ABSOLUTE total of expectations before such changes. As we now know, they could not.

It is clear that the Burgess Hodgson report is NEW EVIDENCE as far as the Ombudsman is concerned and I ask you to RE-REFER my case to the Ombudsman in the light of this new evidence and ask her now to take evidence from policyholders and policyholder's groups into consideration. She should also extend ger investigation back to 1990. Given the strong support from members on the Government side for EDM 1337 I do not see how the Ombudsman could refuse.

(Please note that the Burgess Hodgson report and much other useful material can be found on the EMAG website http://www.emag.org.uk)

To put this all in a wider context, you must be aware that Parliament is currently challenged as rarely before to assert its right to hold Government to account. To have the Parliamentary Ombudsman playing on the Government side at a time like this is an additional burden on the dignity and worth of Parliament itself.

I would very much like to brief you personally on the position and hope that we can meet in the near future.

Brief Analysis of the Ombudsman's Report

I have read the Overview and Findings (Part I) of the Ombudsman's report (HC809) in full and also the representative investigation (Part II) - but not yet the full summary of events Appendix C - which occupies some 55 pages. I find the investigation unsatisfactory and hope that you will find an opportunity to raise the deficiencies in the House.

In the following I refer to numbered paragraphs in the two parts of the report in this style (II,33).

1. The investigation gathered information from (II,41) present and past staff of the Treasury, FSA, GAD (Government Actuary's Department) and an external actuarial specialist. No opportunity was given to the aggreived parties to present evidence nor was material that we had made available, in particular the report by accountants Burgess Hodgson on the `black hole' in the Equitable's accounts, cited in any way.
   
   The problem is that in seeking to find out whether there has been any significant omission (II,184) it is not sufficient to go round interrogating only the subjects of the investigation. By not including the aggrieved parties in the investigation significant factors, which I believe decisive, have been left out.
   Even more importantly, principles of natural justice have not been followed in the conduct of the investigation.
   Surely, in the interests of the public and the standing of Parliament , it is vital for principles of natural justice to be followed in the Ombudsman's investigations.
   
   
2. The Equitable Life was unusual among life offices. It was the oldest life office, a mutual organisation and in some ways a very efficient and fair operator. Indeed, it can be said that the plans for stakeholder pensions were based on the performance of mutual organisations like Equitable Life.
   
   Equitable Life had a policy of `full and fair' distribution of its with-profits funds. It claimed to distribute in the total of guaranteed and final bonuses the full value of its fund, giving to each policyholder his proportionate `asset share'. A valuation of the policyholder's asset share was provided annually. In this simply stated form, its policy was widely known to policyholders and represented its approach to `Policyholders' Reasonable Expectations' (PRE). These valuations formed and still form the basis for contractual payouts and thus represent a very real expectation at the time of valuation.
   
   
3. The ombudsman explains (II,11) that she is reviewing the FSA's role as prudential regulator subcontracted from the Treasury (which it was intil 1 December 2001) but claims (II,19) that she cannot review the role of GAD which was similarly further subcontracted by FSA to give actuarial advice and pro-active warnings.
   
   
4. The ombudsman states clearly (II,9b) that part of the prudential regulator;s responsibility is to ensure that the insurer can meet the `policyholders reasonable expectations' - a concept introduced by the 1982 Insurance Act, inctroduced following the first insurance directive in 1979 from the European Union. The law itself gives little definition to this concept, (II,134), (II,141) but as I shall show, in the case of Equitable Life, and as many, many policyholders could have told the ombudsman, it was made very clear.
   
   
5. The FSA has an approach to regulation which is described as `light touch'. The investigation clearly identifies that `light touch' financial regulation requires rigorous disclosure (II,140).
   
   
6. The Equitable Life was an unusual life office and made claims additional to those of other offices. Policyholders received, as I did, an annual statement , giving the value of their policy. According to the Equitable Life's stated distribution policy this was the policyholders asset share. It formed an objective measure of the PRE. The Equitable Life made much of its fairness and the objective policy values that it gave.
   
   
7. Although it acknowledged its responsibility in respect of policyholders' reasonable expectations, the FSA did not make any efforts to check the statements of the Equitable Life in this regard. It would have been a simple matter to demand from Equitable Life the total PRE in its annual valuation statements to policy holders and compare them to the total assets. It did not do so.
   
   
8. The Burgess Hodgson report commissioned by Equitable Members' Action Group makes it clear that, to the best of our knowledge, the total of the policy values stated to policyholders in the annual statements was in excess of the total assets of the Equitable Life even disregarding the guaranteed annuity rates (GARs) which were the subject of the House of Lords case. The calculations are based on Equitable Life's annual accounts and solvency returns as well as statements by the Independent Actuary in the documents provided for the Equitable Compromise Scheme and on evidence provided to the Courts in the case between Equitable Life and their former auditors
   
   
9. The Ombudsman's report cites actuarial guidance (II,180) that the legitimacy of a practice in respect of PRE depends on whether the policy has been clearly communicated to the policyholders. The Equitable Life did clearly communicate one policy - they carried out another. The Treasury and then the FSA completely missed the discrepancy because they did not fully carry out their responsibilities in regard to PRE.
   
   
10. It could be argued that, until the failure to sell Equitable Life, the company was considered in some way the `good chaps' of life insurance by the regulators. They made larger claims in respect of their distribution of surpluses. Unfortunately, the regulator did not take steps to validate these larger claims. Perhaps unsurprisingly, in a competitive and stressed environment, the unchecked claims were not supportable
    
    
11. The attitude of the FSA to the policy values given in annual statements to policyholders is central(II, 186). They recognised (at least in relation to the policy values stated to the non-GAR policyholders who were obliged, after the House of Lords decision, to pay the additional benefits of the GAR policyholders present and past) that the `bonus notice' (as they miesleadingly term them) might be misleading. But they never seem to have connected this perception to their acknowledged responsibility to confirm the availability of the assets which could realise the expectations. Somehow they lost contact with reality and failed to recognise their responsibilities when they were staring them in the face. They never appear to have required measurement of total claimed `asset shares' against total assets, elementary as that might seem to outsiders. Instead, they simply regarded the matter as not part of their responsibility and referred it to the conduct of business regulators, who, not surprisingly, did not know how to deal with it.
    
    I believe that was plainly maladministration.
    
    
12. The ombudsman, through her one-sided investigation, has simply failed to realise that the policy values given in bonus statements, formed exactly the PRE that the regulator was supposed to safeguard. The regulators ducked the issue, and the ombudsman, having taken evidence from them, also seems to have looked the other way.
    
    
13. The ombudsman acknowledges that PRE is central to her investigation. But she never establishes the meaning of this concept. The investigation turns on an indefined and uninterpreted concept. This is manifestly absurd.
    
    
14. The FSA might claim that, since most offices did not give such valuations, it was burdensome to check it in the case of Equitable Life. In truth, the information was a direct source of policyholder expectation and the Treasury, and hence the FSA, was charged with ensuring that sufficient assets were available to cover the expectations. They did not do so.
    
    
15. It is clear from the report e.g. (II,181) that the issue of PRE was considered exclsuively in relation to the GAR issue which was so dominant at the time. The ombudsman;s report (II, 161), (II,190) simply fails to see the long-standing further problems relating to PRE and to press her investigation. This is because she does not proceed either fairly or logically.As the House of Lords decision and then the potential sale came to dominate the FSA's thinking it continually postponed assessment of the true position with regard to PRE.
    
    
16. A further typical error arises in the FSA's reponse to Equitable Life's requests to allow implicit future profits (!) to be counted as assets for reserving purposes - a practice allowed under the European directives and observed in the UK. the FSA used a `modest return' of 5% for future profit (II, 125). Unfortunately, they failed to recall (II, 45) the guaranteed rates of growth (GIRs) of 3.5% which pertained to about 75% by value of the with-profits policies. Adding this on a rather less modest rate of return of 7.5% is required.
    
    
17. In limiting the information gathering to the subjects of the investigation and denying natural justice, the ombudsman missed these problems. Had the FSA asked the question about `total asset share' it might not have been so surprised when the sale of Equitable Life fell through (II, 108), (II, 210). It might then have perceived (II, 100) that the Equitable Life had deep-seated problems. Had the regulator talked to policyholders and policyholder groups, the importance of the annual statements of value and the `black hole' demonstrated in the Burgess-Hodgson report would soon have become apparent.

I believe that the House of Commons shold urge the ombudsman to re-open her investigation to take evidence from the aggrieved parties including the new evidence of the Burgess Hodgson report and to look again at the FSA's actions. She may then notice what she has previously missed and justice may still prevail.

Yours sincerely,

Tom Lake