Appendix 3

GUARANTEED ANNUITY RATE (GAR) COMPROMISE SCHEME - CONSULTATION

YOUR QUESTIONS ANSWERED

What is the position today?

The House of Lords gave additional rights to policyholders with GARs.

The value of these rights will only be known when the benefits are taken over the next 40 years.

At the time of the House of Lords' judgement in July 2000, we estimated that the value transferred as a result of that judgement from all with-profits policyholders to those with GARs was £1.3 billion (the £1.5 billion you may have seen quoted includes £200 million for bringing past retirements into line with the judgement - that process, the Rectification Scheme, will happen regardless of any compromise scheme).

That transfer of value was achieved by removing seven months of final bonus in 2000 from the smoothed long-term rate of bonus that would otherwise have been available for with-profits policyholders.

Why a scheme?

A scheme of arrangement can bring benefits for all members. Without it, there will be continuing uncertainty and a probability of poorer investment returns.

How was the £1.3 billion calculated?

The Society's estimate of £1.3 billion depended on assumptions we made about the next 40 years, in particular:

• We assumed future investment returns of 6.8% p.a.
• We assumed that the rate of interest which would apply in determining current annuity rates would be 5.6%.
• We assumed funds transferred out before retirement and future premium levels which, based on the Society's experience over several years, reflected some policyholders withdrawing, some reducing or ceasing contributions, and some policyholders increasing their contributions. The assumption for transfers was 1% p.a. for individual products and 4% p.a. for group products. Future premiums (after allowing for both increases and reductions in premiums) were assumed to reduce before retirement by a net rate of 8% p.a. for Retirement Annuities and Group Pension business and by a net rate of 7% p.a. for Individual Pension business.
• We assumed future mortality for pensioners based on the PMA92 and PFA92 standard mortality tables (which are produced by the Continuous Mortality Investigation Bureau of The Institute of Actuaries and The Faculty of Actuaries) which allow for future improvements in pensioner longevity. We adjusted the mortality rates in those tables by assuming pensioners are aged one year younger to take account of the Society's recent experience and estimated future experience.
• We assumed mortality before retirement of 45% of AM80 mortality for male lives and 58% of AF80 mortality for female lives (the AM80 and AF80 standard mortality tables are also produced by the Continuous Mortality Investigation Bureau). Those assumptions took account of the Society's recent experience and expected future experience.
• We assumed that the proportion of benefits taken in GAR form would be 50%, which was the Society's best estimate at the time of the House of Lords' judgement. (This allowed for tax free cash sums and forms of benefits which do not come within the GAR rules being selected). This assumption was higher than our previous experience but is in line with the Society's experience in the second half of 2000 following the House of Lords' judgement.
• The discount rate which was used to calculate the present value of the additional costs of GARs was the same as the 6.8% p.a. assumption for future investment returns.

Clearly, other assumptions would produce other values. We have monitored what members with GARs have actually been doing since the House of Lords' judgement on 20 July 2000 and since the Society closed to new business on
8 December 2000, and members' choices have been consistent with the assumptions we have made.

What would happen under a scheme of arrangement?

On the basis set out, the Society estimated that the House of Lords gave the GAR policyholders who had yet to retire an additional benefit of £1.3 billion.

A scheme would allow, by agreement among the members and with the sanction of the High Court, the exchange of the right to a GAR (whose value varies) for an additional fund benefit set down under the scheme.

There is a range of ways in which the GAR value could be given. However, a scheme cannot succeed unless members vote for it, and the Court decides that it is fair to each class of member. It is therefore necessary to fix a single basis of
distribution and rule out others.

Having agreed what the value of the scheme should be, the scheme will allow GAR members to have that value added as a one-off increase in all GAR policy values in exchange for giving up the GAR option. For example, the estimated GAR cost of £1.3 billion would be sufficient to increase the GAR policy values by around 20 per cent. in aggregate.

What are the benefits of a scheme for all members?

• The fund would benefit from the extra payment of between £250m and £500m from The Halifax.
• There would be improvements in the technical stability of the fund and its resilience to future changes in investment conditions.

Together these would allow the Society to restore the investment freedom of the fund.

What are the benefits of a scheme for members who have policies without GARs?

• A scheme would remove the risk that a rise in GAR liability (above our estimates) would cost them more and reduce their future bonuses.

• A scheme of arrangement worth £1.3 billion would not cost non-GAR policyholders any more than has already been held back from their bonuses.

What are the benefits of a scheme for members with GARs?

• A scheme would remove the risk that the value given to GAR benefits by the House of Lords could disappear (if annuity rates rise).

• A scheme would remove the restrictions in how benefits can be taken (e.g. allowing income drawdown).

• A scheme would increase the value of alternative forms of benefits.

• A scheme would enable many dependants to derive additional financial value if the member dies before drawing retirement benefits.

GAR members may prefer to have the value in a form which is different from that provided by GAR benefits particularly because they do not get the benefit of the added value from the GAR on the tax free cash sum nor on the range of investment backed annuities now available nor on income drawdown arrangements. Furthermore, an individual GAR policyholder may happen to retire when market annuity rates are high and the GAR adds no value.

Those furthest from retirement may anticipate a higher value for their existing GAR benefits as they expect to pay more premiums and their current fund value may be relatively small. On the other hand, without a deal, the value of their existing GAR benefit is lower because they will suffer a longer period with impaired investment freedom.

If I am a GAR policyholder, will I be able to take a cash payment in lieu of my GAR option ?

The purpose of GAR policies is, in the eyes of the Inland Revenue, to provide retirement benefits, and the GAR is an option providing annuity benefits. Consequently a cash payment in lieu of the GAR option is inappropriate and is unlikely to be agreeable to the Inland Revenue or our regulator, the Financial Services Authority .

How can I be sure that my interests are being protected?

• The Society's financial regulator, the Financial Services Authority, will review the scheme.

• An independent report on the fairness of the scheme will be produced and put before the Court.

• The Court will need to decide that the scheme is fair to all classes of with-profits policyholders (both GAR and non-GAR).

• All classes of with-profits policyholders (both GAR and non-GAR) will need to vote in favour of the scheme, 50% by number and 75% by policy value of those who vote in each class. (The classes have not been finalised and will be notified to policyholders with the full details of the scheme).

What will happen to future premiums to GAR policies after the House of Lords' judgement?

In order to finalise a scheme it is necessary to set a date after which benefits purchased by new premiums do not share in the benefits added by the scheme of arrangement (otherwise it would not be possible to finalise the figures). These premiums will, of course, still provide normal policy benefits other than GAR annuity benefits.

There are several possible dates from which this could take effect. For example, a date in the past such as 1 March 2001 (the date the deal with the Halifax was completed), or some date in the future. A date has to be set and we will be very interested to learn policyholders' views on this.

What happens next to take the scheme forward and over what period of time?

What we want to do first is to talk to with-profits policyholders about the proposed scheme. This will help us to decide how best we can communicate the final scheme in a way that will help policyholders understand all the issues and the consequences before making a decision.

At the same time we are also working hard on preparing the details of the scheme taking into account all of the complex legal issues that need to be considered.

When both processes are finished we will write to all with-profits policyholders giving them full details of the scheme. We expect this to happen some time this Summer (possibly around July).

Every with-profits policyholder will then be invited to vote on the issue (either in person or by proxy) at a special meeting which we hope to hold in late Summer/early Autumn this year.

Then the scheme has to be put before the High Court to agree that it is fair. This will take place quite quickly after the special meetings. It is only then, after the approval of with-profits policyholders and the Court, that the scheme can be implemented.

This document provides you with information only. The contents may have been discussed with you by a representative of Halifax Equitable but no recommendation will have been made as to the suitability of any particular approach in relation to your own circumstances.