Uncertainties facing policyholders: a paper by Tom Lake

Introduction:

1.0 Policyholders currently face many uncertainties, as a result of the situation that has been allowed to develop at Equitable Life

1.1 They are having to make decisions on whether to take benefits, whether to transfer out, how to approach the proposed compromise settlement and whether to consider pressing a claim for compensation. If the compromise succeeds members will be legally bound not to make further claims for mis-selling in relation to the GAR liabilities however they voted when the compromise proposal was put to the membership. As we have not yet seen the terms it may be that they will be more tightly bound, as some have supposed.

1.2 The members face considerable uncertainty as to their true legal position, and also as to the financial prospects of their pension arrangements with Equitable Life.

1.3 The legal position is unclear because the 1982 Insurance Companies Act was not clear as to policyholders beneficial rights and further because the House of Lords' decision did not result in a stable or clear position on which the policyholders, the life assurance industry and the regulators could base their decisions.

1.4 Further, the multitude of different contracts issued in the past by the Equitable Life, with a myriad of different guaranteed benefits, makes it very difficult for an outsider to assess the liabilities and potential liabilities of the society. The financial position is unclear because very little information has been released to policyholders, although the Equitable Life is a closed mutual society whose only beneficial owners are the members, i.e. policyholders with an interest in the "With-profits" element of the Society's business.

2. Lack of Clarity in the 1982 Insurance Companies Act

2.1 The regulation of insurance companies is governed by the 1982 Insurance Companies Act as well as other measures. The 1982 Act brought in the notion of Policyholder's Reasonable Expectations but failed to give any definition. It might be thought that it was Parliament's intention that market forces should control the interpretation given to this term, though how they could act over the necessary 40+ year span is unclear.

2.2 FSA research has showed that the industry average with-profits performance has been poor, compared to unit-trusts or tracker funds, although Equitable Life far outperformed this average, and indeed was a thorn in the side of much of the industry, becoming isolated and embattled as a consequence. This shows clearly that market forces have been ineffective in providing a de facto interpretation of the term "Policyholder's Reasonable Expectation". Industry and regulatory practice settled on the `asset share' approach to Policyholder's Reasonable Expectations. For 18 years the entire industry proceeded without sound legal basis. When a challenge came its results were unsurprisingly catastrophic.

3.0 The House of Lord's Decision on Ring-Fencing

3.1 The decision on whether the costs of the GAR policies should have been borne by policyholders in that class alone was made by the House of Lords in a judgment which devoted only a single meagre paragraph to supporting argument. The non-GAR policyholders were not represented in the hearing in relation to that issue - not even by the Equitable Life. While Leading Counsel retained by the Equitable Life have agreed that despite the unclear reasoning, lack of representation of the nonGARs, failure by the Equitable to present the full picture, despite all these failures, the House of Lords decision in regard to ring-fencing is unlikely to be successfully overturned by a direct challenge.

3.2 Nevertheless, the failures cited above mean that it cannot be regarded as completely final, nor can it be seen as leaving a clear basis on which the industry can assess the adequacy of policyholders' benefits. Policyholders throughout the Life Insurance Industry are left without any clear understanding of their position. There will have been cross-subsidy between policyholders throughout the industry on a massive, and so far largely unreported, scale.

4.0 Uncertainties Remain as to Equitable Life's Liabilities

4.1 While the proposed GAR compromise settlement resolves the GAR benefit liabilities it does not deal with any other liabilities flowing from the House of Lords' decision. The situation appears murky and unstable. Challenges relating to, for example, Guaranteed Interest Rates and capital roll-up, loss of the Equitable's sale value, claims in relation to the 16% fund cut on 16th July 2001 and perhaps claims in respect of other guarantees could still raise liabilities.

4.2 As the Halifax agreement remains to this date unpublished it is unknown whether further liabilities or obligations arise under it.

5.0 Uncertainties Remain as to the value of policies

5.1 The Equitable Life's explanation to policyholders of the 16% cut in funds is impossible to evaluate without full access to the precise detail of the financial circumstances which led to the decision to make the cut. Until the society provides policyholders with precise financial details, doubt will remain as to the relative proportions within the total cuts attributable to "prudential" and "immediate over-riding necessity" considerations.

6.0 Uncertainties Remain as to Future Bonus Policy

6.1 Actuaries Bacon and Woodrow in a report for trustees of senior-grade civil servants' A.V.C. pension funds noted that the future outlook for Equitable Life (compared to societies with greater reserves) was likely to be that if investments did well, i.e. in favourable "growth" circumstances, for prudential reasons more would be withheld from distribution via bonuses to policyholders in order to build reserves, while if poorer circumstances prevailed, the bonus outlook would be no better. EMAG has proposed that instead of attempting to reconstruct a society with the resources to offer investment "smoothing", which would involve building prudential reserves at the expense of members crystallizing benefits in the short/medium term, it would be better to unitise the fund, paying proper regard to the interests of annuitants so that future assets would be returned directly to the members.

Tom Lake, ELAS Non-GAR policyholder, EMAG committee member, 22 October 2001

email: Tom.Lake@glossa.co.uk

The Equitable Life Story (paper 1 of 2 by Michael Josephs)

1. I have prepared the attached brief "The Equitable Life Story or The Pollyanna Syndrome" to help us understand the complex background to the Equitable Disaster. Much of the detail has been omitted, or is not readily available, but I have tried to focus on essentials and confine myself to accepted facts and conclusions drawn from those facts.

2. When I began to write the brief, I could not comprehend how such a capable organisation could wreck itself in a few short years. It turns out that the seeds of destruction were planted in the 1970's, but it took sustained arrogance and fecklessness to allow those seeds to bloom into a jungle which destroyed the policyholders proper harvest. I hope that the brief will help others to understand the nature of the failures and how to tackle the many outstanding problems.

3. The fundamental message from this record of misfortunes is that people failed in their duty. It was not that their duties were unknown or poorly defined: the thrust of their responsibilities was clear, but they hid behind a fog of technical detail. They said one thing but did another, and the interest of policyholders came last. The pickings were too good and no one was brave enough to blow the whistle.

4. The second message is that too many of the watchdogs who were meant to prevent such a situation from developing withheld their concerns from the policyholders, the real owners of the Society. One timely letter from a Cabinet Minister could have halted the downward slide. Secrecy is the foe of good regulation, but it still holds sway despite the appointment of a completely new Board.

5. Regrettably there is a third message: once an organisation loses its essential integrity, nothing that it does can be taken at face value and trust becomes just foolishness. All of the actions of the previous Board and its willing helpers need to be re-examined with a sceptical and penetrating eye. None of its policies and plans should be continued without stringent re-evaluation.

6. The Treasury is behaving as if the policyholders brought the problems on themselves, while in truth they are virtually blameless. Currently, Equitable is expected to dig itself out of the deep mire in which it lies, and the policyholders are being made to bear nearly all of the costs. Frankly this is a nonsense. Equitable is too weak managerially and financially to do this on its own, and too many of its managerial echelons are compromised by their involvement in the destruction of nearly 25% of policyholders' funds.

7. At the same time a number of investigations have been completed, are in progress or are just about to start. Most of these are legally oriented, and will help to assign blame in suitable proportions, if and when they are published, and some may help to clarify what share of the cake should eventually be allotted to the various classes of policyholder.

8. Many of the million people dependent on Equitable for their retirement income are in terror of further adverse developments - and why should they not be given recent history and the secrecy which still clouds the Society's affairs? They are being bounced into accepting a premature and ill thought 'compromise proposal' whose only merit is the prospect of a spurious stability.

9. Instead, the insurance industry, the media, Parliament and The Government should all be providing positive help

10. The most immediate needs are as follows:

10.1 To put a stop to the agony by providing each policyholder or annuitant with a minimum figure for the pension that they will receive, come what may. Essentially this implies an industry wide reinsurance with Government involvement. With reasonable skill, this reinsurance need never be called upon.

10.2 To re-invigorate the management and board of Equitable, so that they can cope with the massive task of putting right years of neglect, and hopefully open to new business again.

10.3 To throw the bright light of day on all the workings of the Society and its regulators, so as to rapidly identify what has gone wrong in the past and prevent new errors in the future. The most appropriate way to do this is under the aegis of Parliament with the active involvement of the Parliamentary Ombudsman. The press should play its part by probing the murkier aspects of the whole affair.

10.4 To deal with the issue of compensation in a just and expeditious manner by setting up special machinery to avoid a continuous drip of court cases over the next ten years.

Michael Josephs

17 October 2001

The Equitable Life Story (paper 2 of 2 by Michael Josephs)

PREFACE: This note has been prepared to help convey the nature and the causes of the financial catastrophe which has befallen the policyholders of the Equitable Life Assurance Society. The key events manifested in the summer of 2000 when Equitable lost a 'straightforward' court case in the House of Lords and closed to new business. Subsequently a shortage of at least £1500 millions was announced, and over a period of twelve months Equitable cut 8% from current bonuses and 16% from previously accumulated bonus funds in policyholders' accounts, the cumulative effect being a cut of nearly 25% in policyholders anticipated pensions.

1. Founded nearly 250 years ago, by the early years of the 20^th century, Equitable Life Assurance had become the epitome of reliable and resourceful pensions provision.

2. In the 1950's Equitable introduced policies with guaranteed annuity rates (GARs), as well as guaranteed fund values at retirement. Initially, these guaranteed rates were quite low, but appropriate reserving mechanisms to cover the guarantees were not introduced. In the course of time guaranteed rates from 10% up to 15% were incorporated into these open ended GAR policies, which many people regard as a reckless act.

3. In 1978 Legislation was enacted enabling all personal pension policies to have an 'open-market option', that is to say a fund value that could be transferred to another approved fund at the policyholder's behest. This made it imperative to reserve against the guarantees in each individual policy, but the Society ignored the problem because market rates were still higher than those guaranteed in the policies.

4. In 1988 Equitable ceased to write GAR policies, but continued to mix non-guaranteed policies with the older GAR policies in the same with-profits fund. Essentially the Society was commingling funds of incompatible types. Moreover, none of the new policyholders were advised of the existence of these earlier guarantees underwritten by their own non-guaranteed funds. This meant that non GAR members were unwittingly cross-subsidising those whose plans were written at the highest guaranteed rates. This has provided serious grounds for claims of MisSelling or misrepresentation.

5. In 1990 there were clear indications that annuity rates were likely to drop to levels which would activate the guarantees. Such guarantees are essentially one-way options, and when options are 'in-the-money', nearly all are exercised. Still Equitable did not calculate a reserve for individual policies, nor did they make realistic reserves for each class of policy. The necessary pool of high yielding assets to match the guaranteed rates was not created. This was serious mismanagement.

6. The House of Commons Treasury Committee states in its Report on the situation: "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."

7. In 1993 when the first guarantees were activated, Equitable decided to meet the cost by arbitrarily reducing the final bonuses of the policyholders opting to call on their guarantees. This was a totally opaque method of dealing with the issue, which should have been tackled years earlier by telling the GAR policyholders how much of their 'profits' had been reserved to cover the possible exercise of their guarantees.

8. During the next few years annuity rates dropped further, with the cost of the guarantees rising accordingly, but still the society clung to the policy of using 'Directors Discretion' to reduce the expected annuities to affordable levels.

9. In 1997 when a groundswell of complaint started to build up from GAR holders planning to take their pensions, The Board of Equitable laid plans to tough it out and get legal approval of their apparently arbitrary policy.

10. In 1998-99 when writs were about to be issued by GAR policyholders, Equitable launched their own action, which did not concede any fault or weakness in their handling of the situation, and demanded that the Courts confirm the Directors' 'carte blanche' to vary individual bonuses as they deemed fitting, (as set out in the Society's Rules, but not the policies).

11. The 'all-or-nothing' form of action put Equitable's non-guaranteed with-profits members at great risk of having to bear most of the cost of guarantees that were nothing to do with them. The Board disguised the scale of the risk, by issuing formal statements referring to a cost of £50 millions and reserves of £200 millions. It turned out that £50 millions was the cost of meeting guarantees that could not even be covered by removing the final bonus, and was nothing to do with the court case. This was seriously misleading to its members, and probably aimed at ensuring that they would stay with Equitable and give the directors a free hand with the court case. By and large this is what happened.

12. The Board did not even advise the Courts of the scale of the disruption that would ensue should they lose the case (which was actually in the range of £1500 millions to £3000 millions). Not surprisingly, the Court of Appeal and the House of Lords denied the Directors the carte blanche that they were seeking, and in doing so made it more difficult to restructure the funds in any rational way.

13. Moreover, the Board declined every opportunity to negotiate a low cost settlement with the claimants, particularly after it had won its case at the High Court stage. The Directors arrogance demanded a total victory, but they lost everything instead.

14. At any time between 1980 and 1997 The Board could have admitted the long standing weaknesses in record keeping and reserving, and asked the Courts for permission to restate the Accounts and the allocation of funds within each GAR policyholder's account. No policyholders need have lost what they were due under their policies and the Courts would have been sympathetic. The Board refused to do this, and despite the replacement of the complete panel of Directors, they have not done so to this day.

15. A valuable insight into these events is given by the Institute of Actuaries Inquiry into the technical background of the Equitable affair. Their report was published in September 2001 and is written in a detached academic tone that would be more appropriate to a review of the fiscal weaknesses of the Tudor dynasty, rather than the causes of a present day financial disaster affecting nearly a million people. Put into human language the key points that emerge are:

15.1 The words 'regret', 'sympathy', 'apology' and 'sorry' do not exist in the actuarial vocabulary.

15.2 There was a major cumulative failure of actuarial and underwriting practice at Equitable from as early as 1975 to 1998, but the Inquiry is not prepared to say whether the appointed actuaries were in breach of their professional guidelines on various occasions.

15.3 Although, by the mid-80s Equitable had given a majority of its policyholders guarantees, they never explicitly calculated the size of the resulting liabilities in a proper manner.

15.4 They did not inform those policyholders in advance that they would reduce their already declared bonuses (or by how much) if they exercised the guarantees that were explicitly defined in their policies.

15.5 When Equitable introduced in 1988 a completely new series of policies without guarantees those policies should have been put in a separate bonus pool from the GAR policies, but instead all policies were mixed together.

15.6 With the passage of time the Board allowed the underwriting and investment threats to the health of Equitable to grow increasingly large, and they generally concealed their problems rather than addressing them.

16. A proper awareness of risk is vital to anyone working at a senior level in the life and pensions industry. During the 1990's the Board and executive team at Equitable went the opposite way, courting greater and greater risks. This was demonstrated in the most dramatic way when the Board found itself unable to sell Equitable at any price because of the open-ended nature of the liabilities that they had incurred. They had fallen victim to the fatal Pollyanna Syndrome, the silly belief that risks don't matter because nothing has gone wrong yet, and it will all turn out for the best.

17. At all relevant times Equitable was under the supervision of Government Regulators, Appointed Actuaries and External Auditors, and from 1998 was under the overall supervision of the Financial Services Authority. None of these august and potent supervisors took any effective steps to prevent the misleading record keeping or to alert the Members of the Society to the nature and scale of the problems that were developing. or to the damage done to it and its members. They utterly failed to detect or to counter the Pollyanna Syndrome which had taken over the Society's management.

18. Throughout the whole of this sorry and depressing saga the policyholders must be held blameless. There was nothing extraordinary about the benefits that were being credited to their pension funds and the regulators and the media were consistently silent with any form of criticism until the GAR problem was first aired generally in the summer of 1998.

19. The Board of Equitable are now seeking approval of its members to a 'Compromise Agreement' [draft published September 2001] that would buy out all the GAR policies and change the company's articles and prevent policyholders from claiming recompense for the losses they have suffered whether from mis-management or mis-selling. This idea was inherited from the previous Pollyanna Board. The present Board expects to avoid responsibility and liability both for themselves and the regulator by this device, which is particularly hard on the great majority of current policyholders whose policies are not guaranteed.

20. At the time of writing, policyholders are still denied essential information about the causes of their troubles and about Equitable's present status. This continues a perverse and longstanding tradition of this society. Until such information is provided to the ordinary Member in a form which he or she can reasonably understand it would be rash to fall in line with the Board's proposals.

21. In addition, many people believe that the only fair and effective way to sort out the problems and ensure proper compensation for the policyholders is for their many justified grievances to be pursued in court.

Michael Josephs

12 October 2001

email: city@london.polargrp.com

(I acknowledge the assistance that I have received from the EMAG web site [www.emag.org.uk] and the helpful EMAG members with whom I have discussed these matters. However, EMAG bears no official responsibility for this paper).