EMAG Submission to Treasury Select Committee - February 2001

Submission to the Treasury Committee of Inquiry established "To examine the regulatory environment and the management of risk in the life assurance sector following the Equitable Life affair" from The Equitable Members' Action Group

Introduction

The Equitable Members' Action Group ('EMAG') was formed in July 2000 after the House of Lords ruling on the Guaranteed Annuity Rate ('GAR') issue. That ruling stated, in brief, that the Equitable Life Assurance Society ('ELAS') could not apply a differential to terminal bonuses which policy-holders could be given depending upon whether they chose to exercise an option to take a guaranteed level of annuity which had been written-in to their contract(s), or chose instead an open market (i.e. current market rate) option; furthermore, the Society could not apply different (i.e. lower) terminal bonuses to those holding policies containing annuity guarantees, as compared with those whose policies did not contain a GAR term. (i.e. policies written since July 1988). The group seeks to represent common interests of all classes of policy-holders with an interest in the ELAS with-profits fund, i.e. both types of contract-holder, GAR & non-GAR. The common interests can be defined as seeking member influence on ELAS decision making; clarification of the legal situation following the H.o.L. rulings; pressing for full disclosure of information relevant to members' legitimate interests from ELAS and appropriate regulatory bodies; making representations to such bodies as and when they are considered appropriate in the light of developments. It is currently a subscription-based group with a membership in the region of 1000, and actively seeking expansion as rapidly as possible in order to maximise its effectiveness as a focal point and voice for policy-holders. It is independent of any commercial interest and is entirely funded by its own efforts.

The issues: an overview

This submission is being drafted in the context of a situation where, for a historically new reason, a life assurance society is in a state of severe crisis. The history of assurance and insurance societies and companies over the past two hundred years or so has thrown up, at distressingly regular intervals, "scandals" where operations world-wide have, either through fraud, incompetence, or regulatory failure, or a combination of these factors, and triggered off by some particular situation of the time, failed; or have been seen to be in danger of doing so. Recent cases include Lloyd's of London and several Japanese life companies. After each of these events, lessons are learned, new controls, regulations or even laws are implemented, and all goes quiet for a period of time. Then, invariably, some company, somewhere, somehow, finds a new way to avoid or circumvent (perhaps not even with wilful intent) the existing regulations or market practice and so plunge into disaster; and the process starts all over again. Equitable is such a case. The task now is to find the best achievable solution for the policyholders at large and to close one or more doors of the stable, i.e. to draw appropriate lessons for future action to prevent equivalent situations happening again. We understand the Committee's remit is to discover facts and make recommendations, and to this end we would commend the following areas, of great concern to us, to be considered by the Committee, so as to improve the regulatory environment and to recommend sanctions where appropriate.

1. Matters of Regulation and Audit arising before the H.o.L. judgement
   
   ELAS was trading with the full knowledge of Regulator and Auditor to a very low free-asset ratio. This was apparently considered reasonable, and presumably approved as such, on the arguments of mutuality (the ELAS position - "we give it all back to the policy-holders", the lack of a need to give a return to shareholders), and of the perception that there was no need to build up a substantial reserve fund because the society's future liabilities were accurately and correctly defined. What needs to be discovered is the date on which the potential GAR liabilities were recognised by ELAS for what they were; what ELAS management then proceeded to do about the problem; what inter-action between the regulatory authorities and ELAS took place concerning the problem; what steps ELAS decided to take about informing its client base, and also its own sales force (because they would be the people passing on the information (or disinformation) to future prospective clients).
   
   It is a matter of historical record that ELAS sought to finesse the problem by reducing terminal bonuses to people exercising the GAR option, thus leading eventually to the litigation process which culminated in the H.o.L. rulings. It is less common knowledge, but none the less known to be true, that ELAS, for reasons presumably of perceived commercial expediency, gave assurances, both through their sales force and by public statements in the annual reports and circular letters to policy-holders, that the degree of exposure to which they could be subjected if the litigation process went against them was easily manageable, and that the ELAS with-profits fund was a safe vehicle both for existing and potential investors. (EMAG can provide the Committee with files of correspondence relating to individual members' experiences which contain clear evidence of this, if required).
   
   When, early in 2000, ELAS was telling its members (who, it needs to be reiterated, are the Society's owners) that its maximum exposure was £200 million if the legal process was to end in defeat for its position on terminal bonuses, it was at the same filing a statutory Treasury return which showed that it had made an allowance for planning purposes of £1.5 billion exposure, of which £0.5 billion had been off-set by a re-insurance arrangement. The figures in the Treasury return are clearly not compatible with the figures released to the public. Why was this not picked up by the regulators? (i.e. the Financial Services Authority, who had prime responsibility for this monitoring role).
   
   To summarise: why was the low free-asset ratio position allowed to continue by all responsible parties once the dangers exposed by the annuity-rate Guarantees became apparent? Why was there no concern to redirect some of the investment returns from bonuses into reserves? Was the attitude of ELAS towards bonus declarations predicated on the assumption that it had a continual need to distribute high bonuses for marketing reasons, i.e. to stay at or near the top of performance tables for the sector? If so, in what sense can this attitude be justified in terms of the interests of existing members? How was the mis-selling to non-GAR members after 1988 countenanced? (mis-selling, because these post-1988 members had no means of knowing the risk they ran of having their funds depleted in order to pay off future GAR liabilities; moreover, it was a persistent practice of ELAS to persuade them that they ran no such risk: the risk was supposedly non-existent).
   
   The defence mechanism which ELAS adopted, of planned terminal bonus adjustment, i.e. the differential treatment of GAR and non-GAR holders, appears devoid both of commercial caution and of regulatory wisdom; yet there is evidence that before 1999 ELAS was given support in adopting this tactic by the Treasury. How could the Treasury have given support for a position which, in the final outcome, five law lords so comprehensively rejected? On the principle that "somewhere the buck must stop", what consideration is being given to possible compensation issues? At the time of writing this submission, indications are that losses to policy-holders resulting from the debacle are exceedingly unlikely to be restored in their entirety by some outside bidder. The need for Government recognition of the case for compensatory payments is an urgent requirement. If regulatory bodies are shown to have been remiss in their monitoring and oversight of ELAS, then policy-holders are entitled to expect that appropriate levels of financial compensation will be made available.
   
   
2. Post H.o.L. judgement
   
   Who authorised the continued marketing of with-profits policies by ELAS? Why was a complete embargo not placed on the selling of these policies? Why indeed was such an embargo not imposed at the outset of the litigation process back in 1998, pending a definitive settlement of the issues?.
   
   What right did ELAS have to 'fine' existing policy-holders across the board by sequestering seven-months of growth in their individual policies, irrespective of the nature of those policies or the length of time for which they had been held, to cover the loss of £1.5 billion (the same amount that had been admitted in the secret Treasury statutory return earlier in the year) in December 2000? What was the attitude or involvement of the FSA in this action by ELAS management?
   
   
3. Corporate governance: the culture of ELAS and similar Life Companies
   
   EMAG is seriously concerned at the lack of democratic accountability and openness in the way ELAS has been allowed to conduct its affairs. The Committee may wish to consider this aspect as falling within its remit. Although, as a Mutual Society, ELAS is owned by its members, any suggestion that this fact of ownership is translatable into power and influence over the management and decision-making processes of the Society is not borne out by the historical record. ELAS has in the recent past opposed member representatives seeking election to the Board as non-executive directors (see minutes of 2000 A.G.M.), and has failed to provide a mechanism for involving member representatives in the selection of a new Society President, following the resignation of the present incumbent. EMAG has been informed that new non-executive directors are to be selected by the new President once he/she is in place; again, no involvement of member representatives appears to be envisaged by ELAS in this process, despite the pressing of the case by EMAG for such involvement to the Society.
   
   This is a deeply unsatisfactory state of affairs, in that it apparently allows organisations like ELAS to be run by self-perpetuating oligarchies. Obviously the point at issue is far wider than the matter of the governance of ELAS; it relates to the whole area of how people who own the funds in life assurance societies exercise power and control over those who manage those funds. ELAS provides a good example, the Committee may think, of what can happen when members of a mutual society are denied pertinent information and access to the decision-making processes, which affect in a very direct way their financial interests. The facts are that ELAS has perpetuated a culture of appointment by powers of patronage vested in the office of Society President; and that there has never been any discernible attempt to involve members in a systematic way in decision-making or consultation at any level, other than in set-piece elections at A.G.M.s which are stage-managed to suit the wishes of established board members.
   
   Conclusion
   
   EMAG commends for the attention of the Committee the well-informed contributions made to the House of Commons adjournment debate on 19 December 2000 by Mr. Richard Ottaway and Dr. Vincent Cable; and separate representations made to this Inquiry by EMAG members, particularly those drafted by Mr. Alex Henney and Mr. Andrew Pike. We are willing to make in-person representations to the Committee's hearings if asked to do so. We share the concerns raised in the adjournment debate about the chain of responsibility for the events at ELAS, in particular the roles played by Government ministries and regulatory bodies, which at various times have included the Department of Trade & Industry, the Treasury, the Personal Investment Authority, and the Financial Services Authority.
   
   Ultimate degrees of responsibility may eventually be shown to reside in various places, but an endless sequence of "buck-passing" will achieve little, and in the meantime there exist over one million people (including group scheme members) who have suffered or are fearing totally unnecessary disruption to their individual financial prospects. This is a direct consequence of what has been allowed to occur. That hard-working citizens who have been attempting to make adequate provision for their retirement should find themselves in this situation is self-evidently unacceptable, and very hard questions have to be asked about the culture of the personal pensions/life assurance industry and the manner of its oversight, monitoring and regulation. EMAG welcomes the opportunity that the Committee's Inquiry affords to raise these questions, with a view to: the rectification of past injustice, the seeking out of individual degrees of culpability; and the construction of a different and better-managed future environment for the industry to operate in.
   
   The Equitable Members' Action Group, February 2001
   
   EMAG committee members: Paul Braithwaite, David Browning, John Gardner, Alex Henney, Adrian Howard-Jones, Tom Lake, Michael Lister, Vincent Nolan.