EMAG

The independent action group for current and ex Equitable Life policyholders, funded by contributions.

Equitable Members Action Group

Equitable Members Action Group Limited, a company limited by guarantee, number 5471535 registered in the UK

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Documents: 15/02/2001 - Report of Treasury Select Committee Hearing re: Equitable Life

15 February 2001 - Report of Treasury Select Committee Hearing re: Equitable Life

Topic under investigation"To examine the regulatory environment and the management of risk in the life assurance sector following the Equitable Life affair"

Committee Members present: G.Radice (chair), N.Beard, J.Cousins, E.Davey, M.Fallon, D.Kidney, J.Mallaber, J.Plaskitt, M.Spicer.

Witnesses from ELAS: C.Headdon, P.Martin, J.Sclater.

Witnesses from FSA: H.Davies, M.Foot, M.Roberts

A packed meeting, all places (c. 100 public seats) taken. Attended by several EMAG members, including Paul Braithwaite & David Browning from the committee. Three hours, 10.00 to 13.00; first 75 minutes spent questioning ELAS, then turn of FSA. EMAG committee had presented a briefing paper for the Inquiry members, as had several members of EMAG in a personal capacity. Background briefing papers from both ELAS and FSA had been presented, copies were available to be taken away. (unfortunately I was unable to get copies at the time, but hope to have them to hand shortly. Depending upon their length, & interest, it may be possible to make them, or synopses, available to EMAG members generally. D.B.). The full transcript of the hearing will be published both in print & on the web, but not until early March.

MPs appeared to be well-prepared, questions were sharply focussed; EMAG's own submission plus individual inputs must have been worthwhile. on the history of what had happened and why things allowed develop in certain ways when clearly there alternative courses action. (Corporate governance issues as such, including access members information, influence decision-making processes, which formed one thread submission, only alluded obliquely; but I think concerns these respects will noted. D.B.). >

J.Sclater opened for ELAS, gave a general apology for what had happened (which was later admitted by C.Headdon as having been ultimately due to "management mistakes"). Much of the narrative of events was given by Mr.Headdon.The thrust of this narrative did not diverge significantly from the statements that have been made previously by Mr. A.Nash prior to December 2000, and latterly by the present board. Much of what was said has been reported in the press already, and there are excellent links on the ELMHG site. FSA's statements and answers were given mainly by Howard Davies and, for some of the 'history', Martin Roberts. Mr. Roberts had been a civil servant in the Treasury department dealing with ELAS before going over to the FSA, retaining his ELAS monitoring role, when it was set up in 1999; however he was not allowed to speak other than in very general terms about pre-1999 events.

Much of the questioning was repetitive in that the "asset-share" argument relied upon by ELAS throughout until the H.o.L. judgement was gone into over and over again; it seemed that the FSA, and previously the Treasury, had accepted it as a 'commercial' concept that ELAS were entitled to adhere to, subject to legal interpretation. A satisfactory and clear-cut explanation of precisely why this legal interpretation had not been definitively established as valid years before 2000 was not forthcoming. The FSA repeatedly referred to its own 'legal advice', as did ELAS, and it seems that both sides thought that this was sufficient for the purpose of allowing the asset share policy of bonus allocation, which ELAS presented as a morally just approach, to be maintained after GARs became better than market annuity rates and became a rational option to take advantage of. The Treasury in the the early 1990's had established that there was not a consistent policy in the U.K. life industry; as GAR's became attractive options due to the trend towards lower interest rates,some companies who had 'large estates' i.e. orphan assets or shareholder funds, maintained an even-handed approach to bonuses as between GAR & non-GAR; others, e.g. ELAS, differentiated, using the equal asset-share argument. ELAS were recognised in 1998 as being particularly exposed because of the concentration of its overall business on pension policies, the flexibility of those policies, the high proportion of GAR contracts (because of the proportion of ELAS total business that they had represented, 1957 onwards), and the low free-asset ratio which ELAS pursued as a conscious policy in order (the ELAS argument) to give as much return as possible to the policyholders. Other companies did not have the same combination of circumstances; it was specifically ELAS's situation that the Treasury was worried about, when it issued higher reserving requirement guide-lines in 1998.

Mr. Headdon was asked why ELAS had not recognised the dangers and done something about it earlier. His answer was that this would have amounted to adopting the approach ultimately forced upon it by the H.o.L. in advance of that decision, i.e. reducing bonus levels to and build reserves, and there was no reason to do this, according to their legal advice. The auditors approving ELAS accounts were equally basing their conclusions upon this legal advice. The Treasury, although it had accepted the differential bonus approach, had been concerned about another issue in 1998: the danger posed to ELAS solvency if interest rates continued to fall, and future take-up of GARs was much higher than that planned for by ELAS actuaries. This concern led to increased reserving requirements being imposed upon ELAS, and other companies; ELAS particularly took exception to the particular requirements specified for it, and threatened the government/FSA with judicial review. This led to a compromise which involved ELAS taking out a re-insurance contract for £800m. cover in early 1999. The fact of this cover, and the concerns which had led to it being taken out, did not appear in any information passed to policyholders, other than that contained in the statutory return to the Treasury of Jan. 2000. This revealed that the overall GAR contingency liability had been increased to £1.5bn., a figure several M.P.s noted as being far higher than that admitted to policyholders in ELAS statements, which initially referred to £50m. This figure, Mr. Headdon stated, had been revised upwards as a result of more conservative assumptions to £200m. When asked how an ordinary policyholder could have found out about the "secret" £1.5bn. figure, Mr. Sclater said that the statutory return would have been available to any policyholder had it been requested. When asked where amongst its 400+ pages the information was contained, Mr. Sclater confessed that he did not know.

When pressed on why ELAS had not foreseen the possible outcome of the court process, one of the ELAS team said "we were reasonably confident that the final verdict was a remote possibility". (The precise attribution of these words will have to await the publication of the full transcript; due to the seating arrangements in the hall it was not possible always for observers to determine exactly who was speaking at any given instant. D.B.). This gave rise to the accusation, made by more than one committee member, that ELAS had been "gambling on the result of litigation", or alternatively, "gambling on the validity of a legal opinion". An article in the Daily Telegraph of 22 Jan. 2000, (immediately after the Appeal Court verdict), which had implied that ELAS were facing a crisis of solvency, was quoted; did that article not give a truer picture of the financial predicament than that available to ordinary policyholders via ELAS statements? Mr. Sclater: Should accounts be based upon their best (i.e. legal) advice, or upon articles in the Daily Telegraph?. Mr. Headdon stated that the article had mis-represented the effect of the Appeal Court judgement, citing Lord Justice Waller's opinion (i.e. one of the three judges) that 'ring-fencing' (i.e. the application of a differential bonus policy amongst classes of policyholder) was an allowable course for ELAS to take.

There follows a selection of interchanges during interrogation of ELAS board members (very much edited and condensed).

Q.: Why did ELAS not reserve adequately? A. (C.Headdon): Board had wide powers of discretion under its articles, which it was advised it could use to allow a flexible allocation to final bonuses to reflect asset share. Final bonuses were not guaranted and did therefore not need to be reserved against.

Q.: If you had been building up reserves from 1993 onwards (i.e when differential bonus allocations first introduced according to whether GAR option exercised or not), would this have averted the problem? A. (C.H. again): Yes, but a block of assets would have been doing nothing over the years.

Q.: With hindsight, this is what you should have done? A.: Yes.

Q.: Did you inform policyholders of your low reserve policy? A.: We made it clear over the years.

Q.: What provision did you make for GAR liabilities before 1999? A.: None, it was not seen as necessary.

Q. (re. auditors' understanding of future GAR liabilities). A.: Auditors relied on ELAS actuarial evaluation of liabilities.

Q. (Mr. E.Davie): were the full terms of the re-insurance deal revealed in the statutory return? A.: Yes. But the re-insurance did not cover situation arising out of H.o.L. outcome. The regulator was aware of this. But it did not appear as such in the statutory return. It was not intended as an insurance against an adverse legal judgement; it was against future losses which could accrue in the face of an bad economic environment and a high rate of GAR take-up.

Q.: Why did ELAS not insure against possible H.o.L. outcome? A.: probably impossible to obtain such cover, and policyholders would not have had a right as such to be given this information. After H.o.L., because economic circustances had not changed, the re-insurance terms did not apply, therefore it was of no value (i.e. as compensation for the effects of the judgement).

Q. (Ms. J.Mallabar): As a new policyholder, what information would I have got from ELAS (about its exposure to the GAR liability)? A.: From late 1980s onward, newspaper comment was widespread; policyholders could be presumed to have been aware of this comment.

Q. July-Nov. 2000, ELAS spent £2.9m. on advertising. A proper thing to do? A. (J.Sclater): Best to keep ELAS as a going concern (& maintain its value) whilst it put itself up for sale. Not an aggressive advertising campaign; expenditure was less than in same period previous year.

Q.: Were approaches made to ELAS to be taken over, 1993 to 1998? A.: (J.S.) Informal soundings were made. Not explored, as ELAS was doing well, policyholders wanted mutual status retained.

Q: (re. Halifax deal, propriety thereof) A.: Weeks of uncertainty would have led to loss of sales force. We had power under articles (of association), had to take best decision for policyholders. Wrong to say deal had been concluded in haste.


Some points from FSA's deposition and subsequent interrogation. (extremely selective).

(Howard Davies): FSA undertaking its own internal review of actions it had taken with regard to ELAS. Complete by summer, submit to Treasury, then it would be published.

Halifax deal: if GAR deal achievable, total Halifax funds injection would restore health of w/profits fund, would mean it would be freed from restrictive investment strategy. Normal fund mix could be restored. Loss would be limited to 2000 loss, i.e. c. 4% of long-term policy values.

Roots of problem lay in GARs being issued 1957-88. Some kind of hedging mechanism should have been put in place. A long time ago, this was generally seen not to be necessary. Had (H.o.L.) problem been foreseen, bonuses would have been kept at lower level over period of time. Instead, reduced in one fell swoop in 2000.

Q.(G.Radice): are you advising policyholders to vote yes to Halifax deal? A. Not yet - terms have to be worked out first. FSA would set out pros & cons of deal. Would show consequences of acceptance or rejection.

- November 1998, letter from Treasury to FSA (about to take over regulatory role) raised serious concern about ELAS solvency. ELAS became a high-priority issue. December, increased reserve guidance issued. ELAS threatened judicial review. Compromise reached (re-insurance deal).

Q: They (ELAS) went for re-insurance route rather than increasing reserves? A.: Partly. Re-insurance was against particular economic circumstances.

Q. Was this reasonable? A.: They were not attempting to cover themselves against H.o.L. judgement scenario. If differential approach (i.e. within individual policies) was vetoed, we thought higher GAR take-up likely; we thought re-insurance arrangement was a reasonable response to perceived risk. Not intended to cover H.o.L. (i.e. vetoing of ring-fencing).

Q. You knew H.oL. outcome was possible - Treasury letter Nov. 1998 had indicated it. You miscalculated? A. Economic circumstances dominated our thinking, not H.o.L. judgement possibility.

Q. Mr.Sclater had earlier said ELAS technical insolvency possible. Agree? A.: ELAS rating had been down-graded; any life company can go insolvent in certain economic circumstances. Policyholders' Protection Fund is final safeguard. Sale (of assets)needed, otherwise fund would have to maintain defensive approach, more gilts, fewer equities. Sustainable solvency, but lower returns.

Q. Why did you allow ELAS to hide behind their interpretation of the law? A.: Bonus policy was up to ELAS. FSA made sure it took good quality legal advice. Interpretation seen as reasonable. Ring-fencing seen as accepted reality.

Q. Why was ELAS not compelled to disclose £1.5bn. provision to policyholders? A.: It was disclosed in statutory returns. It could be looked at by analysts, and filtered out to public via 'league tables' &c.

Q. Sufficient clarity in information available to w/profits fund-holders generally? A.: We are looking at it.

   (M.Roberts): £1.5bn. provision was against adverse economic circumstances. Quite different from H.o.L. judgement exposure.

Q. When did discussion take place with ELAS which included possibility of actual H.o.L. outcome? A.: Some time between Court of Appeal and H.o.L. judgement, everything was discussed, including what ELAS would do if judgement was as it turned out to be, i.e. freeze on 7 months growth for year 2000 on policy values. Not for us to determine what a company should do. Question applicable: is proposed course of action compatible with regulatory requirements? This scenario was compatible.

Q. Did you miscalculate the risk (of H.o.L.). A. (H.D.) : We were wrong.... we were not right on what the law was.

Q. All the relevant legal advice proved to be wrong? A.: The H.o.L. judgement was unexpected and overturned a fundamental principle of the way these (life) companies operated, in dealing with policies containing annuity rate guarantees.

Q. The seeds of legal doubt were sown some time before? A. Yes.

Q. (G.Radice): H.o.L. judgement perverse? A . (H.D.) Unexpected. Other companies have to live with it.

Q. In what circumstances would compensation become applicable? A. Policyholder protection "kicks-in" upon insolvency. (M.Foot): mis-selling of policies a matter for the P.I.A.

Q. Is there a case for compensation? A. It depends on what you are compensating for. Need to be clear who had lost out, and by how much.

Q. Correct that Court of Appeal did not specifically enable ring-fencing? A. Scenarios were discussed with ELAS actuaries; in improbable event (of actual H.o.L. decision), ELAS' proposed response was satisfactory to FSA.

   (General observations): FSA does not ask companies necessarily to provide against "worst-case" scenarios. It asks for "reasonable provision". Not reasonable to have asked ELAS to provide against all perceived "worst-case" contingencies.

Q. Is information and advice to policyholders adequate (i.e. from life companies/agents)? A. FSA has objective to improve public knowledge. Is reviewing rules on terms/transparency of policies and the pay-out of bonuses. Either a company is authorised, or it is not authorised. No "half-way house". Compensation being looked at for individuals who have claimed mis-selling in 2000. The FSA initially is scrutinising the way in which an estimated 6000 w/profit policies were sold after the H.o.L. decision, up to December when ELAS closed to new business.

Q. FSA inquiry into itself (re. ELAS ) - is this satisfactory? A.: Yes; led by Director of Internal Audit (quite separate from other departments of FSA), has external advisers, reports to Board, majority of whom are non-execs.

Q. (J.Cousins): When was reserving problem first recognised at ELAS? A.: (M.Roberts) Soon after February 1998. There was a review of exposure generally, and ways of handling it. Late summer, early autumn 1998, became aware of particular problem of ELAS.

Q. Any other involvement of ministers prior to Nov. 5, 1998? A.: You will have to ask ministers. (H.D.: Mr.Roberts cannot be expected to answer questions relating to his work as a civil servant. FSA would discuss "context" but would not go into detail about ministerial involvement before 1999).

Q. During the final period of Government oversight, was it the FSA or Government that was being threatened with judicial review by ELAS? A.: Government.


The Treasury Committee is now "in recess". It meets again on 22 February; after that its time-table is uncertain, particularly so because of the likely imminence of a General Election. It can hold further hearings if it so decides, calling such witnesses as it thinks fit. There is no pre-ordained "blueprint" for the progress of the Inquiry into ELAS. In principle there is no reason to suppose that any future hearings will not be in public, in the manner of this initial hearing.

     (David Browning, on behalf of EMAG committee, 17 Feb.)