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.)
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