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

Documents: 01/03/2002 - What brought Equitable down? It wasn't the GARs

1st March 2002 - What brought Equitable down? It wasn't the GARs

Now that the court has formally sanctioned the compromise, it is appropriate to examine how Equitable got into this mess and where it might go from here. Let me say that though I'm not an IFA, over the last 18 months I have become something of an expert on the Equitable Life in my capacity as "pro bono" chairman of the leading independent non-partisan policyholder action group EMAG.

How did it happen?

The Equitable has historically always been a very secretive Society. Vanni Treves has continued in this unhappy tradition. However, some relevant information has crept out, mostly from the small print of the Baird report and the various actuaries' reports.

Let's start by looking at the GAR problem: The anticipated cost of running off was circa £1.3bn, based on the fund in the summer of 2000 of £27bn. So the "hit" represented broadly 5% of the assets.

One should ask what sort of business is brought to its knees by a 5% hit? I would suggest the answer is either a very new one (not Equitable Life then!) or one that has far over-reached itself.

A 5% hit - for example a big bad debt - might cause the average business to tighten its belt, but not to force it to cease selling. However if that business was already over-extended by 15% when the 5% problem broke, it would probably not have sufficient strength to survive. This, I believe, is what happened to Equitable Life.

Let's put the GAR problem aside and consider the other major risk that the Equitable's directors ran: This is what they described as the "full and fair" bonus policy. Most traditional life companies W.P. funds accumulate assets well in excess of what they allocate to policyholders - hence the obfuscation. But it is the fund's surplus assets, or estate, that covers declarations in the cyclical bad patches on the stockmarket.

The Equitable actuaries and directors thought that they could exist without any such estate. They thought they could pay pensions out and vote bonuses, not only to match but to exceed rises in the stockmarket and this is what they did throughout the late 90's. This was economics from the school of Charles Dickens (annual outgoings twenty shillings and sixpence etc etc) - a folly that was bound to end in disaster.

Mike Arnold, the Independent Actuary, reported that at 31st December 2000 the aggregate of policy values exceeded 'available assets' by about 10%. Of this about 5% was attributable to the GAR cost, which resulted from the adverse decision of the House of Lords in July 2000, leaving a general deficiency also of about 5%. Until that time the Equitable was widely thought to have an accumulated goodwill value measured in billions. During 2000, apart from the GAR cost, income and bonuses broadly balanced each other off, so we can deduce that the general deficiency was also 5% at the end of 1999.

FT Adviser readers will recall that the end of 1999 was about the high point for the stockmarket. After the long bull market from about 1991, this is the time when all life companies should have had "something in the kitty" for the inevitable downturn. It now appears clear that the Equitable did not. It was actually 5% down - not up.

What sort of buffer should they have had? One would have hoped 10% or so would have been accumulated over the previous 8 years. So, I conclude that at the top of the bull market, Equitable were perhaps 15% "the wrong way" through systematic over-declarations. Add to that the unexpected 5% GAR hit in 2000, and we can see why the world's oldest mutual was brought to it's knees and forced to close to new business.

The old board bragged about its 'full and fair' distribution policy. It was only because Equitable was largely a direct-selling operation (without the benefit of IFAs to highlight the dangers) that it got away with it. Whilst investors may have been aware that Equitable did not have any massive buffer, how many people would have kept on investing if they had known to what excesses the policy was being over-stretched? 140,000 new and unlucky policyholders joined the Society in the two years before closure and they, most of all, have a valid grievance.

This brings us to the real culprits - the Regulators. The objective of "prudential regulation" is to ensure that insurance companies do not stick their necks out. From the Baird report last October it is very clear that the Regulators were well aware of Equitable's increasingly thin reserves problem, but took no action over a period of several years - this, at a time when the stockmarket was going up and the Society could have been saved. In the Sunday Telegraph (Feb 10th, 2002) it was reported that the Government Actuarial Department (GAD)received a letter in 1997 from the Equitable stating: "At 31.12.96, the total face value of policies, including accrued final bonus, was in excess of the value of the assets?."

Today, the most obvious party to take action against the Regulators is the Equitable Life society itself, but under the present regime it doesn't even look like it's on the agenda. If current and past policyholders want to see compensation, they would be wise to back EMAG's new campaign to go seriously in pursuit of the politicians.

Future prospects for the Equitable

During the ruthless process of bullying policyholders into accepting the compromise, Vanni Treves concentrated on how bad the Society's position was and how much worse it could become if the compromise were to be rejected. Now the society has been successfully stabilised, the situation is very far from sound. The new appointed Actuary (Peter Nowell) has insisted that the board keep the policy values within a 5% margin either way of available assets. He has also indicated that bonuses are likely to be depressed for the next few years. This confirms Bacon & Woodrow's conclusion in their report in July last year on the poor prospects for the Equitable.

Nevertheless, now that the compromise has been sanctioned there may be a silver lining amongst the doom-laded clouds.

One of the pieces of information which the board has kept quiet is what was included in the calculation of "available assets". In particular, what deduction did the Appointed Actuary make in respect of the GAR cost and non-GAR mis-selling? When he did his sums last summer, prudently this was pretty substantial. Now, these provisions have proved to have been overly cautious - and they appear to have been excessive to the tune of £1bn. Based on the current, much reduced fund, this 'undisclosed asset' represents perhaps 5% of the W.P.'s value and this percentage will increase if a post-uplift rush of policyholders depart without their share. That would be a change for the better!

In the last year the W.P. fund has decreased in value by fully one third (£9bn) and it has looked like the new board has deliberately presided over the systematic unravelling at high speed of our once fine society. Whilst the trend need not continue, there's little evidence that this management has any intention to stem the rate of departures. The board appears to be totally neutral on whether policyholders stay or leave and this alarms me. Isn't a duty of any board to preserve the entity? Many policyholders are considering leaving now uplifts are in place. Of course, some of them have had more than enough of Equitable Life and won't be influenced, but "conventional wisdom" is often proved wrong.

Last year, there must surely have been an intention by the Halifax to take over Equitable if the GAR liability could be capped. Whether this is still the case, now that we know the state of the Society's finances and Halifax has joined forces with the Bank of Scotland, must now be in doubt but demutualisation must one day be in prospect.

One new initiative that the board should consider is "unitising" the fund. EMAG first raised the issue with the board last September but at that time it displayed no interest in looking beyond the compromise. Currently the Equitable has all the complexity of a With Profits Fund but little prospect of any smoothing kitty to work like one. The policyholders all thought they bought into an equity-based, smoothed fund wheras currently they are invested in bonds, with only one third in equities and little immediate prospect of change. It is virtually a managed fund, whose value will go up and down with the market, but without the transparency of a unit-linked operation. A unit-linked fund doesn't need a smoothing kitty, so all the value is reflected in the unit price. Although conversion would be difficult, if Mr Treves embraced the idea I am confident members would support him. Some of those considering moving elsewhere might think twice if they could see transparently the value of their assets and not have to rely on actuarial "smoke and mirrors" they have learnt to mistrust.


So it's not all bad news for the Equitable. If enough policyholders, present and past, combine together with my group EMAG and hopefully the board to put real pressure on the Treasury, we may yet succeed in extracting much deserved compensation from the series of culpable Regulators. And the opportunity is there for Mr. Treves to apply some new imaginative thinking on how to stabilise and re-jig the closed fund for the future prosperity of policyholders. It's certainly the end of the beginning but it need not be the beginning of the end. EMAG fights on!

Paul Braithwaite
Chairman of EMAG