Annex B - Key submissions received

Excerpts from letters from Lord Penrose (22 May and 7 July 2004)

EQUITABLE LIFE

As you know, my remit was to enquire into the circumstances leading to the position at Equitable as at 31 August 2001, to identify lessons to be learnt for the future conduct, administration and regulation of life assurance business and to report to Treasury Ministers. That exercise was completed with the delivery of the report, and I have now returned to full time judicial duties. My team has been disbanded and I do not have any continuing support in relation to the affairs of Equitable Life. That appears to me to be right and proper. It was not envisaged that I should have a continuing remit in this matter and finality had to be achieved with the delivery of the report.

Quite apart from the practical implications that arise, however, the report had to express my final views on the matters I was asked to investigate. It would be inappropriate for me to seek to enlarge on the contents of the report, or to engage in any discussions that could detract from, or be thought to detract from, the views I have expressed. The implications of the report remain a matter of controversy, as appears from continuing comment in the press, at the Society's general meetings, and in political circles. As a serving judge I cannot make a contribution to the continuing debate, and I have no wish to do so.

It appears to me to be equally clear that I should have no part in your consideration whether to conduct a further investigation. In carrying out your function you will, I think inevitably, have access to different evidence from the evidence I had available, and the issues you will have to consider, within the terms of your remit, will, equally inevitably, be different from those that engaged my attention as reporter. It would have been, and remains, outside the scope of my remit as reporter to form and express views on the issues you have to consider. It would certainly be inappropriate for me as judge to form and express views that might become the subject of challenge in judicial review proceedings brought against you…

… Policyholders cannot, of course, be expected to understand, as you and I must, the constitutional conventions derived from the separation of powers that preclude a serving judge from involvement in Parliamentary processes such as you conduct. No one with the authority to do so has yet suggested that I should demit judicial office in order to take some further part in this affair! Nor has it been suggested that there is any appropriate role that I could have in an independent judicial capacity…

… I appreciate that all of this might seem unhelpful and, indeed, obstructive. In some respects that may be the result, but it is not the objective, of the decision I have taken. I have an interest in protecting the integrity of my own work, such as it is, and in the final analysis I must approach the issues raised with that in mind. I regret that I do not think it appropriate to meet you to discuss my report in the light of the exercise on which you have embarked.

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Letter from the Chairman of the Public Administration Select Committee (26 May 2004)

EQUITABLE LIFE

Thank you for your letter of 22 April inviting the Committee's views on whether you should carry out a further investigation into the regulation of Equitable Life and if so in respect of which period and matters. You said in evidence to the Committee that you would consider whether to carry out any further investigation once Penrose had reported and we welcome the extensive consultation you are currently undertaking.

Lord Penrose concluded that the main thrust of his criticism was, "that for the most part it was the system that failed to provide the regulation that changing circumstances in the industry required, not that there was failure to implement what was fundamentally a satisfactory system" (Chapter 20, para 69). Nonetheless he prefaced that conclusion by stating that in the report he had been "critical of the regulatory system, and on occasion critical of the performance of the regulators and their advisers". Moreover his eleventh key finding was that, "There was a general failure on the part of the regulators and GAD to follow up issues that arose in the course of their regulation of the Society, and to mount effective challenge of the management" (Chapter 19, para 240). This suggests there is a prima facie case for investigating potential maladministration.

Therefore it seems to us that:

Firstly you should now carry out a further investigation. The investigation should encompass the same period covered by the Penrose report. The scope of that investigation should also be as wide as possible in terms of the bodies to be examined.

Secondly you should begin by setting out the limits of your jurisdiction as you understand them to be. In your evidence to us on 27 November we discussed some of the difficulties surrounding your ability to pursue maladministration leading to injustice and possible redress in a context where both some of the bodies and conduct of business regulation were not under your jurisdiction. We assume your limitation primarily involves the Government Actuaries Department (GAD).

Thirdly and consequently you should also set out clearly what extension to your jurisdiction you would need to ensure that you are not hampered needlessly by jurisdictional issues. The Committee, as no doubt others in the House, would support your approach to Ministers to ensure speedy passage of the necessary secondary legislation amending Schedule II of the Act as appropriate.

Fourthly when embarking on your investigation you should also make clear a) the criteria under which you are required to undertake your investigations and b) the extent to which, subject to any findings of maladministration and injustice, you are able to recommend redress and the nature of that redress.

Fifth you reminded us in your evidence of 27 November about the difficulties you and your predecessor faced in looking at all the events and all parties involved and why Sir Michael Buckley advocated a full inquiry covering all the issues. In light of this it is important that your further investigation should be undertaken with the cooperation and assistance of Lord Penrose who has had the benefit of a comprehensive inquiry.

Lastly when you last came before the Committee your ability to give evidence with regard to Equitable Life was circumscribed by the judicial review hearing. Now that you are consulting on the way forward on Equitable Life, I am extending an invitation to you to discuss with us how you plan to take this forward, more broadly, how these sorts of inquiry should be conducted in future and the implications this may have for your Office.

Tony Wright MP 
 Chairman

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Letter from the Chairman of the Treasury Select Committee (7 May 2004)

EQUITABLE LIFE

Thank you for your letter of 22 April, asking for any Committee views on possible further investigation by you into the regulation of Equitable Life.

As you know, following the publication of the Penrose Report, the Committee took evidence on Tuesday 16 March from Lord Penrose and from Ruth Kelly. This added to the information in the public domain. However, apart from observations on the general lessons for the development of the long-term savings industry which will be discussed in our planned report on that subject, we have no current plans to prepare a report or do further work on Equitable as such.

Members of the Committee will have their own views on the way forward from here, and will have received your letter to each individual Member of the House. In these circumstances I think it would be appropriate for me to leave it to each Member of the Committee to respond to you individually.

John McFall MP 
 Chairman

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Letter from Andrew Tyrie MP on behalf of the Official Opposition (29 April 2004)

Thank you for your letter of 22nd April inviting representations from MPs on "whether and, if so, in respect of which period and matters, I should carry out any further investigation into the regulation of Equitable Life."

Your letter was timely, and very welcome in view of the publication of Lord Penrose's Report, on 8th March.

The regulatory failure identified by Lord Penrose is particularly well suited to an investigation by the Ombudsman for maladministration. The high regard in which your office is held depends on thorough investigation of such cases.

In summary, I consider that

• you should conduct a further investigation;  
• the purpose of your investigation should be to investigate whether any public bodies concerned with the regulation of Equitable Life were guilty of maladministration;
• where any maladministration is found and where, as a consequence, losses have been sustained by policy-holders and annuitants, you should make recommendations for remedy;  
• the period covered by your investigation should be the same as that covered by Lord Penrose's report; 
• you should invite Lord Penrose to assist you in the investigation;  - you should reconsider your earlier decision not to investigate the Government Actuary's Department (GAD);   
• if, after that reconsideration, you still believe such an investigation into the GAD to be beyond your jurisdiction, you should immediately recommend to the government that they request parliament for an extension of your powers of investigation to include the GAD.

Lord Penrose's Report identified regulatory failure both of the system of regulation and of its operation over a sustained period, and particularly throughout the 1990s. These are documented in detail in, among others, Chapters 15 to 18. No doubt you will already be examining Lord Penrose's findings of regulatory failure in the short period covered by your first report, from 1st January 1999 to 8th December 2000. The scale of the regulatory failure identified by Lord Penrose prior to that period, and the accompanying detail he provides, also require investigation. Of the whole period Lord Penrose states: "There was a general failure on the part of the regulators and the GAD"¹. He writes of 1998, that "GAD's approach over this period seems to me to have been persistently naïve."² In his conclusions, he describes the Department for Trade and Industry and the Treasury (who were between them responsible for prudential regulation from the early 1980s until 1st January 1999) as "ill-equipped"³ and the GAD as "complacent".⁴ Lord Penrose notes "short-term objectives related to support of solvency that should have alerted regulators to the Society's weakening position." ⁵ He says that "information was not used to form a realistic appraisal of the society's financial position" ⁶ and that "unsatisfactory answers were accepted without follow up". ⁷

The events described by Lord Penrose which led to these and other conclusions of regulatory failure are very extensive. Among those which would benefit from investigation for maladministration are that public bodies:

• allowed the Society to accumulate huge contingent liabilities by selling unguaranteed policies without ring-fencing the funding of Guaranteed Annuity Rate (GAR) policies and without declaring that those prior guaranteed policies existed;  
• failed to discover that the Society was not reserving for the guarantees expressly contained in the GAR policies; - endorsed the Society's attempt to redress the balance by paying differential bonuses, later ruled illegal; 
• permitted the publication of inadequate accounts and the submission of inadequate regulatory returns which obscured the financial weakness of the Society;  
• failed to recognise the inadequacy of the reinsurance policy negotiated to cover reversionary bonuses for GARs in late 1998 and early 1999; 
• allowed the Society to "over-bonus" for many years;  
• allowed the Society to trade with totally inadequate reserves and to claim throughout that they were selling a lowrisk product, coupled with prudent management and the benefits of mutuality.

The GAD was the subject of particular criticism by Lord Penrose. In your first report you took the view that the GAD was outside your jurisdiction and gave your reasons. I strongly urge you to reconsider that view. In evidence to the Public Administration Committee you said you were influenced by the description of the GAD in government documentation "as a separate department rather than subordinate to the Treasury"⁸. However, after taking evidence from the Treasury and the GAD the Treasury Select Committee concluded that the GAD was a "non-Ministerial government department . . . to provide actuarial advice to Ministers"⁹ and that it "does not have policy-making responsibilities of its own." I know of no advisory government department, the accountability for which does not flow through a Minister. In this case, responsibility for the GAD clearly lies with the Treasury. The GAD is therefore not independent but subordinate to the Treasury, a department maladministration of which may be subject to investigation by you. You will, in any case, want to consider whether the Department of Trade and Industry and the Treasury asked the right questions of the GAD and acted correctly on the responses.

Should you feel unable to reconsider your earlier conclusion that the GAD was beyond your jurisdiction I strongly urge you to invite the government to obtain parliamentary authority to add the GAD to the list of bodies which you can investigate. This can quickly and easily be done by amending Schedule 2 to the 1967 Act, using a negative Statutory Instrument.

The addition of the GAD to your list of responsibilities will not preclude a retrospective investigation for maladministration. The Parliamentary Commissioner Act 1967 enables you to extend an enquiry beyond the period of 12 months before a complaint was made if the Ombudsman "considers that there are special circumstances which make it proper to do so." (6.3) I consider that the long and detailed investigation of Lord Penrose, and his findings, constitute "special circumstances". Further clarification of Parliament's intentions with respect to retrospection is provided by Clause 14 (3) which states that "a complaint under this Act may be made in respect of matters which arose before the commencement of this Act". This presumably would be expected to apply also to complaints made in respect of matters covered by an extension of the Act's scope. In the House on 24th March the Financial Secretary to the Treasury, Ruth Kelly, dismissed my suggestion that the GAD should be added to your list of responsibilities on the grounds that such retrospection was not permitted. She has recently reversed her view on retrospection in a letter to me, which I attach.

Of course, your view on the period that should be covered by your investigation relates to all the relevant public bodies, not just the GAD. As you pointed out last year, it was a decision of your predecessor to limit the period of investigation to less than two years. I consider that the special circumstances brought about by Lord Penrose's Report warrant an extension of your investigation to include the whole of the period covered by him.

In your earlier report you distinguished between public bodies falling within your jurisdiction when they were acting as the prudential regulator and conduct of business regulation, which falls outside your jurisdiction. Having examined the Penrose Report, I am not persuaded that this should be a substantial bar to your work. A very large proportion of the regulatory failure identified by Lord Penrose was of the prudential kind. Furthermore, prudential regulation and conduct of business regulation was, in certain periods, carried out by the same bodies. For example, from 1st June 1998, the Personal Investment Authority, which had responsibility for conduct of business regulation since 1994, contracted out its role to the FSA. The FSA also became responsible for prudential regulation six months later.

I strongly urge you to invite Lord Penrose to participate as fully as possible in your further investigation for two reasons. First, his lengthy investigation has left him uniquely well placed to assist you. Secondly, his involvement will enable you to conduct your inquiry more quickly, without any loss of thoroughness. Minimising the delay will reduce further uncertainty about the industry created by the Equitable Life affair. Even more important, minimising further delay is essential for those most deeply affected: we are dealing with nearly a million policy-holders and annuitants, a high proportion of whom are elderly and vulnerable. All of us owe it to them to complete this essential work as quickly as possible.

This letter represents the views of the official Opposition and, with that in mind, I would be very grateful for an opportunity to meet you to discuss these issues further.

Andrew Tyrie
 Shadow Financial Secretary

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Letter from Vincent Cable MP and Norman Lamb MP on behalf of the Liberal Democrats (13 May 2004)

EQUITABLE LIFE

Thank you for your letter of 22 April. My colleague Norman Lamb and I are writing on behalf of Liberal Democrat MPs responding to your request for representations to be made to you as to whether you should carry out further investigations into the regulation of Equitable Life.

Early Day Motion 1090

Our view is outlined in the wording of EDM 1090, co-signed by Norman Lamb and myself. This notes that the Penrose Report identified operational regulatory failure as well as failings of the regulatory system. As such it is now appropriate for an assessment to be made as to whether such failure amounts to maladministration.

Findings of Lord Penrose

When you originally agreed to investigate whether there had been maladministration during the period when the FSA was acting as regulator on behalf of the Treasury, you made it clear that you would wait for the Penrose Report to be published before deciding whether to expand your enquiry to look at the earlier period. Lord Penrose conducted an exhaustive investigation of this period. It seems now to be appropriate for you to determine findings of fault amount to maladministration.

As I noted in my response to Ruth Kelly when Lord Penrose's report was laid before the house on the 8th March 2004 there are several areas which Lord Penrose identified as regulatory failures which went beyond systemic failure. Those I mentioned were:

- The DTI's appointed actuary also being Chief Executive of Equitable in the period between 1991-1997 Penrose, section 240 (7)

- The government in its regulation did not take into account that a number of measures used to finance the Society's solvency position were predicated on the emergence of a future surplus: section 240 (10)

- A wider failure by the GAD to follow up any issues that arose in the course of their regulation and to mount effective challenge of the management, section 240 (11)

The crucial question is whether these criticisms by Lord Penrose amount to maladministration. It is not for Members of Parliament to make that judgement. This is properly a matter for you to investigate. This is not without precedent. The Parliamentary Ombudsman's follow up to the Le Quesne report into Barlow Clowes in 1988/1989 followed this course of action.

Lord Penrose's remit

Crucially, Lord Penrose was not asked and nor did he look at whether there was a case to answer over maladministration. He made this clear in his report and when later questioned by the Treasury Select Committee:

Q631 Norman Lamb:… Lord Penrose. I fully understand the "gates" you say you have to go through in order to establish a link between failure and loss that might result from it; but saying you cannot infer one from the other crucially is not the same that you do not rule it out. It is simply not part of your remit?

Lord Penrose: That is so

Q632 Norman Lamb: So you cannot rule out the possibility that compensation does flow from failures of the regulatory system?

Lord Penrose: I have sought to avoid adjudicating one way or the other. 

Examination of Witnesses (Questions 620-639, 16th March 2004)

The issue of maladministration is particularly relevant to the Government Actuaries Department. I appreciate that the GAD is not currently within your remit and thus you cannot investigate any case of potential maladministration within the GAD. However after cross party pressure Ruth Kelly has conceded that the GAD could be added to the list of bodies you can investigate. Ruth Kelly has since written to confirm that she would consider extending your remit following a request from yourself.

Can I therefore urge you to request from Ruth Kelly that the Government Actuaries Department be added to the list of bodies you can investigate. Following that can I ask that you reopen your enquiries into maladministration in the case of Equitable Life more broadly?

Vincent Cable MP 
 Lib Dem Shadow Chancellor 

Norman Lamb MP
 Treasury Select Committee member

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Letter from the Equitable Members' Action Group (EMAG) (18 May 2004)

In advance of our meeting next week I enclose EMAG's response to your consultation request.

We understand that the Government has indicated that it would accede to a request from you to extend your jurisdiction retrospectively to the Government Actuary's Department. We believe that any further investigation by you would be meaningless without such jurisdiction and recommend that you request such powers.

In Chapter 20 Lord Penrose says:

64. One of the regulators involved with Equitable referred to the boundary between prudential and conduct of business regulation as more an awkwardness than a lacuna. While that may be a fair comment on how the two branches were intended to operate, in practice the lack of co-ordination of prudential and conduct of business regulation in relation to the Society was unacceptable. The Society's changes of policy forms and of the guarantees provided is a typical area where there was a role for each regulator. The conduct of business team were no doubt interested to ensure that the prospectus met the requirements of the disclosure. There may be questions whether the risks were adequately focused in the Society's literature in any event. But the risks could not have been assessed by the conduct of business regulator without reference to the prudential regulator. Had this happened, it might have focused attention on the implications of the low free asset ratio for new policyholders.

In the light of his comments, you might usefully consider whether your jurisdiction could be extended to cover the relevant 'conduct of business' regulator.

Colin Slater
 Deputy Chairman

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EMAG’s Criticism of the Parliamentary Ombudsman’s first report on Equitable Life. Updated in the light of Lord Penrose’s report.

PART I - POINTS OF PRINCIPLE DISCLOSED BY LORD PENROSE

The original report of the Parliamentary Ombudsman Ann Abraham ('PO') covered only the period from 1st January 1999 to 8th December 2000. It considered only one 'representative' investor, Stewart Simpson ('Mr P'), who bought a with-profit annuity in June 2000, just before the House of Lords decided against Equitable Life's differential terminal bonus policy in Hyman case.

Limitations of Time and Scope

Penrose makes it clear that the real failure of regulation occurred during the period 1987- 1998. The PO restricted her investigation to the period of the FSA's involvement 1999-2000. The critical period was not covered.

The PO claims that the Government Actuary's Department ('GAD') is outside her jurisdiction. It is accepted that it is not on the 'list' contained in the Parliamentary Commissioner Act. However that Act does give her to jurisdiction over 'unlisted' departments acting 'on behalf of' listed ones. This is how she investigated the FSA, which is also 'unlisted'. Her theory is that GAD acted only as advisers, whilst the empowered regulator (Department of Trade and Industry 'DTI' to 1997, Treasury 1998-2000) carried the responsibility. Penrose reports that in practice the DTI was incapable of fulfilling its functions and 'for all practical purposes, scrutiny of the actuarial functioning of life offices was in the hands of GAD until the reorganisation under FSA was in place [in 2001].' In short GAD did most of the job. Why should policyholders be denied access to justice because a part of a listed department's (DTI) functions were subcontracted to an unlisted one (GAD)?

Key New Evidence (a)

Each year the Society's actuaries were required to present a 'solvency' return to the regulators comparing, on the one hand, its contractual liabilities (excluding terminal bonuses) to policyholders with, on the other hand, its assets. This was a lengthy and technical appraisal and was studied by the regulators. Lord Penrose shows that, in presenting these returns, the Society's actuaries consistently used the least prudent methods of valuation and indulged in several practices of 'dubious actuarial merit'. These included:

1. valuing future liabilities at an inappropriate rate of interest. This typically understated those liabilities in the period 1990-1996 by about £500 million
2. treating selling costs as an asset, estimated in 2000 at £900 million
3. making no provision for the guaranteed annuity rate ('GAR') cost applicable to the (undisputed) contractual liabilities until much too late
4. valuing a financial re-insurance policy, which proved to be worthless, at over £800 million in the years 1998-2000
5. placing increasing reliance on 'future profits' allowances (from £250 million in 1994 to £1,000 million in 2000)
6. taking on a 'subordinated loan' of £346 million in 1997 which was not counted as a liability

Lord Penrose revises the solvency figures eliminating items 4-6. For no explained reason, he makes no adjustment for items 1-3. Had he done so, Equitable Life would appear to have been technically insolvent for the whole decade of the 1990s.

Lord Penrose makes it clear that the regulators lacked confidence, consistency and robustness in countering these devices. Only the re-insurance policy was considered in detail by the PO's report.

Key New Evidence (b)

Lord Penrose attributes part of Equitable Life's demise to its persistent practice of voting bonuses well in excess of assets (over-bonusing). He chronicles the movement of the realistic financial position shown by the 'office valuation', which compared the aggregate of policy values indicated to members (including terminal bonuses) with the value of assets available to support it. It discloses a deficiency of assets ('un-funded policy value position') from 1989 onwards.

The above figures include a substantial allowance for GAR costs only in 2000. The office valuation confirms the validity of the conclusions reached in the report that EMAG commissioned from Chartered Accountants Burgess Hodgson, which was published in March 2003.

The table demonstrates that Equitable Life's 'smoothing kitty' was overdrawn throughout the 1990s culminating in an 'overdraft' of £3,057m at 31st Dec 2000. Lord Penrose estimates that about £1,800m of this related to excess bonuses paid out to departing policyholders during that decade. Equitable Life was running a Ponzi-type scheme.

Lord Penrose shows that by June 2001 the asset deficit from all sources had grown to £4 bn and he says that overbonusing was a 'major contributory factor to the weakness that required a substantial reduction in policy values in July 2001' (Chapter 19 Paragraph 56). He confirms that this cut applied to with profit annuitants as well as to pension and endowment investors. Because the cut related to policy values rather than bonuses, late joiners such as Mr P were particularly hard hit. They had enjoyed little or no benefit from past excess bonuses, but their policy values (effectively the amounts they had invested) were cut anyway.

The PO's report did not sufficiently consider this aspect of the Society's finances.

Lord Penrose described the smoothing of a with profit fund as follows (Paragraph 62 Chapter 19):

'Smoothing is generally taken to imply that payout ratios should average 100% of a projected norm over time, with aggregate policy values and payouts running below the level of available assets during market peaks, and above the level during downturns. A rigorous and prudent adherence to a clearly defined set of smoothing parameters would appear to be all the more essential in a fund that is being operated on the basis of a policy of full distribution and no estate [as Equitable Life operated].'

In short, the existence of deficits in years when the stock market was low (e.g. 1990 and 1994) might have been acceptable if there were surpluses in years when it was high (e.g. 1993 and 1996-1999).

Lord Penrose says 'In and after 1989, when the Society adopted a new approach to accumulating policy values, the failure to recognise accruing final bonus in its entirety was untenable, having regard to the terms of the statute and to the Society's publications and communications with policyholders.' (Chapter 19 Paragraph 75)

Representations were apparently made to him by the Society itself, by GAD, by the Treasury and by the FSA that the pattern of values shown above constituted an appropriate smoothing policy. Lord Penrose rejects this approach.

'Apart from the absence of a consistently expressed and coherently followed smoothing policy (of which more below), it is hard to reconcile what the inquiry has found with any credible approach to smoothing. The Society's pattern of 'smoothing across the peaks' (to borrow Headdon's phrase) did not represent, and could not have represented, a credible approach to smoothing for a mutual espousing the principles the Society did.' (Chapter 19 Paragraph 240, emphasis added).

The Treasury, on advice, has now, as we believe rightly, accepted the correctness of Lord Penrose's view. The PO's report accepted the now discredited Equitable/GAD/FSA line.

Incorrect interpretation of Regulator's Responsibilities and Powers

In addition to maintaining technical solvency, the 1982 Insurance Companies Act requires the regulator to assess whether the long-term insurer can meet policyholders reasonable expectations ('PRE'). Unlike most with-profit companies Equitable Life created its own quite specific PRE by sending members annual policy valuations. These were not 'funny money' estimates of prospective future entitlements, but were current values, upon which actual payments to departing policyholders were based.

Lord Penrose says that the regulator (DTI) asked for and received the responsibility to police and the powers to enforce Policyholders Reasonable Expectations in respect of the maintenance of a smoothing fund. His report demonstrates that the policing was badly done and the enforcement powers were not used:

'The regulators acted as if they had power to investigate PRE with a view to taking action, and I believe that they were right to do so. They never got round to taking such action, but that is a different matter.' (Chapter 15 paragraph 18)

The PO largely ignored PRE and the responsibilities placed upon the DTI and (later) the Treasury by the Insurance Companies Act and regulations issued under it. In particular, she made no attempt to consider the effect of a part of all new investment being used to make excessive payments to departing policyholders. She accepted the regulators' excuse that the concept of 'light touch' prevented them identifying the problem and taking action, notwithstanding the draconian powers available to them under the Act.

Penrose stresses the regulators' statutory responsibilities and barely mentions the 'light touch' concept. The principle, as we understand it, rejects heavy additional reporting requirements, but expects the regulator to act where he picks up PRE issues from the solvency returns. If he does so, the Insurance Companies Act 1982 gives the regulator wide powers to protect PRE. Lord Penrose reports that the PRE numbers (the office valuation) were actually supplied to the regulator from 1991 onwards. The figures (reproduced in the above table) consistently showed a deficit of asset vales as compared to the aggregate of policy values represented to members. Lord Penrose's report shows that the regulators took no effective action to protect PRE in the form of Equitable Life's promise of a 'smoothed asset share'.

PART II - SPECIFIC MATTERS

In addition, Lord Penrose takes a more rigorous view of some of the regulatory actions 'cleared' by the PO.

The FSA's Gross Error of Judgement and Administrative Failure

The main complaint against the FSA during the limited period covered by the PO's Report was the undue reliance that it placed upon the Society's market value. Equitable Life was allowed to continue to trade and advertise aggressively after it lost in the Court of Appeal (January 2000) and even after it lost in the House of Lords (July 2000) on the assumption of a substantial market value (£3 to £5 billion). In the event no one was prepared to pay anything at all for Equitable Life's goodwill.

Bidders were surprised by the poor state of the Society's finances and by the risks inherent in the fund. They concluded that the cost of making good the asset deficit was greater than the goodwill of the world's oldest life insurer running a £30 billion fund. They came to that conclusion in a matter of weeks.

Lord Penrose report shows that the FSA and its predecessors had known for almost a decade that the Society had a deficiency of assets, which any purchaser would need to make good out of whatever amount he was prepared to pay for the business. Nevertheless the FSA with little thought or calculation, managed to assume that Equitable Life's goodwill carried a substantial value. The FSA were wrong to the tune of several thousand million pounds.

Lord Penrose says:

'…it remains my view that the regulators' inability to make an independent and reliable assessment of the Society's financial position from information gathered through the regulatory process at this critical stage was a serious impediment, and is a further indication that there are serious issues about the effectiveness of regulation generally at that time.' (Chapter 18 Paragraph 63)

This valuation was crucial to Mr P's case, since the FSA deliberately sacrificed his and many other 'late joiners' interests so as to safeguard existing policyholders' rights to this goodwill.

Of the absence of a 'Plan B' Lord Penrose says:

'The question that regulators and GAD failed properly to address was not whether the actual result [of the Hyman case - July 2000] should reasonably have been anticipated, but whether the outcome was within the range of possible results for which contingency planning should have been in place so as to instruct their enquiries and supervision over the material period. As discussed above, the possibility of failure was included in the list of scenarios, but that did not lead to significant planning for the event.' (Chapter 18 Paragraph 66)

Of the failure of the FSA to protect the interests of 'late-joiners' Lord Penrose expressed concern.

'It appears that the regulators proceeded on an assumption that, if anyone were disadvantaged by the decision, compensation would be available. No legal assurance was sought that this would be so, and there was no examination of the legal issues involved. There was no recognition recorded that, if compensation claims were sustained, those claims would be at the expense of the with-profits fund, nor any attempt to quantify the risks to which potential policyholders were exposed relative to the benefit claimed by management for continuing to trade. No consideration was given to measures that might have mitigated the potential for subsequent claims of misrepresentation. The Society was even permitted to continue its advertising, and so those taking new or further policies with the Society did so by invitation and not as mere volunteers, without the risks of doing so being made known to them.' (Chapter 18 Paragraph 115).

He goes on to suggest an obvious but unconsidered alternative. 'Be there might have been contractual options open in the case of new contracts at least that would have allowed for penalty-free transfer of funds to another provider, for example, in the event of failure of the sale: that could have been seen as an appropriate counterpart of the proposal to exclude such policyholders from the benefit of the proceeds of sale. Other possibilities could no doubt have been developed. To allow business to continue without exploring means of protecting those who were exposed to risk by the decision, and relying on an untested view that there would be a remedy was unfortunate.' (Chapter 18 Paragraph 116)

In short, Lord Penrose exposes the regulators' failure to discharge their responsibilities to investors in 2000, in a way not appreciated by the PO, who had less knowledge of Equitable Life's history and practices and less detailed understanding of the regulators' duties and powers.

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The Re-Insurance Policy

During 1999 the Society bolstered its technical solvency position by taking out a re-insurance policy with Irish European Reinsurance Company Limited. The contract was at best an agreement to refinance GAR costs and at worst a sham.

Lord Penrose found it 'difficult, if not impossible' to bring the refinancing arrangement with Irish European Reinsurance Company Limited within the scope of the regulations. He said 'Treating the contingent rights of the Society as a present asset appears to involve a very strained construction of the regulation' (Paragraph 105 Chapter 7). Even if it were allowed, he found the sums ascribed to it [over £800m] were 'disproportionate to the benefit understood by the Society and regulators to be conferred by the treaty.' The regulators bent over backwards to facilitate this arrangement, giving credit in the 1998 return, even though the agreement was not signed until September 1999. They also knew that Irish European was taking no real risk. Other re-insurers had suggested very much higher premiums for policies that did take on real risk.

The PO considered that episode and cleared the FSA of mal-administration. In the light of Lord Penrose's analysis we believe she was wrong to do so.

In addition to points upon which Lord Penrose sheds more light, EMAG found other unsatisfactory aspects of the PO's report including factual errors, which we have been able to identify from our own knowledge.

Errors in taking evidence leading to factual mistakes

In exercising the quasi-judicial role of Parliamentary Ombudsman Ms Abraham erred in taking extensive evidence from those complained about, but NONE AT ALL from the complainants or anyone else who might have contributed some degree of balance to the process.

The PO clearly but mistakenly believed that Mr P (the complainant) was able to transfer his investment in Equitable Life elsewhere. He is not so able; with-profit annuitants are locked in. This is a simple but crucial error of FACT. She also criticised Mr P for nor taking professional advice, which was also incorrect in fact. The PO did not check either matter with Mr P. She did not interview him at all before publishing her report.

The report describes a meeting of an ELAS spokesman (Alistair Dunbar) with members of the Equitable Members Action Group (EMAG) in 2000. Notes taken at the time and then published on the EMAG web-site record doubt as to ELAS ability to meet its solvency requirements. At least one of those present (Tom Lake) is a continuing EMAG committee member.

The PO discounted that evidence, by quoting the response of the Society's current lawyers, who were NOT appointed at that time and were NOT present at the meeting. She took no steps to verify the position with Tom Lake or indeed anyone who had been present at the meeting (including apparently Mr Dunbar, who still works for Equitable Life).

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PART III - SUMMARY OF CRITICISMS

Points of Principle

Lord Penrose's report undermines the basis of the PO's report in the following fundamental ways:

1) The PO's report did not consider the over-bonusing, which was a contributory factor in the Society's demise and in the losses sustained by those who held policies on 16th July 2001 and thus suffered the policy value cuts.

2) The PO's report did not consider the question of PRE in the context of the relationship between policy values and assets. To the extent that she knew about the asset deficit, she accepted the Equitable Life/GAD/FSA line that it was part of its smoothing policy. Penrose conclusively discredits this approach.

3) The PO's report accepted the regulators line that the 'light touch' approach required them to consider only 'technical solvency' (which ignored terminal bonuses) and virtually to ignore PRE in the context of balancing total policy values (including terminal bonuses) against assets. Lord Penrose found that the regulators had the responsibility and the powers to police PRE, but shows that they were ineffective.

4) The PO's report examined only some of the practices of dubious actuarial merit by which the Society maintained its technical solvency.

5) The PO's report covers a short period, long after the real damage was done

6) The PO's report claims to lack jurisdiction over the GAD, whose actions (and in-actions) were criticised by Lord Penrose. His descriptions of the manner, in which GAD worked, supports the view that it carried out part of the regulatory functions of the DTI, which was ill-equipped for the role. In our view this brings GAD within the jurisdiction of the PO.

Specific Matters

Lord Penrose correctly identified the regulatory failures, which were insufficiently considered by the PO.

1) The regulators failed to use the information and powers at their disposal to make a reasonable assessment of how much of the total amount a purchaser might pay for the Society's business would be consumed by the need to make good the asset deficit. Given the previous history of misconduct of the Society's affairs, of which the regulators had notice, they should have been extremely dubious about accepting the director's assurances that the Society's business could be sold. In fact they assumed those assurances were well formed and sacrificed the interests of 'late-joiners' to protect a goodwill value that proved to be illusory.

2) The regulators considered no 'Plan B' in the event that a sale could not be achieved.

3) The regulators failed to insist upon even the simplest steps to be taken to protect late joiners, instead relying upon untested legal remedies.

4) The regulators accepted a high value for the re-insurance agreement, whereas in fact it was effectively worthless.

In addition:

5) In EMAG's view, the PO's original report was unbalanced in taking evidence, which led to both factual errors and undue influence from those being investigated

In the light of the factors shown in Lord Penrose's report the PO's earlier report was clearly prepared upon unsuitable assumptions, did not investigate the actions and in-actions of regulators with appropriate rigour, was biased in taking evidence and should be withdrawn.

PART IV QUESTIONS RAISED BY LORD PENROSE'S REPORT

Lord Penrose was not instructed to apportion blame. However his report provides ample evidence for policyholders to form their own views. Obviously the main fault lies with the old directors. However they could not have perpetrated their activities for as long as they did and get the Society into a state of terminal decline, without a regulatory system that was badly organised, lacking in rigour and self-confidence and almost totally ineffectual. Policyholders have a right to be outraged that a major insurer was so badly regulated. They are also entitled to ask the Parliamentary Ombudsman to investigate aspects of this fiasco for mal-administration. Examples include:

a) Regulators did not identify that guaranteed annuity rates would become a problem as interest rates fell during the 1980s, even though it was inherent in the deferred annuity contract that was widely used by the industry for pension provision from the mid 1950s until the late 1980s. By the time the matter was belatedly examined by the actuarial bodies in 1997 it was estimated that policies worth £35 billion were involved. Why not? Whose job was it? Why was it not done?

b) In 1989 Equitable Life actuary executives Roy Ranson and Chris Headdon published 'With Profits Without Mystery'. This was a technical statement for the actuarial profession of how Equitable Life was run. It disclosed that Equitable operated without an 'estate' of surplus assets that helped other companies finance expansion and provided security for the inevitable 'rainy days'. It also set out the Society's intention to distribute profits fully as they arose. This should have put regulators on their guard that Equitable was taking unusual risks, but there is no indication that it did. Why not?

c) The amazing fact revealed by Lord Penrose is that the awful state of the Society's affairs in 1990 (assets fell short of values indicated to policyholders by 28%) was reported to GAD in 1991. This should surely have initiated closer inspection of Equitable Life's finances, which might have revealed its substantial guaranteed annuity rate problem and the practices of dubious actuarial merit that it used to bolster its technical solvency. Why was no such inspection undertaken?

d) Roy Ranson appears to have supplied GAD with the 1990 figures in the expectation that the department would take no action, would be 'implicated' in the Society's wrongdoing and consequently allow him plenty of time to turn things around. His poor opinion of GAD was justified by events. How was this allowed to happen?

e) Lord Penrose further reveals that the 'office valuation' figures for later years were supplied to GAD from time to time and both could and should have been required every year. Yet as individual scrutinising actuaries changed the matter seems to have been 'forgotten'. For example, it was not used to illuminate annual decisions on 'future profit' allowances. Why not?

f) The weakness of the Society's finances was not communicated to the conduct of business regulators, who may well have taken action upon the clear conflict between Equitable Life's 'safe and prudent' projection of its activities and the facts of its finances. How many policyholders would have started/continued to invest in the Society if they had known that their terminal bonuses were only partly covered by assets even at stock market peaks and that the Society's much vaunted past performance was largely hot air? Why were conduct of business regulators not informed?

g) Lord Penrose reveals that even the solvency numbers, which GAD studied in detail, were riddled with imprudent assumptions and practices of dubious actuarial merit. Why were none of these found and acted upon?

h) Bidders for Equitable Life were surprised by the poor state of its finances and by the practices that the regulators had allowed it use. They were clearly concerned that if they acquired the business the regulators would require them to inject money to fill the holes. Did regulators adopt a different (much lower) standard for Equitable Life than they applied to the rest of the industry? If so, why?

i) The Burgess Hodgson report showed that the non-profit (conventional annuity) side of the Society's business was a drain on its finances during the 1990s. Lord Penrose report effectively confirms that this was the case, but does not say so explicitly. Was this aspect being run at a loss? Should regulators have identified it? This is important, because any loss was being borne by the with profit investors. Furthermore the Society repeatedly included in its investment performance claims, growth which supported the non-profit side, which was not available to with-profit investors and which exaggerated the apparently healthy margin between growth and distribution. The Society's presentation was misleading. Should not the regulators have identified this? Should they not have insisted in changes of presentation?

j) The DTI allowed Roy Ranson to hold the conflicting roles of both Appointed Actuary and Chief Executive during the critical early years of the 1990s. This was clearly against their considered judgement. It must have been apparent from 'site visits' that Ranson dominated Equitable Life at this time. Why did they allow it?

k) It is known that in addition to its regulatory functions GAD also advised other public service departments upon pension matters. For example civil servants, MPs, judges and health workers all had policies with Equitable Life. Did this conflict of interest affect the way the Society was regulated?

Finally, Lord Penrose has identified relevant issues that were not properly considered in Parliamentary Ombudsman's first report.

l) The Treasury demanded that full provision for GAR costs be made in the 1998 solvency return. To have done so would have rendered Equitable virtually insolvent. When threatened with judicial review the Treasury backed down. Why?

m) Lord Penrose concluded 'In the case of the reinsurance agreement, it is not clear on what basis the Society was permitted to take the credit against its potential annuity guarantee liability that it did [£800+ million].' Why was that credit allowed? How was the amount justified?

n) Lord Penrose reports that in spite of the information gathered over many years the regulators were not able to make a reliable assessment of the Society's financial position to assess the prospects of a sale in 2000. As a result the FSA failed to protect the interests of 'late joiners' such as Mr P. Why was this? Why was there no 'Plan B'?

PART V CONCLUSION

There is ample evidence that the PO's first report looked at the wrong period and the wrong people and was based on a wrong interpretation of the regulators' duties and powers. It should be withdrawn forthwith and a new one prepared to address the questions raised above.

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Letter from the Chairman of Equitable Life Trapped Annuitants (ELTA) (1 May 2004)

Ms Ann Abraham, the Parliamentary Commissioner has written to me asking for some input regarding a further investigation by her office into the regulation of the above company. My response falls into two parts:

A) In my capacity as the Chairman of ELTA

As you may know, I have set up and manage a group called ELTA (Equitable Life Trapped Annuitants) that is seeking compensation through the courts for the actions of Equitable Life. To that extent, I have access to a large database of information about the members annuities and how they have been affected by the debacle surrounding this society and the failure of the relevant Government departments to conduct their affairs in a manner that the public have a reasonable right to demand from the Civil Service.

Self evidently, that information cannot be disclosed to you with out the consent of the individual member, though I am at liberty to provide you with statistical data should that be of value.

I am also able to ask members if they are prepared to put their names forward as being willing to provide their personal data, history and experiences to you should you decide that a wider survey of members and their experiences of dealing with the various Government departments would enhance the input and thus hopefully the output from your investigation.

Finally may I request that you look at the ELTA web site www.elta.org.uk review its contents particularly the various reports that can be found there that highlight the many failures of all the parties involved in this saga and not least a number of Government departments.

B) In my capacity as an Annuitant of the Society

I consider that the issues you should include in your further investigation are as follows:

a) Lord Penrose shows that Equitable's difficulties began long before 1st January 1999 at a time when the DTI was responsible for prudential regulation and thus your investigation needs to go back well before the GARs were withdrawn by the Society in 1988 and before the Society introduced the With-Profits Annuity.

b) Lord Penrose makes it clear that the GAD was acting as agent for the DTI. The work of the GAD is therefore the work of the DTI, which is a body within the scope of the Parliamentary Ombudsman's activities. This should specifically focus on why the GAD failed to act after the presentation of the With-Profits Without Mystery (WPWM) paper by Mt Headdon to the Institute of Actuaries, which was widely condemned by members at the time.

c) Lord Penrose showed that Equitable had no genuine smoothing policy as it pretended, and that it was essential to prudent management. Specifically, why the regulators allowed the Society to make such assertions, when the WPWM presentation specifically stated that the Society did not intend to keep any reserves.

d) The new inquiry must be extended back at least from the time that the Equitable's estate began to be dispersed, which is 1973. 1973 is also an important date in that it was when PRE was first given official recognition in the Insurance Companies Act of that year. This the year when Mr Sherlock and Mr Ranson took over from Maurice Ogborn, and the pivotal year when the Society decided to persist with its new sales drive to replace FSSU business in spite of swinging capital losses - as a result of which reversionary bonus levels were maintained. It's also the year in which there was a switch to non-guaranteed bonuses which didn't need to be reserved for. In essence, therefore, it was the year in which the road to selective discrimination against newer policyholders, non-disclosure and misrepresentation began.

e) The new inquiry must include the actions or inactions of these Government departments on whom the public rely to use their expertise to protect them, the public, from errors of omission or commission that lie outside their own reasonable experience.

f) The new enquiry must invite contributions from the various user associations that have been formed to protest at the action of the Society, such as ELTA, EMAG and others.

g) The new enquiry must invite contributions from a reasonable wide selection of individuals who are With-Profits Annuitants of the Society and whose experience of dealing with the Society itself and various Government departments will contribute to a greater understanding of the problems that have been created.

h) The new enquiry must invite contributions from those members of public or professional organisations that have written extensively on the Equitable Life saga and whose insights and conclusions will contribute a greater understanding of how and why the events that have occurred were actually caused.

i) When the inquiry is reopened, it must be conducted in a fair manner, which does not invite the legal challenge, which the first Report has naturally attracted. This will require procedure in accordance with natural justice, which was not perceived to have been the case with the first inquiry.

I hope you find these comments useful and if I can be of any further assistance please do not hesitate to contact me by phone or email.

Peter Scawen

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Letter from the Equitable Life Members' Help Group (EMHG) (12 May 2004)

Regarding the Parliamentary Ombudsman's request for representations on the subject or the Equitable Life situation, I should like to put forward the following representation.

The Penrose Report that was issued to the public in March 2004 points at several possibilities of regulatory failure over the period in which Lord Penrose investigated. I feel that Lord Penrose's findings deserve further investigation and the Parliamentary Ombudsman would be an ideal person to undertake such an investigation.

Lord Penrose particularly pointed his finger at the GAD which I understand could now be brought into the remit of the PO to investigate based on a statement by the minister Ruth Kelly MP this week. The GAD were "sub-contracted" to by the DTI as the DTI did not have suitable expertise in house and so they were acting under the remit of the DTI and it is important that their role is looked at.

There are various points that I would like to make that were raised by Lord Penrose regarding the regulators, which makes it important that the Parliamentary Ombudsman should make a full review.

1. Lord Penrose states "There was a general failure on the part of the regulators and the GAD"

2. He also states that during 1998 he felt that GAD's approach had been persistently naïve". He also calls them 'complacent' and states "that short-term objectives related to support of solvency that should have alerted regulators to the Society's weakening position."

3. During the period of the early 1980s through to the end of 1998 he states that both the DTI and the Treasury who had been responsible for prudential regulation over the period were 'ill equipped', they did not use information they had to appraise the Society's financial position and they accepted unsatisfactory answers without ever following them up.

It appears that Equitable was allowed to accrue large liabilities by not ring fencing the non GAR (GAR - Guaranteed Annuity Rate) policyholders from the GAR policyholders and not telling non GAR policyholders that the GAR existed. This was further exacerbated by the fact that the Society was failing to reserve for the GAR, which also seems to have been overlooked by the regulator. The House of Lords ruled that Equitable's decision to pay differential bonuses to the different type of policyholders was endorsed by the regulators.

Lord Penrose also states that Equitable was able to produce inadequate accounts and returns which obscured the underlying problems, the regulators failed to recognise the inadequacy of the re-Insurance policy negotiated by Chris Headdon in the late 1990s to cover reversionary bonuses for the GARs, they allowed Equitable to 'over bonus' over several years in spite of the fact that there were totally inadequate reserves. This should have been stopped by the regulators as the fund was a with profits one and by definition it requires a smoothing process for which the reserves appear to have been totally inadequate. Equitable stated that they were selling a low risk product, but this was definitely not the case and the result of this can now be clearly seen by the plight of the with profit annuitants.

I do hope that you take this opportunity of extending your inquiry, as a terrible wrong has been done to innocent policyholders and it would be good for all concerned to actually find out exactly where the failures were. Equitable is now automatically mentioned in the press as one of the major financial scandals, it does deserve some more in depth investigation.

I hope that you are able to get assistance from Lord Penrose and that he has not gone totally into retirement, as he must now be one of the most knowledgeable people with regards to Equitable Life.

Liz Kwantes

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Submission from the Equitable Life Assurance Society (20 May 2004)

Questions for discussion at meeting with Parliamentary Ombudsman on 25 May 2004

1. Should the Parliamentary Ombudsman carry out any further investigation into the regulation of Equitable Life, to the extent that she has jurisdiction to do so?

Yes.

2. If ELAS considers that the Ombudsman should carry out a further investigation:

(a) On what grounds does ELAS seek to persuade the Ombudsman that she should do so?

The purpose of the office of the Ombudsman is aptly summed-up by one of the leading works on public law:

'[T]here is a large residue of grievances which fit into none of the regular legal moulds, but are none the less real. A humane system of government must provide some way of assuaging them, both for the sake of justice and because accumulating discontent is a serious clog on administrative efficiency in a democratic country.(Wade & Forsyth, Administrative law, 8th Ed 2000, page 87)

The Ombudsman has the task of investigating complaints by members of the public that they have sustained injustice as a result of maladministration by bodies subject to investigation by her (s 5 PCA 1967). 'Maladministration' was defined by Sedley J in R v Parliamentary Commissioner for Administration ex parte Balchin [1998] 1 PLR 1, 11 B-E:

'it is accordingly accepted that maladministration includes bias, neglect, inattention, delay, incompetence, ineptitude, perversity, turpitude and arbitrariness in reaching a decision or exercising a discretion, but that it has nothing to do with the intrinsic merits of the decision itself'

The meaning of injustice was considered in the same case, and Sedley J adopted the definition provided in De Smith Woolf & Jowell's Judicial Review of Administrative Action, 5th Ed 1995, at paragraph 1-102:

"'Injustice' has been widely interpreted so as to cover not merely injury redressible in a court of law, but also 'the sense of outrage aroused by unfair or incompetent administration, even where the complainant has suffered no actual loss'"

The matters complained of in this submission fall within the Ombudsman's remit, and are apt for investigation by her as real grievances that, at least as a matter of practicality, are not justiciable in the courts.

Further, it is appropriate for the Ombudsman to carry out the investigations requested, for the following reasons.

Firstly, the Ombudsman enjoys jurisdiction to investigate the acts and omissions of DTI, HMT, FSA, and GAD in their prudential regulation of the Society.

Section 4(1) PCA 1967 provides

'Subject to the provisions of this section and to the notes contained in Schedule 2 to this Act, this Act applies to the government departments, corporations and unincorporated bodies listed in that Schedule; and references in this Act to an authority to which this Act applies are references to any such corporation or body.'

Both the 'Department of Trade and Industry' and the 'Treasury' are listed in schedule 2 to the Act.

GAD falls within the Ombudsman's jurisdiction.¹ In brief:

(a) GAD is a subordinate department of the Treasury. Note 6 to Schedule 2 to the PCA 1967 provides

' …. Any reference to the Treasury includes its subordinate departments and the office of any Minister whose expenses are defrayed out of monies provided by Parliament for the service of the Treasury'

(b) GAD acted at material times as the agent of the regulator. Section 5(1) PCA 1967 provides

' …. the Commissioner may investigate any action taken by or on behalf of a government department or other authority to which this Act applies, being taken in the exercise of administrative functions of that department or authority ….'

(the Society's emphasis). The Penrose Report neatly summarises the position at paragraphs 19/157ff², in a section on the regulatory regime to which the Society was subject headed 'Structure and Resources':

'Until the late 1990s, the regulatory system involved the delegation by the responsible authority (successively DTI, HMT, and FSA) to GAD of the essential task of actuarial scrutiny of life offices' returns. This persisted until FSA brought the separate elements together and began to implement an integrated regulatory system. Until that reorganisation, GAD reported to the regulator, initially in terms of service level agreements that defined the scope of the delegated duties.'

An example of the reality of the situation is given by a letter of Chamberlain of GAD to Ranson of 3 April 1996, in which he records the heavy reliance placed upon GAD by DTI [16/188].

Further, commentators support the proposition that s 5(1) PCA 1967 brings within the PCA's jurisdiction bodies exercising functions delegated to them by government departments (see for example Seneviratne, Ombudsmen, 2002, pg 103; Wade, pg 87ff). It would be strange if the PCA's jurisdiction could be removed by virtue simply of a government department delegating relevant powers.

As to the FSA, the Society agrees with the decision reached by the PCA in PREL³ (at paragraphs 3 ff of the Full Text), that the FSA is subject to investigation in respect of its prudential regulation of the Society. This is clearly correct.

Secondly, there seems to be no dispute that the other preconditions for the exercise of the PCA's jurisdiction, set out in section 5 PCA 1967, are satisfied.

Thirdly, the failures of GAD and the regulator highlighted by the Penrose Report are not simply bad decisions taken without maladministration. Each failure complained of constituted or directly resulted from an act or acts of maladministration.

Further, general circumstances strongly suggest that an investigation is appropriate. There is wide public concern about the acts and omissions of the regulators and GAD in their prudential regulation of the Society. The Penrose Report provides clear prima facie evidence of maladministration causing injustice. No proposals for redress have been made by the relevant departments. The Ombudsman enjoys powers under ss 8 and 9 PCA 1967 that were not available to the Penrose Inquiry; the lack of such powers on occasion hindered it (see for example 19/174). The Ombudsman enjoys the ability to make proposals for redress. There is no other realistic prospect of redress for those policyholders who have suffered injustice as a result of the maladministration of GAD and the regulator.

In the premises, the conditions for further inquiry set out by Sir Michael Buckley in his Supplementary Memorandum to the Select Committee on Public Administration of 30 April 2002 are fulfilled: there is strong evidence in the Penrose Report of unremedied injustice to individuals caused by maladministration by bodies within the Ombudsman's jurisdiction and the absence of proposals to remedy that injustice. The Ombudsman herself, correctly, adopted this approach in her letter to Members of Parliament dated 5 December 2002. Investigation would help lead to the fulfilment of one of the aims of the Ombudsman, set out in the first paragraph of the PCA Business Plan, 2002: to achieve appropriate redress for grievances found to be justified.

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(b) In respect of which matters and over which period should any further investigation be undertaken?

(i) In his report, Lord Penrose details at length how the prudential regulators ie, the DTI, the Treasury ("HMT"), and the FSA approached their supervisory task; how they responded to, and dealt with, the various issues that arose over the relevant years; and the way in which they resolved the supervisory dilemmas that they inevitably faced as the crisis developed [15/3]. These matters should all be investigated. GAD acted on behalf of DTI, HMT, and FSA and should be included in the investigation.

See Chapters 15 to 18 of Lord Penrose's report.

(ii) The most important aspects of those chapters are that the regulators -

- Knew that during the late 1980s and 1990s, the Society's capital was diminishing to a dangerously low level. In effect, the regulators allowed the Society to trade with inadequate reserves and they ought to have insisted on appropriate corrective action;

- Failed to challenge the lawfulness of the terminal bonus policy despite knowing of it at the time it was introduced in 1993 [16/116-118], or that it might be contrary to Policyholders' Reasonable Expectations [16/116];

- Failed to act on the early knowledge that the Society was not reserving for the guarantees expressly contained in the GAR policies [16/116-117]. Again, they ought to have insisted on proper reserves.

- Each of these amounts to a serious regulatory failure and maladministration. If the regulators had intervened in respect of these matters, the problems that beset the Society and its policyholders would have been prevented.

(iii) The period that should be investigated is from 1989, when the bonus system was changed [16/8 and 16/16], to December 2000 when the Society closed to new business.

(c) If it does, why does ELAS consider that it would be in the public interest for the Ombudsman to carry out, at substantial expense, a further investigation and to submit a report to Parliament, having regard to the wide ranging investigation carried out by Lord Penrose and his detailed report, which is already before Parliament?

Lord Penrose did not address the question of whether anyone had sustained "injustice in consequence of maladministration". As he said in the postscript to his report [20/77], it was no part of his inquiry to answer the questions "who is at fault for the problems encountered by the Society, and who deserves redress as a consequence". But he did conclude that the regulatory system did fail policyholders; and that the jurisdiction to adjudicate on regulatory failure in duty was not his; and it was not for him to comment on how the government should respond if it were to acknowledge that there had been regulatory failure. [See 20/83-84].

As stated above, the Penrose Report provides clear prima facie evidence of maladministration causing injustice. No proposals for redress have been made by the relevant departments. The Ombudsman enjoys powers under ss 8 and 9 PCA 1967 that were not available to the Penrose Inquiry; the lack of such powers on occasion hindered it (see for example 19/174). The Ombudsman enjoys the ability to make proposals for redress. There is no other realistic prospect of redress for those policyholders who have suffered injustice as a result of the maladministration of GAD and the regulator.

An investigation by the Ombudsman would save considerable cost and expense for those policyholders who wish to make a complaint and who would otherwise be left with no other choice than to contemplate formal legal action against the regulators - with, as the Society is advised, no real prospect of success. The Ombudsman will complete her investigation quickly; much quicker than any court action could be concluded.

There is a widely felt and public concern that the question of whether the regulators were guilty of maladministration has not yet been addressed or determined. It is in the public interest to establish whether there has been maladministration and whether there has been injustice in consequence.

Those are matters for the Parliamentary Ombudsman.

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3. Does ELAS accept Lord Penrose's conclusion that the Society was principally the author of its own misfortunes? If not, why not?

The Society does accept that there were serious deficiencies in the way in which it was managed during the time it was under the control of the old board of directors. But the role of the regulators was (and is) to keep a check on the management of the Society, and especially its management of its financial affairs, so that it was in a position to protect policyholders from the consequences of management deficiencies.

See, for example, the DTI brief from the late 1970s which stated -

"the main purpose of insurance supervisory legislation is to protect the public from loss through the insolvency, dishonesty or incompetence of an insurer." [15/8]

The primary objective of the insurance division of the DTI was defined in a Service Level Agreement between the DTI and GAD as follows -

"regulate the insurance industry effectively (within the duties and powers set out in the [1982] Act) so that policyholders could have confidence in the ability of UK insurers to meet their liabilities and fulfil policyholders' reasonable expectations." [15/7]

The FSA summarised the objectives of regulation in a statement prepared for Lord Penrose as -

"to protect policyholders against the risk of companies being unable to pay valid claims. In the case of life insurance companies, this includes the risk that they will be unable to meet policyholders' reasonable expectations." [15/7]

Lord Penrose's report sets out in great detail how the regulators knew enough of the management deficiencies of the old board to be in a position to ensure that matters were rectified but failed to take steps to do so - and so failed in their duties. See, for example, the report at 16/21.⁴

4. We note that you have been advised that 'the findings in the [Penrose] report provide grounds for encouraging the Parliamentary Ombudsman to carry out a further investigation'. Does ELAS think that this is consistent with the statement in the same advice that 'it cannot be said that the regulator failed to consider whether to exercise its powers of intervention under the ICA 1982 or that no rational prudent regulator could have acted in the way in which it did'? If so, on what basis does ELAS take this view?

The second passage set out above from the letter dated 14 April 2004 from Herbert Smith comes from the section in the letter explaining (very briefly) the firm's view and the view of counsel that the Society does not have any claim against the regulators for breach of statutory duty under the ICA 1982.

It is an entirely separate and different question to consider whether the regulators were guilty of maladministration and whether that maladministration has led to injustice. Those questions are for the Parliamentary Ombudsman and should be addressed by her. She is able to consider cases where no other remedy is available.

5. Does ELAS contend that regulatory systems deficiencies and/or operational failure by regulators caused or contributed to any loss incurred by the Society or by others? If so, please identify the loss(es) concerned and explain the basis for this contention.

The Society is not in a position at present to comment on questions of loss as a consequence of any findings of maladministration that may be made by the Ombudsman. There are several reasons:

- Until the Ombudsman has decided the logically prior questions of whether the regulators were guilty of maladministration and in what respects and during what periods, it is impossible to deal with questions of what loss was suffered in consequence.

- The Society does not know the facts relating to the policyholders whose claims the Ombudsman would be considering.

- Issues as to loss, causation and quantum will be difficult and will need to be dealt with in the light of all the findings of fact that the Ombudsman will make in the matter.

The Society is firmly of the view, however, that losses caused by the falls in the equities and other investment markets should not be eligible for compensation.

The Society would wish to make submissions on questions of loss at the appropriate time.

6. What are the views and conclusions expressed by Lord Penrose with which ELAS has difficulty and does not accept?

There are many matters of detail in the report with which the Society has difficulty and does not accept. None of those details are relevant to the matters that the Ombudsman would have to consider in the course of any investigation, and therefore it is unnecessary for present purposes to go into any of them. It may be helpful to note that the Society does not accept much of the detail and the conclusions set out in chapter 6 of the report.

On the other hand, the Society does accept Lord Penrose's views and conclusions relating to the regulation of the Society during the second half of the 1980s and the 1990s. Those are the matters with which the Parliamentary Ombudsman would be primarily concerned if she were to carry out a further investigation into the regulation of the Society - as we urge her to do.

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1 See also the reasons set out in the Statement of Grounds in the application for judicial review made by EMAG.

2 In this submission references to paragraphs of the Penrose Report are made in the following fashion: the number of the chapter is given, followed by the paragraph number of the paragraph in that chapter referred to.

3 Report of the Parliamentary Ombudsman into the Prudential Regulation of Equitable Life, printed on 30 June 2003.

4 Paragraph 21 states: "Burt [a principal actuary with GAD] then ended with a surprising conclusion about the way forward:
 'At present we do not have enough information about the society to be more specific and indeed, unless the society makes more signals, we do not suggest that further information should be sought. The society is our longest established life company and is well respected in the market.'
 The Society, it appears, was too venerable to be of real concern, and lack of information provided grounds for inaction. The risk of undermining market confidence in the Society appeared to influence regulators at later stages as well as at this time. Regulators had been given an insight into the Society's practice that might reasonably have alerted them to a need for monitoring of current and future practice. No special steps were taken to put in place a suitable system."

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Letter from Herbert Smith on behalf of Equitable Life (11 June 2004)

The Equitable Life Assurance Society

We are instructed by the Equitable Life Assurance Society ("the Society").

We understand that, following your meeting with representatives of the Society on 25 May 2004, you requested further details of the Society's position in respect of one issue arising out of our and Counsel's advice to the Society as summarised in our letter of 14 April 2004. That issue was whether our advice that the findings in the Penrose Report provide grounds for encouraging you to carry out a further investigation (page 5 of our letter), is consistent with our advice that:

“it cannot be said that the regulator failed to consider whether to exercise its powers of intervention under the Insurance Companies Act 1982 or that no rational prudent regulator could have acted in the way in which it did” (page 2 of our letter).

Since your query relates to our letter of advice, the Society has suggested that we respond directly to you. We have further consulted Mr Iain Milligan QC and Mr Guy Morpuss of Counsel on this issue, and what we say represents their and our collective views. Mr Robert Miles QC, whose views were also set out in our letter of 14th April 2004, was not available to advise further but we have no reason to assume that he would not concur with what follows.

We do not consider that there is any inconsistency in our advice, for the reasons set out below:

(1) At page 2 of our letter we were expressing the view that the Society would not succeed in showing that the prudential regulator had behaved irrationally in a public law sense. That is a very different question from whether the regulator: (i) had been negligent; or (ii) was guilty of maladministration. The distinction is evident from Wade & Forsyth on Administrative Law, 7th ed, as follows (at pages 400 to 401):

[Irrationality in the public law sense] … is not therefore the standard of 'the man on the Clapham omnibus'. It is the standard indicated by a true construction of the Act which distinguishes between what the statutory authority may or may not be authorised to do. It distinguishes between proper use and improper abuse of power. It is often expressed by saying that the decision is unlawful if it is one to which no reasonable authority could have come …

Taken by itself, the standard of unreasonableness is nominally pitched very high: 'so absurd that no sensible person could ever dream that it lay within the powers of the authority' (Lord Greene MR); 'so wrong that no reasonable person could sensibly take that view' (Lord Denning MR); 'so outrageous in its defiance of logic or of accepted moral standard that no sensible person who had applied his mind to the question to be decided could have arrived at it' (Lord Diplock) …

It will be apparent from those passages that the test which we were considering at page 2 of our letter is a high one. All that we were saying at page 2 was that that test was not satisfied.

(2) The test for negligence is less high; and that for maladministration lower still. As to the latter:-

(a) In R v Parliamentary Commissioner for Administration, ep Balchin [1998] 1 PLR 1, it was said that:

… maladministration includes bias, neglect, inattention, delay, incompetence, inaptitude, perversity, turpitude and arbitrariness in reaching a decision or exercising a discretion …

(b) In R v Local Commissioner for Administration, ep Liverpool CC [2001] 1 All ER 462, Chadwick LJ said:

… there is no reason in principle why the considerations which determine whether there has been maladministration should, necessarily, be the same as those which determine whether there has been unlawful conduct. The Commissioner's power is to investigate and report on maladministration; not to determine whether conduct has been unlawful …

It should be noted that Chadwick LJ specifically draws the distinction between unlawful conduct - which would include irrationality in the public law sense - and maladministration.

(c) To similar effect, we note that your predecessor defined maladministration widely to mean poor administration or the wrong application of rules (About the Ombudsman (1998)).

(3) Accordingly, the conclusion which we expressed at page 2 of our letter (which was concerned with the narrow question of irrationality in a public law sense) does not touch on the question of whether the prudential regulator was guilty of maladministration in the sense set out in (2) above. Even if you were to ask yourself the narrower question of whether the prudential regulator had acted "unreasonable", our view on "irrationality" does not assist you.

(4) Where a regulator has acted irrationally in a public law sense it would inevitably follow that it has acted unreasonably and been guilty of maladministration. However, the converse does not follow. The fact that a regulator has acted rationally does not mean that it has not acted unreasonably or been guilty of maladministration.

(5) Our reasons for encouraging you to carry out a further investigation (page 5 of our letter) were based on our view that the Penrose Report did provide grounds for concluding that the prudential regulator had acted unreasonably or been guilty of maladministration. We refer, by way of example, to the criticism of the regulator for: (i) allowing the Society to trade with inadequate reserves; (ii) its failure to challenge the lawfulness of the Society's terminal bonus policy after 1993; and (iii) its failure to insist on proper reserves in respect of guaranteed annuities.

We trust that this clarifies the position. We and Counsel remain of the view expressed at page 5 of our letter, and we do not believe that any of the other conclusions which we reached detract from that view.

Herbert Smith

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Letter from the Equitable Life Assurance Society (15 June 2004)

At our meeting on 25 May 2004, it was agreed that we would ask Herbert Smith and Counsel to deal further with the point you raised at para 4 of the questions you submitted before our meeting. Herbert Smith and Counsel have now written to you, and we trust that you are able to accept what they have said.

We also agreed that we would give further consideration to the matters relating to quantum raised at para 5 of your questions. We have done so, and now turn to these matters.

In the context of a claim before the ordinary courts, as you know, once a court has found a breach of duty owed by the defendant to the claimant, it then (but only then) goes on to consider what loss, suffered by the claimant and caused by the defendant, should be attributed to the defendant. At that stage, it also quantifies the loss. In other words, issues of causation, remoteness and quantum are considered and dealt with.

As we understand the position, you are able to approach issues of loss in a less formal way, but nevertheless you will no doubt be concerned to be satisfied that any alleged loss was caused by, and is properly attributed to, any act or omission you will have decided amounted to maladministration as a result of your investigation. The issue for you is whether any complainant has 'sustained injustice in consequence of maladministration' (s.5 of the Act). Injustice will include loss, as well as a sense of outrage. But the loss or sense of outrage must have been caused by, or suffered in consequence of, the maladministration.

It follows that issues of loss cannot be considered in isolation from the maladministration. Given the breadth of the investigation it is proposed that you should carry out, including the lengthy period of time involved, there are many possible areas of regulation in relation to which a finding of maladministration could be made. Each such potential finding will raise its own issues of loss, causation and remoteness. In relation to each such finding, consideration would have to be given to what would have happened if there had been no maladministration before going on to consider loss, causation and remoteness. It is because of the sheer breadth and extent of the task that we suggested in our response to your questions that we should not at this stage comment on those issues.

Where courts are faced with complex issues relating to loss, it is now commonplace for there to be a split trial: the first trial dealing with liability and the second dealing with loss and related issues. We suggest that your questions relating to loss should be addressed in an analogous way and deferred until you have considered whether there has been any maladministration and what would have happened if there had been no maladministration. At that stage, we would be anxious to assist you by making appropriate submissions.

At this stage, however, we can appreciate that you may be reluctant to embark on a new investigation if you consider it unlikely that at the end of the day any significant loss will have been suffered by anyone. But it seems to us that it is easy to see how losses may have been suffered as a result of maladministration. Thus, for example, let us suppose that in due course you find maladministration; and that if there had been no maladministration, the regulators would have acted, by intervention or in some other way, to require the Society to close to new business by a certain date. It would follow that all policyholders who in fact first effected a contract with the Society after that date, would not have done so. Many of them may well be able to show that if they had not effected their contracts with the Society, their financial position would be better than it now is (excluding losses attributable to falls in the equity markets). In other words, they will be able to show that the relevant losses were caused by the maladministration. We cannot be sure of this because, as we stated in our original response, we do not know the individual circumstances of those who may have complained to you (or who may do so in the future). But it seems inherently unlikely that in the circumstances of this case, no loss would have been suffered by anyone as a result of maladministration.

It is worth making the point that the mere fact that the Society remained open to new business and that in consequence the policyholders were able to effect their contracts, does not give them any cause of action against the Society.

Vanni Treves
 Chairman

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Letter from HM Treasury (20 May 2004) 

EQUITABLE LIFE

Thank you for your letter of 22 April.

You explain that you are considering whether to carry out any further investigation into the prudential regulation of Equitable Life and that you are inviting representations from the Treasury and other interested parties in order to inform your decision.

The Treasury is grateful for the opportunity to contribute to your consultation process. We, of course, realise that the decision whether to undertake any further investigation remains a matter for you.

The Treasury will, of course, co-operate fully with your Office should you decide to carry out any further investigation.

Findings of fact

You ask specifically the extent to which the Treasury accepts the findings of fact in Lord Penrose's report.

Lord Penrose's report presents a narrative of the events at Equitable Life over many years. His purpose was to discover what had led to the situation of the Society as at 31 August 2001 so as to learn lessons for the future. As he makes clear in the postscript to his report he was not seeking to provide answers to the questions of 'who is at fault for the problems encountered by the Society, and who deserves redress as a consequence?' (Chapter 20, paragraph 77). In the foreword to his report he notes that;

“Breach of duty, and the financial consequences of breach, are properly matters for the established courts of justice and for other appropriate tribunals in the financial sector, to be dealt with in accordance with rules of procedure that take account of the interests of parties, typically focused in adversarial terms.” (Foreword, paragraph 9).

We do not, therefore, believe that any investigation seeking to determine whether there had been maladministration resulting in an unremedied injustice can proceed solely on the basis of the narrative set out in the Penrose report. The report does not make findings of fact which it would be open to you simply to adopt. It will, in our view, be necessary, if you decide to undertake such an inquiry, for you to undertake a full investigation by your Office in order to reach your own view on issues of maladministration.

It is also perhaps worth noting the complexity of much of the material that would have to be examined. In this context the findings of over allocation of bonus by Equitable, which forms one of the main conclusions of Lord Penrose's report, provide a particularly difficult example. Lord Penrose drew the information for this section of his report from figures held by Equitable. However, working from the same basic data, we understand that Equitable Life itself and its advisors strongly dispute that any inappropriate bonus allocations were made. Lord Penrose accepts that the financial analysis exercise he carried out on this information in order to reach his conclusions was 'necessarily crude' (chapter 6, paragraph 54), this provides one example of how the issues raised in this case give rise to extremely complex policy, legal and actuarial questions and that very different interpretations can be legitimately placed on the available factual material.

Therefore, while in the event of your deciding to undertake a further investigation into the regulation of Equitable the Treasury will, as noted above, give your Office its full co-operation, it is important to recognise that the extent of the task facing you would be enormous and that difficult questions of both fact and judgement will arise for you in many areas.

Period and matters of any further investigation

You also ask for our views as to the period and matters which should be covered if you were to carry out a further investigation. If you were to decide to undertake a further investigation these would, of course, be matters for you to decide.

In our view, given Lord Penrose's conclusion that the problems at Equitable go back over a considerable period of time (at least to the late 1980s), it would be very difficult to limit the period of any investigation. We would, therefore, suggest that, if you were to undertake any further investigation, it would be necessary for such an investigation to cover the whole period examined by Lord Penrose. It appears to us that limiting any investigation to a more focused period would prevent you from reaching meaningful overall conclusions which would be generally defensible.

However, with regard to the period (1999-2000) covered by the report you published in July last year, we think it is worth pointing out that, as far as we are aware, you received the same documentary material as Lord Penrose (at least as far as the regulators were concerned) and had the opportunity to interview any relevant members of staff. We do not believe that any new facts relating to this period have emerged from the Penrose report. Therefore, we would suggest that there are no grounds for re-examining the period covering the investigation already undertaken by your Office although doubtless if you investigate events prior to 1999 you will be faced with calls to re-open your first investigation.

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Other points 

Jurisdiction

We believe that the restrictions on your jurisdiction which you referred to in your earlier report continue to be material. As you observed in the overview section of that report:

'I could look at only a very small part of what is a much larger and more complex picture. My predecessor had expressed strong reservations as to whether such a restricted investigation could properly establish the key determinants in these events and the lessons to be learned from them.'

We have, of course, discussed the possibility of extending your jurisdiction to cover the Government Actuary's Department (GAD). The Government has agreed to consider such an extension if you were to request it.

However, we understand that it would not be possible to extend your jurisdiction to cover Equitable Life, Equitable's auditors and other advisers or the Personal Investment Authority (or its predecessor bodies). None of these bodies would appear to fall within the categories of bodies which can be brought within your jurisdiction under the 1967 Act.

Therefore, even if the Government were to agree to the extension of your jurisdiction to cover GAD it would remain the case that many of the most important parties would remain outside it. This means that any investigation which you were to undertake would, necessarily, be less comprehensive than that already carried out by Lord Penrose. Given that, as you yourself have said, the role of the regulators is only part of a large and complex picture it is not clear to us how an investigation which looked only at the prudential regulators (and possibly GAD) could properly reach definitive and generally defensible conclusions. You may also wish to consider, in this context, whether a further inquiry into this issue at public expense represents value for money given its, necessarily, limited remit.

The nature of the regulatory failure

Lord Penrose clearly states that the regulatory system failed policyholders in the case of Equitable. I accept this. However, Lord Penrose also says that this was not:

“. . . because of individual failures. I do not pin that blame on individuals, who in the main have operated in good faith and to the best of their abilities within the system as they found it.” (Chapter 20, paragraph 83).

The regulatory failure was, therefore, one of the overall system rather than at the operational level. The system failures described were due to the policy adopted by previous governments and approved by Parliament. It is our understanding that maladministration covers the failure of a department to properly operate a system rather than any deficiencies which might exist in the policy being implemented by that system.

Hindsight

Lord Penrose makes clear that he made full use of hindsight:

“I have the benefit of hindsight, and I have not restricted the comments made to those matters that can be shown to have been within the knowledge or contemplation of individuals or groups at material times.” (chapter 19, paragraph 2)

The comments made in the Penrose report about the regulators must be seen in the light of this. Having the benefit of hindsight is appropriate when considering the lessons to be learnt from particular events. However, it means that the comments Lord Penrose made do not necessarily provide evidence as to whether the regulators performed their duties properly based on what would have been expected or known about at the relevant time. We would submit that this provides further support to our view, set out above, that if you were to undertake a further investigation it would be necessary for you to conduct a full examination of the facts with a view to reaching your own conclusions about the matters being investigated.

Ongoing legal and other actions

As you are aware, Equitable Life are undertaking ongoing civil proceedings against some of the former directors and auditors of the Society. Equitable has, however, concluded that it has no case against the regulatory authorities.

You may also be aware a group of with-profits annuitants have recently announced that they intend taking legal action against the Society.

The Financial Ombudsman Service (FOS) is, we understand, considering a substantial number of complaints from policyholders and ex-policyholders (continuing policyholders are barred from complaining about GAR related issues by the terms of the compromise agreement).

The existence of these proceedings and the FOS investigations suggest that a number of routes remain open for investors in Equitable who believe that they have a case for compensation.

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Effect on Equitable Life

We would also suggest that in deciding whether to proceed with a further investigation you should consider the potential wider effects of such an investigation, which on the basis of the previous investigations is likely to take several years to complete, on both Equitable Life and the procedures for dealing with complaints against financial sector regulators.

The setting up of further investigation is likely to prolong the uncertainty surrounding Equitable. This could hinder efforts by the company to settle outstanding issues and return to stability. Continued uncertainty may also cause further distress to policyholders.

No doubt you will also have in mind your overall role, responsibilities and workload in considering whether to undertake any investigation into issues surrounding Equitable Life. It is possible that doing so would lead to your Office being asked to intervene across a wide range of complex financial services issues by investors who feel they have lost money unjustly. As you are aware these areas are largely outside your jurisdiction and the Government has set up a structure under the FSA, FOS and FSCS - including a Complaints Commissioner for the FSA - to deal with such issues.

Ruth Kelly MP
 Financial Secretary to the Treasury

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Letter from Financial Services Authority (letter of 21 May 2004)

EQUITABLE LIFE

I am writing to take up your invitation to make representations on whether, and, if so, in respect of which period and matters, you should carry out any further investigation into the supervision of Equitable Life. Although we discussed this with HM Treasury, (on whose behalf we conducted prudential supervision of Equitable Life from 1 January 1999 to 30 November 2001) this letter is sent solely on behalf of the FSA.

We fully understand the reasons which led you to consider conducting a further investigation, and indeed why there have been calls on you to do so. But we believe that there would be very substantial difficulties in your doing so, and significant public interest detriments, without any substantial basis for believing that this would achieve the purposes which those advocating it would seek. We would therefore ask you not to conduct a further review for any period, and most particularly consider that it would be very difficult for you to justify conducting a further review of the short period for which we were responsible for the prudential supervision of the company. You yourself have already reviewed this, without finding maladministration.

I should start by saying that we see no benefit in a further review from the viewpoint of enhancing the future effectiveness of the regulatory system. We learned very substantial lessons from our own internal audit review, conducted with external support by Ronnie Baird and published in September 2001. As a result of those lessons, we have made substantial changes to the way the regulatory system operates which were supported by Lord Penrose in his report. We have also made further changes in the light of that report, which was able to look at the period before we took over prudential supervision of the company, and been able to study your own earlier report. We consider the likelihood that a fourth review of the same events will produce further significant reforms to be very low. There would also be, inevitably, public interest detriments from a further significant diversion of resources, including senior management and legal resources, away from ongoing supervision and risk mitigation.

We recognise that the purpose of a further review by your office would be to look for maladministration on which the Government could be recommended to pay compensation. But for the period of our own responsibility, we do not think that the Penrose report undermines your own earlier conclusions that the FSA, acting as prudential regulator on the Treasury's behalf, 'cannot be said to have acted maladministratively and to have caused the injustice which the complainant alleges', which we consider to have been a proper judgement, reached after thorough investigation.

We also consider that a further review would face considerable difficulties of practice and principle. Lord Penrose undertook a very wide-ranging review, which considered the position of all those involved over the full period at issue. This work involved study of many thousands of documents, took several years and led to a report of over 800 pages. But in spite of the intellectual rigour and expert advice he was able to bring to bear, he was clear that 'breach of duty and the financial consequences of breach are properly matters for the established courts of justice and for other appropriate tribunals'. We respectfully endorse this conclusion.

In this context, it makes sense to respond to your enquiry about the extent to which we accept 'findings of fact' in the Penrose report. As we see it, the Penrose report does not make findings of fact in the way that a court could be said to do so. Its terms of reference are clear, that its purpose was to examine events and learn lessons. We believe that it achieved that purpose very well, but are equally clear that the descriptive material in the report, however useful it may be in assisting lessons to be learned, cannot be regarded as making findings of fact from which conclusions on the existence or breach of duties or on maladministration could be drawn. ('I have been able to produce an account of what happened . . . It will be for others to consider in an appropriate forum, and in the context of the facts found according to the practice of that forum, whether fault occurred . . .'). The courts have made very clear in the BCCI case that this is the approach that they would take to considering descriptive material in such reports. We similarly consider that descriptive material in the Penrose report could not be relied on to make a finding that maladministration had occurred.

I should also express concern about a further public interest detriment which would arise from a decision to conduct another review. We have a very keen interest in being able to recruit and retain high quality staff. There are now very few individuals still with FSA who might be asked to give evidence. But equally many of those of our former staff whom you might need to interview will have given evidence previously to three earlier inquiries, the Baird and Penrose inquiries, both designed to learn lessons for the future, and your own previous inquiry, looking for maladministration. A fourth inquiry could quite legitimately be regarded as oppressive and it is important to recognise that potential exposure to a series of inquiries would undoubtedly be a deterrent to anyone considering working as a regulator.

Finally, of course, your jurisdiction is quite properly limited to public bodies, and so would not extend to regulation conducted by the Personal Investment Authority and its predecessor self-regulatory organisations. Although we understand that the Government has indicated that it would consider extending your jurisdiction retrospectively to cover the Government Actuary's Department, we think that different issues would be raised if it were to be suggested that it could retrospectively extend your jurisdiction to self-regulatory organisations. It therefore seems to us unlikely that a new inquiry on your part could ever be as comprehensive as the Penrose review, even in its coverage of regulators.

Callum McCarthy 
 Chairman

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Second letter from Financial Services Authority (7 July 2004)

EQUITABLE LIFE

I very much appreciated the opportunity which you gave Andrew Whittaker and me at our recent meeting to expand on the FSA's concerns about the possibility of a further review of the supervision of the Equitable.

In this letter I want to reinforce my reasons for believing that a further review now would not be in the public interest. The key issues raised are not about us, but about the impact on consumer confidence and on consumers themselves.

As I said when we met, there is no evidence or reason to believe that a further review would help restore consumer confidence in the insurance industry or in its regulation. If anything, the reverse is true, with a long period of uncertainty (as you know, I see no grounds to believe that a review conducted by your office could be other than lengthy) distracting attention from making the new system work, and risking confidence in the new system being undermined by lack of confidence in its predecessor.

I also believe that a further review would raise consumer expectations which in reality it could not meet, because it is very unlikely to be able to conclude that there was maladministration or that it was maladministration that caused any loss suffered.

We think it would be difficult to find maladministration, because:

- Lord Penrose not only did not make a finding a maladministration in the operation of the previous system; indeed he found that it was the system itself that was at fault;

- This makes it difficult to find that there was maladministration, because no one can expect a system which is fundamentally flawed to produce the results of an effective system; and

- The basis on which you could find maladministration is not, as I understand you to believe, substantially different from that on which regulators could be held liable in the courts, when the Equitable itself has been advised that such a claim would be unsuccessful.

We also think that there is real doubt about whether any loss can in fact be attributed to the regulatory system. On Lord Penrose's view, many policyholders were in fact paid out more than their asset share. While others will get less than they had come to expect, it is very unclear, even after considerable analysis by legal and actuarial experts, that this can be shown to result from any culpable conduct by the company itself. Still less is there any clear link with the regulatory system in allowing such conduct to take place. We think it much more likely that losses were in fact caused by a combination of a full distribution policy, about which the company made no secret, and very substantial falls in the equity market which as a result of this policy the company had no cushion to absorb. I should make it absolutely clear that I am not, trying to defend the regulatory system we inherited. We have made the case for change and are well on our way to completing a fundamental programme of reform. What we are questioning is the causative link between the way the old system operated and any losses that policy holders may have suffered.

So we think that the reality is that this is a case in which you are being asked to make findings on maladministration where it is the system itself which is in question. But as you will recognise, this would potentially lead to you being asked to look at every company regulated under the old system - a position which would clearly be unsustainable.

I know that you will consider these points seriously before embarking on a further and no doubt lengthy review. Of course, if you do conduct a further review, we will cooperate with it fully. I am also happy to confirm as you requested that my earlier letter, and indeed this letter, can be made public.

Callum McCarthy
 Chairman

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Letter from the Department of Trade and Industry (11 May 2004)

EQUITABLE LIFE

Thank you for your letter of 22 April.

You ask about the extent to which the DTI accepts the findings of fact in the Penrose Report and for any written representation the DTI may wish to make. As the Penrose Report and Government response made clear, the DTI transferred to HMT all responsibility for the prudential supervision of insurance companies in January 1998. The Treasury acquired all the relevant papers together with DTI staff at that point engaged in insurance company supervision. So I have a nil return for you.

I should perhaps add that the Report did raise issues of corporate governance and accounting practices for which the DTI does have policy responsibility. Ruth Kelly outlined at the time of publication of the Report, measures to consider these elements more closely - asking the Accounting Standards Board to look at accounting for with-profit insurance policies, and Paul Myners to consider corporate governance issues for mutuals. Needless to say, I am entirely happy with these measures. Lord Penrose also recommended that there should be an authoritative statement on the rights, duties and privileges of directors. The Government accepted the need for a statement of director duties in the Modernising Company Law White Paper of July 2002. The intention is to legislate as soon as parliamentary time allows through a Bill to modernise company law.

Sir Robin Young 
 Permanent Secretary

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Email from Mr Robert Lewis (16 May 2004)

Prudential regulation of ELAS

I wrote to you on the 28th January 2004 outlining my reasons why I thought it would be wrong for you to reopen your investigation into the prudential regulation of Equitable Life. You were kind enough to respond to my letter, although not to reply to the specific issues I raised. In light of your request for "interested parties" to write to you on this matter, I have taken this opportunity to send you a second missive reiterating and expanding upon some of the issues I raised in light of the Penrose report. I hope that you do not find these letters too presumptuous; I simply aim to be of some assistance in the difficult decision that you have to make.

Limits on Jurisdiction

Ironically, the limits on your jurisdiction were clearly enunciated by you in the report on the Prudential Regulation of ELAS and your recent appearance before the Public Administration Committee (27 November 2003).

Your jurisdiction only extended to the prudential regulation of ELAS ; it did not cover the actions of ELAS itself, its auditors, its legal and actuarial advisers. You were unable to review the actions of those charged with regulating the conduct of ELAS business; you did not comment on decisions reached by the courts. As you wrote to Francis Maude MP, "In the event that I were to find maladministration by a body within my jurisdiction, I would be required to consider whether that maladministration had caused injustice and whether the injustice had been or would be remedied. I concluded that it would be impossible for me to decide to what extent any maladministration identified had either caused or contributed to the injustice alleged by complainants in a situation where I was not able in law to investigate the actions of all of the relevant parties."

I also note the EMAG Press Release, 11 March 2004:

“EMAG maintains that the Parliamentary Ombudsman is the wrong way forward because her remit and jurisdiction is so hopelessly hamstrung. She cannot comment on the GAD or look into the Conduct of Business regulation or even the Society.”

If these factors apply during the period covered by the Baird Report, surely they also apply to the period covered by Lord Penrose? The court of law is the appropriate forum to examine the respective roles of the Law lords, the regulator, the accountants and the management of ELAS. The court of law is the appropriate forum to establish issues of liability and quantum of damages.

If you proceed in the circumstances, which you eloquently articulated in your report, you risk unfairly tarnishing those public servants who worked for the relevant regulatory authorities. The former auditors and directors of ELAS have the opportunity to defend their reputations in a court of law, are you to deny this to the civil servants who worked at the Treasury and the FSA?

Mutuality and ownership risk

Equitable Life is a mutual company ; it is owned by its members. This has certain financial benefits but also entails certain risks. In a proprietary provider of with-profit policies, shareholders stand behind the fund and are ready to supply capital should it be required. However, they are remunerated for this function. In the 90/10 model, shareholders receive 10 per cent of bonus distributions ; in the 100/0 model, 100 per cent of the bonuses are distributed to policyholders and shareholder returns are instead funded by way of an explicit charge to the fund.

In a proprietary with-profit provider, there is an inherent conflict of interest which may result in adverse financial consequences for the policyholder as regards the allocation of costs, the selection of investment ventures and the distribution of investment returns. ELAS policyholders suffered from none of these financial impediments. (These matters are discussed in considerably more detail in the Sandler Review on Medium and Long -Term Retail Savings in the UK, Chapter 6.) Numerous financial surveys (Money Management, April 2004) indicate that with-profit policyholders receive greater rewards from investing with a mutual, than publicly quoted company. The corollary is that if the fund hits trouble, its members at that time pay the price.

ELAS policyholders sought the economic benefits of mutuality; they now wish to transfer its economic risks onto the taxpayer. They did not want to pay dividends to shareholders but they are now annoyed that they have to shoulder the whole financial burden by themselves. Those who complain that their indicative policy values have been cut, neglect to mention that those same policy values were augmented by the past financial rewards of ownership. In a publicly quoted company, if the board pursues misguided managerial policies its owners, the shareholders suffer economic loss ; in a mutual , its members as owners should suffer likewise. If it were otherwise, then mutuality would become a one way bet and moral hazard would ensue.

People would seek the greater returns of mutuality, knowing that if there are mistakes made by the management, they can claim "misregulation" and the government will pick up the bill.

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Hyman litigation

It is interesting to note that ELAS's differential terminal bonus policy was held to be valid in the court of first instance. The judge concerned was actually a Law Lord. Sir Richard Scott, Lord Scott of Foscote, Vice Chancellor of the Supreme Court and author of the report on illicit arms trading with Iraq. The fact that such an illustrious member of the judiciary should have found in favour of ELAS suggests that their argument was not without merit. In fact, it is surprising that the precise ambit of ELAS's directors' discretion should give rise to three different definitions (Sir Richard Scott/ Morritt LJ / Lord Steyn). It is also noteworthy that only their Lordship's interpretation would have brought such disruption to ELAS's finances or for that matter the entire life assurance industry.

In the Court of Appeal, Lord Woolf M.R., as he then was, argued that the courts could review the exercise of discretionary power of a private body in the same way as they control administrative discretion via judicial review.

This approach is highly dubious. The State is an involuntary association as citizens of a country are automatically subject to the discretionary power of a public body. Equitable Life is a voluntary association; its members chose to grant its board "absolute discretion" as to how to allocate bonuses in order to benefit from guarantees and smoothing. When the court finds an exercise of discretionary power by a public body illegal or irrational, it engages in the fiction that it is merely declaring what the legal position already is. In reality, the judgment has a retrospective effect; what was apparently legal has ceased to be so. The State with its financial resources can cope with this retroactivity ; a private individual or organisation cannot.

From a factual point of view, it is difficult to reconcile the House of Lord's judgment with the reasonable expectations of non-GAR policyholders as to their asset share and the existence of a class of policyholders entitled to a guaranteed investment return. It should also be noted that at least three other life assurance companies operated bonus policies which were in practical effect the same as ELAS's.

From the point of view of black letter law, it could be argued that Lord Steyn has actually implied a term into a contract which restricts an express term, "absolute discretion". At any rate Sir Guenter Treitel, QC MA DCL FBA, Vinerian Professor of English Law at All Souls, emeritus fellow of All Souls College has also commented on the "novel" features of the case (Law of Contract, 11th edition, pp 212).

As far as jurisprudence is concerned, their Lordships' view runs contrary to the values implicit in the rule of law. As Joseph Raz argues in the Authority of Law, the rule of law demands legal rules are capable of guiding of human action. How were the directors or the regulators to know that the term "absolute discretion" really meant "severely restricted discretion"?

This may help to explain the widespread criticism their Lordships' judgement has drawn from the legal community, including Michael Zander, an Equitable Life policyholder and emeritus Professor of Law at the London School of Economics.

In light of the controversial nature of the House of Lord's decision, can it really be said that the regulators were negligent to rely on their own or ELAS's directors' legal interpretation of the policy documents?

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Over-distribution

Lord Penrose's view is that it was not the GAR issue which brought about the collapse of the Equitable Life but the inherent weakness of the society due to years of overdistribution...

...Firstly, if you accept the fact the cost of the GAR issue was £1.5 billion and there was overdistribution of £3 billion, then the Hyman case made Equitable Life's financial situation 50% worse. A small business which was surviving with thirty thousands pounds worth of debt would not consider a bill for another fifteen thousand pounds a minor issue. And Equitable Life did not have to pay the three billion. The Hyman case created a liability which had to be paid; the difference between policy values and assets did not have to be paid. It also damaged the Equitable brand name and created a run on the society. If the Hyman case had been decided differently, Equitable Life could have brought policies values and assets back into line gradually over the next decade. This is, after all, exactly what the other life assurers are doing right now. The Money Management survey April 2004 illustrates the sharp cuts to policy values across the sector over the past few years which suggests Equitable Life was not the only institution paying out to much in the nineties. Pearl assurance and the life companies owned by Abbey National are in terrible trouble. If overdistribution has occurred throughout the entire life assurance industry, what makes Equitable Life policyholders so special that they deserve compensation? Absolutely nothing.

In this regard, the views of Ned Cazalet, independent life assurance expert, are particularly apposite : "despite the problems, the return on an Equitable pension might be no worse than one bought through any other poorly-performing life offices. Many life offices are paying zero bonuses, so Equitable policyholders may be no worse off than some of those with the competitors ... if that's a case for compensation, I can't see it. " (Financial Times 6th / 7th March 2004) Mr Cazalet's views carry weight not only because he has been called as an expert witness by the Treasury Select Committee but he was also commissioned by EMAG to produce "An evaluation of the financial position of Equitable Life" (5 December 2002). The fact that one of the experts hired by the most vociferous policyholder group demanding taxpayers' money doubts their case speaks for itself.

One of the interesting revelations in the Penrose report was his insight into the germination of the EU 3rd Life directive. It appears that a provision that life assurance companies should be under a legal obligation to reserve for the unguaranteed terminal bonus was rejected by the member states at the behest of the then United Kingdom government. To my mind, the concept of maladministration means the poor or negligent implementation of government policy. The truth of the matter is that the regulatory authorities correctly administered this aspect of policy ; it was the policy itself which had unfortunate results. One should also consider the implications of the converse policy. If Equitable Life had reserved for the likely value of terminal bonus, the fund would have consisted of higher proportion of assets displaying lower volatility, for example cash, bonds and property. This would have resulted in a lower overall return for the period. Equitable Life policyholders want things both ways; they want policy values predicated on a fund with a high proportion invested in volatile equities and then they effectively argue that the terminal bonus should have been backed by low yielding assets.

Equitable Life policyholders chose to invest in a with-profit policy, rather than a unit trust, investment trust or for that matter a unit-linked with-profit policy. They chose to place their money in an investment vehicle which gave a wide degree of discretion to the management as to what their return should be. Furthermore, the right to asset share, in its strict sense, and the guarantee are incompatible in the context of a fund where there is a fixed set of financial contributors. The money to fund the guarantees has to come from somewhere.

If you accept that there was over-distribution during the nineties, it is useful to ask where the beneficiaries of such generosity are now. Some of these policyholders have no doubt left Equitable, but others have stayed and taken up standard annuities, with profit annuities or entered the income drawdown scheme. In the later two cases therefore, the cuts to income or policy values that they have experienced have to be set against the amount they benefited from overdistribution. As far as those on standard annuities who were previously holders of policies with Equitable Life which matured in the nineties, either they have been unjustly enriched and their incomes should be cut accordingly or they have not in which case no legal wrong has been committed and no redress at the taxpayers' expense is due to those who claim they have received less than their asset share.

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Barlow Clowes

Much has been made about the alleged precedent set by Barlow Clowes. It seems to me that there are significant differences between this affair and Equitable Life. In Barlow Clowes, the claimants were simply clients of the financial adviser; in Equitable Life, they were not only clients of that financial institution but also its owners and hoped to benefit financially through their ownership. In Barlow Clowes, the issue was a fraud about which the regulatory authorities were in possession of sufficient information to have halted. In Equitable Life, the issues are managerial policies which were prima facie lawful in the case of differential terminal bonuses and lawful in the case of over-distribution. In Barlow Clowes, the compensation paid by the Government was 90% of their loss under £100,000, which was their capital invested; it was not the sum that the investor would have received if the fraudster's claims as to rate of return had been fulfilled. In Equitable Life, this is exactly what some policyholders are demanding. On the one hand, the policyholders are arguing that the policy values were fictitious because there were not sufficient assets behind them; on the other hand, they expect the taxpayer to fund these fictitious policy values.

Furthermore, the whole concept of loss is nebulous in relation to Equitable Life because the member is only legally entitled to the guaranteed fund value, not the policy value, before the policy is surrendered or matures.

Parliament and Equitable Life

One of the most notable features of the Equitable debacle is the large number of MPs with past or present financial connection with that institution. The parliamentary additional voluntary contribution scheme was with the mutual. Of those lobbying for taxpayers' money, the MPs Ottaway, Lamb and Cable had past financial links with Equitable Life. I do not believe that this is a coincidence. The records of the Parliamentary debates and select committee hearings in connection with Equitable are replete with MPs declaring interests in the company...

...Parliament had good reason when it decided to grant the FSA immunity from actions in negligence. Whenever an individual loses money, he can always claim that if the regulator had done X, Y or Z he would be a richer man today. However, there is always risk when one invests. That risk is greater when ownership of the investment vehicle is involved. ELAS policyholders claim to compensation is not based upon identifying who bears the greatest responsibility for the collapse of the mutual company but is rather a brazen attempt to attach liability to the institution with the deepest pockets, the State.

Robert Lewis

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Letter from the National Association of Pension Funds (NAPF) (11 May 2004)

As you will be aware the NAPF represents the interests of workplace pension arrangements in the UK. Accordingly, I am writing to you on behalf of the many hundreds of members of NAPF Member pension funds who where inadvertently caught up in the Equitable Life saga through membership of their employer's workplace pension scheme. In many cases Equitable Life was the AVC provider.

The NAPF supports calls for the Parliamentary Ombudsman Scheme to look again at complaints cases about Equitable Life, both to include regulatory bodies previously excluded (specifically the Government Actuary's Department) and to cover the period prior to the 1999-2000 period previously considered.

We look forward to hearing that you have agreed to look again at relevant cases.

Christine Farnish 
 Chief Executive

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Letter from the Consumers' Association (28 May 2004)

Investigation into collapse of Equitable Life

Thank you for the opportunity to submit Consumers' Association views on whether the Parliamentary Ombudsman should open a new investigation into the circumstances surrounding the failure of the Equitable Life.

As it has been said many time before, 'the die was cast' for Equitable Life by the time the Financial Services Authority (FSA) took over responsibility for regulating the society; the cause of the crisis is to be found in a different time. We are of the view that the primary cause of the failure can be traced back to the 1980's and 1990's and, although we did not agree with the Parliamentary Ombudsman's report of June 2003 which appeared to exonerate the FSA, (we believe that the FSA could have handled the crisis better), there was probably little that could have been done to avert the crisis by the time the FSA took over.

Consumers' Association view is that the Equitable Life crisis arose as a combination of management and regulatory failure during the 1980's and 1990's. We think that the Penrose report support's this view and contains a number of findings which point to regulatory failure on the part of the Government Actuaries Department (GAD) and lead government departments during the 1980s and 1990s, namely the DTI and HM Treasury. We believe the handling of the Equitable Life case by regulators and departments, warrants a new investigation and we would urge you to instigate one.

Whilst we think that a new investigation is justifiable in its own right, the investigation would take on a greater significance given the collapse in consumer confidence in the long-term pensions and investment industry. Consumers' Association produced a survey last year which found that fewer than half of consumers surveyed were contributing to a pension; of those who were not contributing, fewer than one in twelve said they planned to do so. When we asked why consumers weren't contributing, one of the main reasons given was lack of trust and confidence following scares such as Equitable Life.

We are firmly of the view that if confidence is to be restored, the regulatory and redress framework will not only have to protect consumers but be seen to protect consumers. A new investigation would help that confidence rebuilding process.

Louise Hanson 
Head of Campaigns