The prudential regulation of Equitable in the post-closure period

Introduction

1 In this Chapter, I summarise how the prudentialregulation of the Society was undertaken during theperiod from when the Society closed to newbusiness on 8 December 2000 until the end of myjurisdiction over the relevant events on 1 December2001.

2 As was explained in Chapter 6 of this report, thiscovers the period within my jurisdiction duringwhich the Society was closed to new business. Theregulatory approach to the Society changed toreflect its changed circumstances and the differentnature of the issues faced both by Equitable and bythe prudential regulators and GAD as a result of theclosure of the Society to new business.

3 In the immediate aftermath of the closure of theSociety to new business and for the rest of theperiod covered by this Chapter, a considerableamount of regulatory activity took place, as theSociety’s policyholders and annuitants – and thewider world – came to terms with the new realityand as both the Society and those regulatorssought to find ways of putting the Society’sfinancial position back onto a stable and sustainablefooting.

4 The chronology of events set out in Part 3 of thisreport demonstrates the extent and nature of theissues that the Society – and thus its regulators –faced. It is impracticable in this Chapter to doanything other than summarise the key aspects ofthat activity. The reader is referred to the veryextensive chronology of events if they wish to gaina fuller understanding of the extent and directionof the activity which occurred during this period.

5 I begin with an account of the events whichoccurred in the immediate aftermath of theSociety’s closure to new business. I then focus theaccount given in this Chapter on four importantthemes of regulatory activity during this period.  

6 The first theme is the monitoring of the solvencyposition of the Society. The second theme is theinformation about the Society which was providedby the FSA to policyholders and others. The thirdtheme is the FSA’s reaction to the Society’s bonusdeclaration for 2000 and to the July 2001 policyvalue cuts. The final theme is the FSA’s review of thedevelopment of proposals for a scheme ofarrangement under the Companies Act 1985,through which the Society hoped to compromisethe competing claims of its policyholders andre-stabilise its financial position.

7 I conclude my account by indicating the otherstrands of regulatory work that were undertakenduring the period covered by this Chapter.

8 This Chapter is structured in the following way:

•  in paragraphs 9 to 29, I summarise eventsthat occurred in the immediate aftermathof the Society’s closure to new business on8 December 2000;
• in paragraphs 30 to 114, I summarise eventsrelevant to the monitoring of the Society’ssolvency position;
• in paragraphs 115 to 135, I set out the informationthat the FSA gave to policyholders during thepost-closure period;
• in paragraphs 136 to 143, I summarise theconsideration given by the FSA to the Society’sbonus declaration for 2000 and to the July 2001policy value cuts;
• in paragraphs 144 to 158, I summarise eventsrelevant to the development of proposals for aCompromise Scheme, pursuant to section 425of the Companies Act 1985, and to theconsideration given by the FSA to thoseproposals; and
• in paragraphs 159 to 186, I summarise the otherstrands of work that the prudential regulatorsundertook during the period covered by thisChapter.

 The immediate aftermath of the closureto new business

9 On the day that the Society closed to new business,8 December 2000, the FSA noted internally thatthey did not believe that the Society’s problemswere symptomatic of a wider industry problem: itwas said that ‘the underlying cause is specific toEquitable’s own circumstances’.

10 FSA also prepared a more detailed note for internaluse when briefing journalists. This set out some ofthe background to the closure of the Society tonew business. The note dealt specifically with‘Regulatory Issues’, setting out possible questionsand suggested responses. In response to thequestion:‘Why didn’t the FSA take action sooner –how could you let them keep taking newbusiness?’, it was said that:

The Company remained solvent and there wasa realistic prospect of a sale which would havebeen in the long term interests ofpolicyholders. So there was no clear reason orbasis for taking action.

11 In response to the question:

‘How do you judgepolicyholders’ reasonable expectations (PRE)? Howcan Equitable have been meeting them in recentmonths?’, it was said that:PRE can not be precisely defined but it is
important to remember that this company isowned by its members andWith Profitpolicyholders share in the fortunes of mutualsfor good or ill. Generally speakingpolicyholders have received benefits from thisarrangement either through improvedinvestment returns or windfall benefits afterdemutualisations but it is a two way street.

12 In response to the question: ‘On what groundswould someone launch a legal action against FSAfor its action or inaction, or are you just a lawunto yourself?’, it was said that it was:

Not clear to us that a person could havegrounds to bring a case. FSA has acted in goodfaith and with integrity throughout. Nostatutory immunity for those functions of theFSA delegated by the Treasury under theInsurance Companies Act 1982. But FSA doeshave the protection of the common law whichwould make successful challenge very unlikely.

13 In response to the question: ‘Why didn’t you atleast require Equitable to explain to prospectivepolicy holders its precarious position?’, it was said:

We understand that prior to the House ofLords judgement the position as reported topotential policyholders would have been in linewith the current understanding of the law –where a differential approach to GARs wasjustified. Post the [House of Lords’] judgementit is our understanding that potentialpolicyholders were advised about thecircumstances surrounding the proposed saleof the company.

14 In response to the question: ‘Would you like tohave more or different powers over insurers?’, itwas said that ‘it is not clear that there is anydeficiency in the regulatory powers available.’

15 On 13 December 2000, the Treasury prepared aresponse to a written question in the House ofLords, which had asked whether the FSA had takenadequate action to safeguard the interests of theSociety’s policyholders. The text of the suggestedanswer was: ‘The FSA is working with The EquitableLife Assurance Society to look after the interests ofits policyholders’.

16 In the background brief for the proposed answer,Treasury officials explained:

The Society’s difficulties stem from with profitguaranteed annuity rate policies (GARs) whichit wrote up until the late 1980s. These pensionpolicies gave policyholders the contractualright to an annuity at a specific percentagerate when the policyholder retired, whichalthough appropriate for the time in which thepolicies were offered, can be seen in today’slow inflation environment as generous. Duringthe 1990s, when interest rates fell, the GARsbegan to exceed current annuity rates.Reserving standards were increased to reflectthe revised expectations of investmentperformance in a low inflation environment,but it became apparent to the Society that theincreased costs of reserving for these increasedGAR benefits would add a significant financialburden on the company, with one set ofmembers getting a larger slice of the assets ofthe mutual than another.

17 The brief continued:

The Directors of the Society took the view thatit would be inappropriate for one set ofmembers to disproportionately benefit in thisway and they put in place a bonus policy thatdifferentiated between GAR and non-GARpolicyholders on maturity of the investment.This policy caused resentment amongst some GAR policyholders who felt that they werebeing deprived of their full entitlement. TheEquitable responded by funding a representativeaction in Court to decide the issue.

18 The brief concluded by saying:

The result of the judgment meant that,although the solvency of the Equitable wasunaffected, the cost of the GAR liability wouldcurtail its investment freedom and so adecision was made by the Board that it wouldbe in the best interests of policyholders to seeka buyer for the Society.When this optionfailed to materialise, the Society took thedecision to close to new business in order toconcentrate on safeguarding the interests of itsexisting policyholders.

19 On 19 December 2000, GAD sent the FSA a paper,entitled ‘Reserving and related issues’, which it wassaid had been prepared in order to ‘demonstratethe substantial dialogue that has been heldbetween FSA (previously HMT), GAD, and theSociety over recent years in respect of theirreserving practices’.

20 This paper summarised the background to theguaranteed annuity rate issue and set out theexchanges on this issue that had taken placebetween the Society and the prudential regulatorsand GAD since July 1998, when the issue had firstbecome known to those regulators and GAD.

21 Turning to the financial reinsurance arrangementinto which the Society had entered, GAD describedthe Treaty in general terms, noting that the ‘mostcontroversial’ aspect was that it could be cancelledin the event of the Society being wound up. GADsummarised the discussions that had taken place onthis Treaty between the Society and the prudentialregulators and GAD from the end of 1998 onwards.

22 GAD explained that the FSA and GAD had reviewedthe Treaty in the early part of 1999 and ‘wereeventually satisfied that it was reasonable for theactuary to take credit for the cover provided’. GADcontinued:

Such treaties continue to depend on regulatoryarbitrage to achieve the desired result. (It isunlikely that the reassurer, [IRECO], willcurrently be setting up compensating reservesto those removed from the balance sheet ofthe Equitable.) … The reliance on an offshorereassurer, and the cancellation clause leave thetreaty as a more controversial device by theSociety, but the treaty has been accepted assatisfactory in statutory reserving terms upuntil now.

23 GAD then explained the Society’s practice ofreporting the valuation which accorded with theapplicable Regulations as an appendix to theirreturns, saying that:

… in recent years, the resilience reservereported by the Society in their bonus reservevaluation has been such that the free assetposition in the net premium valuations and thebonus reserve valuations has been the same.This means that the resilience reserve in theBRV is simply a balancing item, and so therobustness of the BRV is somewhat dubious.However … GAD do not use the BRV to monitorsolvency.

24 GAD explained that, in the early 1990s, the Society‘took advantage of its use of a bonus reservevaluation in the statutory returns to hide itsresilience reserve’ and say that the Society’sdisclosure had improved, following theimplementation of the 1996 Accounts andStatements Regulations.

25 GAD went on to quote the statement that theSociety had made within its 1996 returns:

‘Foraccumulating with profits pensions business, ½%pa of the benefit value has been deducted foreach year up to the date it is assumed thatbenefits will be taken as a charge for expenses’.

GAD explained that this:

… was never questioned by GAD; it appeared tobe a part of the Society’s overall provision forrenewal expenses. However, in our Scrutiny ofthe 1999 Returns – in October/November 2000– and in discussion with potential purchasers ofthe Society, this was identified as an unusualstatement. [Equitable] confirmed to GAD in[their] letter of 16 November 2000 that this wasan allowance, not for renewal expenses, as wehad understood, but amechanismto recover asyet unrecouped acquisition expenses. GAD viewthis as totally unsatisfactory, since it anticipatesthat future premiums will be paid on therecurrent single premiumpensions contracts,when there is no obligation on the policyholderto do so, and furthermore the Society is takingcredit in advance for expensemargins in thosepremiums, to reduce the accrued liability.

26 GAD then set out how they had pursued thismatter – the ‘quasi-zillmer’ adjustment – with theSociety at the end of 2000. GAD concluded that‘there has been a history of unsatisfactorydisclosure regarding the Society’s approach toresilience’ and that the statement in the 1996returns ‘is particularly opaque’.

27 Under a heading of ‘other reserving issues’, GADstated that, in their scrutiny of the Society’s 1995returns, they had noted that Equitable had takenthe view that their interests were best served byusing a weak valuation basis in order to show asstrong a free asset position as possible. GAD notedthat the Society had made the same point at ameeting between them on 9 December 1994.

28 GAD also explained that they had had concerns atthe time of the scrutiny of the 1995 returns aboutthe sustainability of the Society’s present contractstructures, although GAD had not written to theSociety about those matters, but instead had takenthem up at a meeting on 8 November 1996.

29 GAD in their note recorded that, at that meeting,they had come away with the view ‘that the Societyhad to be very careful that customers were notmisled about their eventual benefits’.

The monitoring of the Society’s solvencyposition

30 Throughout the period covered in this Chapter, theFSA, with the advice and assistance of GAD in theperiod up to April 2001, monitored the financialposition of the Society on a monthly basis. TheSociety first submitted monthly solvency figures toGAD and the FSA on 26 July 2000. It subsequentlyagreed to an FSA request on 11 August 2000 toprovide information about the position as at eachmonth-end (and did so for each month-end, withthe exception of November 2000, when no reportwas submitted).

31 This was done to supplement the scrutiny processof the Society’s returns, which was the usual way inwhich the prudential regulators and GADmonitored the solvency position of life insurancecompanies. Further consideration is given to thedetail of this work in Chapter 10 of this report.

32 Shortly before the Society’s closure to newbusiness, GAD wrote to the FSA on 1 December2000, ahead of a meeting with Equitable that day.GAD provided a summary of the implicationsof their assessment of Equitable’s response (of29 November 2000) to the questions that GADhad raised about reserving. Those implicationswere as follows:

• 
  that GAD were looking for ‘an increase from85% to say 90% in the assumed GAR take-uprate’. However, GAD said that this would haveno effect on the net level of reserves whilst thereinsurance treaty remained in place;
• 
  that GAD were unhappy with the 20% rate ofdecrement in future premiums when assessingthe ‘future premiums’ part of the reserve forannuity guarantees. On the basis of informationprovided by Equitable’s actuarial consultants,GAD estimated that, if no such decrement wereassumed, Equitable’s net liabilities wouldincrease by up to £360 million;
• 
  that GAD believed Regulation 72(3) of ICR 1994might require Equitable to assume in futurevaluations that personal pensions benefits wereall taken at age 50. On the basis of informationprovided by Equitable’s actuarial consultants,GAD estimated that the effect on Equitable’sliabilities would be an increase of up to£200 million;
• 
  that GAD believed the new resilience test2 would lead to increased reserves of£600 million, or £300 million if the Societyadopted the ‘synthetic bond’ concept;
• 
  that GAD believed that a more sophisticatedhypothecation of assets in the resiliencescenario could reduce the resilience reserve byup to £750 million (or less, if a synthetic bondwere used); and
  that GAD did not accept the use of a 0.5% paallowance for expenses in the resiliencescenario. GAD stated that ‘the resilience reserveis therefore weak and not in accordance withthe guidance. [Equitable’s actuarial consultants]say that reserves are £950m lower than theyotherwise would have been because of this’.

33 GAD noted that the Society’s monthly solvencyfigures for the end of October 2000 showed that ithad assets of £1,080 million in excess of its requiredminimum margin. GAD advised the FSA that takingaccount of those reserving issues increasedEquitable’s liabilities by £1,060 million, resulting inthe Society having assets in excess of its requiredminimum margin of just £20 million. GAD alsopointed out that, if the IRECO reinsurance treatywere to be terminated, Equitable’s liabilities wouldincrease by about £500 million.After the Society’s closure to new business

34 On 19 December 2000, GAD prepared a report on‘Reserving and related issues’. GAD’s report repeatedwhat they had said in their note of 1 December 2000,namely that a corrected solvency position for theSociety would show assets of only £20million abovethe requiredminimummargin. GAD’s report alsodiscussed the level of themarket value adjuster whichwas applied to non-contractual withdrawals, alongwith the current level of payouts against asset shares. Ireturn to this issue later in this Chapter.

35 The following day, in response to being informedthat the FSA were not going to approve Equitable’sapplication for a section 68 Order to permit theSociety to use a ‘synthetic bond’ or ‘artificial bond’approach to the calculation of the valuation ofcertain fixed interest assets, GAD pointed out that:  

We understand that the artificial bondapproach would have led to reserves £300m.lower than otherwise in this scenario.The adjustments which we believe need to bemade to the Society’s liabilities … become anincrease of £1,360m. (instead of £1,060m.), whenthere are only £1,080m. of assets available (atend-October 2000).It is all very tight, to say the least.

36 On 16 January 2001, Equitable told the FSA and GADthat they expected to show in their returns for 31December 2000 that the Society would have freeassets of approximately £500 million above itsrequired minimum margin. However, Equitable saidthat this was subject to further work that their newAppointed Actuary had to undertake and to‘confirmation by [the FSA] of some technicalwaivers to the valuation rules as intimated to uslast year (and as given recently to some othercompanies)’ (i.e. the section 68 Order for a‘synthetic bond’, which GAD had said would reducethe reserves required to be held by £300 million,and which the FSA had decided they would notapprove).

37 Equitable also said that this valuation included thevarious changes that had been agreed in recentcorrespondence ‘(other than the possibleadditional £250 million for personal pensionpolicies on which we await legal advice), but doesnot include a contingent liability for any possibleredress for pension fund withdrawal contracts thatmight be imposed by PIA (estimated by the PIA as£40m on a worse case scenario)’.

38. On 19 February 2001, the FSA wrote to Equitable’sAppointed Actuary, ahead of a meeting arrangedfor the following day. The FSA said that they wouldlike an indication of the Society’s current solvencyposition and emphasised the importance of thetimely provision of all solvency reports, while notingthat Equitable had not yet provided the monthlyreports for November and December 2000, andthat the January 2001 report was due.

39 At that meeting, it appears that the solvencyposition as at 31 December 2000 was the onlymonth that was discussed, with the FSA recordingthat:

The position disclosed demonstrated fairly thinsolvency cover and had assumed that both theconcessions for the artificial bond (valuationrate of interest) and for an increased valuationtaking into account the sale of the Permanent[Insurance] had already been given.Withoutthese concessions the company would not beable to demonstrate coverage of the RMM inits statutory returns. The [Appointed Actuary]had, however, now adopted the strongerresilience basis that had been required byrecent changes in the regulations in thesefigures. He thought that all other reservingissues had been ironed out but GAD pointedout that there was still an issue surroundingRegulation 72 and retirement dates to beresolved.

40 Following that meeting, the FSA’s Line Managerinformed the Managing Director of FinancialSupervision that the Society’s Appointed Actuaryhad reported that Equitable had free assets abovetheir required minimum margin of £340 million, as at31 December 2000. However, the Line Managerexplained that this valuation had relied on certainconcessions which had at that time not beengranted. The Line Manager listed those concessions,which the FSA had estimated as totallingapproximately £430 million. The Line Managersuggested that this information about the Society’ssolvency position:

… does point to the need to be careful aboutwhat we say, if we want to be certain that weare right. Either we should refer specifically tothe position at 8 December, or simply say thatthe company is solvent.  

41 The Line Manager also informed his ManagingDirector that Equitable would like to be able toreport their year-end position as if thoseconcessions had been in place at the year-end. The FSA’s Chairman commented to all of the supervisorystaff who held responsibility for the Society on thispoint that:

If we are to concede that, I hope there areprecedents (and preferably hundreds of them)!  

42 On 21 February 2001, GAD recorded in an internaldiscussion that they had thought that Equitable hadaccepted GAD’s interpretation of the requirementsof Regulation 72 of ICR 1994 as to whetherassumptions could be made concerning retirementages. GAD’s interpretation was that the Regulationsrequired Equitable to ‘set up a liability to cover thecash payment that would result from an exercisingof the vesting of the option, at any time that theoption may be exercised’. GAD had estimated thatthis would lead to an increase of £200 million in thereserves required to be held (Equitable hadthemselves estimated that it would increase thereserves required by £250 million).

The Society’s solvency position following thecompletion of the Halifax deal

43 At the beginning of March 2001, Equitable’sadministrative and asset functions were transferredto Halifax and the Society’s solvency position wasboosted by a £500 million payment in respect ofthat transfer.

44 The FSA and GAD met Equitable on 6 March 2001, inorder to get an update on the key issues that theSociety faced. On the solvency position that was tobe reported within the Society’s 2000 returns, theFSA recorded that:

… solvency cover was likely to be tight withonly £300m free assets after RMM coverage. Inmaking this assessment the Society was takinginto account the benefit from the “artificialbond” concession that had yet to be formally applied for or given (which itself would beworth c£300m). It was also taking into accountthe debt from the sale of the Permanent[Insurance] to Liverpool Victoria which was notcompleted until 2001 …

45 Equitable told the FSA and GAD that, as at31 January 2001 and before they had received the£500 million from the Halifax deal, it was estimatedthat the Society had free assets of approximately£700 million above its required minimum margin.The FSA also noted that:  

Solvency was boosted by the sale of £1.8bnof equities and the reduction in the resiliencetest. It was thought that current solvencycover was of a similar magnitude despite the£500m injection, this was because the FTSE atc5900 was a lot lower than it was at the end of January. [Equitable’s Chief Executive] disclosedthat prior to the end of February with weakequity markets solvency cover was thin.

46 On 8 March 2001, Equitable provided theirestimated monthly solvency figures for 31 January2001. Those figures showed that the Society hadfree assets of £1,930 million to cover its requiredminimum margin of £1,215 million.

47 On 15 March 2001, the FSA’s Managing Director ofFinancial Supervision reported to his Board onEquitable’s solvency position. He informed thatBoard that the Society had free assets ofapproximately £300 million. However, the ManagingDirector pointed out that this solvency positionrelied on certain concessions from the requirementsof the Regulations, and that those concessions hadnot at that time been granted by the Treasury. TheManaging Director explained that, if thoseconcessions were not granted, ‘the position will bevery tight’.

48 During a meeting held on 20 March 2001, Equitableconfirmed to the FSA that they were at that timefollowing GAD’s interpretation of Regulation 72. TheSociety said that, should the FSA accept Equitable’sinterpretation instead, ‘there could be a c£100mrelease from reserves’. (The effect of thisadjustment had previously been valued by theSociety at approximately £250 million.)

49 On 27 March 2001, the FSA informed Equitable thatthey could not recommend to the Treasury that theSociety’s request for a section 68 Order in respectof the calculation of the valuation of certain fixedinterest assets (i.e. the synthetic bond) should beapproved.

50 The FSA explained that the reason for this was thatthe Treasury had no powers to grant such an Order,which would have had retrospective effect.However, the FSA suggested to Equitable that ‘it ispossible for the Treasury to make an order undersection 68 that would require the Society toprepare its annual returns on a particular basis,even though that information would relate to aperiod that has already ended but has not yetbeen reported upon’.

51 On the same day, the FSA were advised by Counselthat Regulation 72(3) ‘did permit assumptions to bemade as to the age at which the individual wouldtake benefits’. However, Counsel also advised theFSA that ‘there was scope for amendments to …put in a requirement for reserving so that therewas a smooth curve leading to the position whereregulation 72(2) took effect’.

52 On 23 April 2001, Equitable reported to the FSA thatthe ‘end of March figures were almost completeand would show the notable improvement insolvency following the £500m injection and theadded knock on benefit of the reduction inresilience’. However, the Society said that: ‘Both the end of February and March figures are based onthe latest test 2 for resilience, assume the Section68 Orders for Permanent/equivalent bond buttake a more conservative approach than requiredby the regulations for Regulation 72 (assumed ageof retirement). The value of the equivalent bondconcession was estimated at c£200m for the endof the year, although this would be reduced overtime as the yield curve flattens’.

53 Equitable also provided to the FSA their estimatedmonthly solvency figures for 28 February 2001.Those figures showed that the Society had freeassets of £1,500 million to cover its requiredminimum margin of £1,200 million.

54 During the first week of May 2001, there wasextensive discussion, between the members of theFSA’s Insurance Supervisory Committee (who wereresponsible for deciding whether to put a
recommendation to the Treasury that a section 68Order should be granted) and the Society’ssupervisory team, about the section 68 Orders forwhich Equitable had applied.The implications for the Society’s solvency position ofCounsel’s opinion on mis-selling

55 On 8 May 2001, the FSA were informed by theSociety’s Chairman that Equitable had received anopinion from Counsel which suggested that non-GAR policyholders might have reason to makeclaims that the Society had mis-sold their policies.The FSA immediately turned their attention to theimplications of the opinion for the Society’ssolvency position.

56 A great deal of activity was undertaken by the FSAon this issue to establish what claims couldlegitimately have been made by policyholders andto quantify the potential values of such claims. Thatactivity is recorded fully within Part 3 of this report.

57 The implications of Counsel’s opinion werediscussed the following day, during a meeting withEquitable. The FSA recorded that:  

A significant additional reserve would almostcertainly lead to the Society not covering its[required minimum margin]. The AppointedActuary said that if required the Society couldfind the amount required in the worse casescenario (the £1.5bn) but this would mean thatthe Society would have to move entirely out ofequities and into gilts.

58 On the same day, the FSA decided that they shouldput their recommendation to the Treasury that thesection 68 Orders in relation to the valuation ofPermanent Insurance within the Society’s 2000returns and in relation to the valuation of certainfixed interest assets should be granted. On thelatter Order, the FSA recorded that they had:

… concluded that on balance it supported theapplication, largely on the basis there were noclear grounds for rejecting it. It was agreed thatthis should be made clear to the Treasury,along with the points about the impact andreasonableness of Equitable Life’s tendency touse the most favourable valuation basis to it.

59 Also on 9 May 2001, Equitable provided theirestimated monthly solvency figures for 31 March2001. Those figures showed that the Society hadfree assets of £2,020 million to cover its requiredminimum margin of £1,150 million.

60 On 21 May 2001, the Treasury raised a number ofconcerns with the FSA about the FSA’srecommendation that the section 68 Order, inrelation to the calculation of the valuation rates ofinterests for certain fixed interest assets, should begranted. The Treasury explained that their concernscentred on ‘consistency and presentation’.

61 On 31 May 2001, the FSA provided to the Treasury afurther explanation of the justification for theirrecommendation. The FSA also recorded at thattime that the Society believed that the Orderwould improve its solvency position byapproximately £150 million to £200 million.

62 On 8 June 2001, the Treasury granted the twosection 68 Orders (in relation to the valuation ofPermanent Insurance and the calculation of thevaluation rates of interests for certain fixed interestassets) which had been requested by the Society.

63 The Society submitted its 2000 regulatory returnsto the FSA on 28 June 2001. The solvency positionshown in Form 9 of those returns said that, as at31 December 2000, Equitable had free assets of£1,632 million to cover their required minimummargin of £1,221 million. A full description of thecontent of those returns is contained within Part 3 ofthis report.

64 On 10 July 2001, the FSA’s Head of Actuarial Supportcommented on the emerging legal opinion ofCounsel who were advising the FSA, saying that:

[Counsel for the FSA] is looking at possible missellingclaims for all with-profit policies soldfrom around 1996 as being a possibility (thoughhis view may well differ from [Counsel forEquitable] who has so far come at his from arather different angle). The present policyvalues in respect of this business are likely tobe of the order of £10bn, so that if thequantum of claim were say 15% of policy value(and it could be higher on the approach he islooking at), we could have mis-selling liabilitiesof £1.5bn or more.

In present investment market conditions, thiswould very likely mean that the company wasinsolvent.

65 Around this time, Equitable sent to the FSA copiesof four papers which had been prepared for theirBoard. In one of those papers, the Society’sAppointed Actuary commented on the financialposition for the year-end 2000, as presented in itsreturns. The Appointed Actuary advised theSociety’s Board that:

It should be noted the £411m of free assets isafter taking credit for the reinsurance benefit(£808m) and future profits (£1000m). It alsoignores the value of the subordinated debtliability of £346m.

These are all permissible and previously agreedwith the FSA. However, their use clearly eatsinto any conservatism in the basic valuationregulations.

In relation to the strength of the valuation basisused by Equitable, the Appointed Actuary advisedthe Board that:

In arriving at the valuation, specific assets arehypothecated to particular liabilities, andreallocated in the resilience scenarios. I believethat the process we used is close to the bestachievable.

Overall I think that whilst prudent in allrespects according to the valuationregulations the Directors should be aware thatit would, in my view, not be possible toproduce a satisfactory valuation whichproduced a materially higher net assetposition at 31/12/2000.

66 At a meeting with PIA held on 18 July 2001, the FSAreported that they thought that a recent statementmade by the Society’s Chairman regarding thesolvency of Equitable was ‘arguably misleading’.

67 It was agreed that the FSA should issue a Noticeunder section 44 of ICA 1982, requiring the Societyto provide monthly financial information and todemonstrate that it was solvent under therequirements of both ICA 1982 and the CompaniesAct 1985. However, the FSA did not in fact imposeformal reporting requirements on the Society.Instead, they asked for enhanced reporting but onan informal basis, so as to provide the FSA with‘greater flexibility to update the form and contentof the information to reflect concerns at anyparticular time’.

68 It was also agreed that there should be anindependent review of Equitable’s financialcondition, to be carried out within three to fourweeks.

69 On 18 July 2001, the FSA provided answers to certainquestions which had been raised by the EconomicSecretary to the Treasury. On solvency, the FSAadvised that:

We are satisfied, on the basis of the latestfigures supplied by the company, that itcontinues to meet its solvency marginrequirements. As the company has made clearin its Annual Report and in its regulatoryreturns, it continues to face some fundamentaluncertainties…

There are however uncertainties, including inrelation to the opinion on mis-selling which isdue shortly (the FSA is also doing work on thistopic). Subject to those uncertainties, at thisstage, we do not think insolvency likely and wehave been assured by the appointed actuarythat there are further steps the company cantake to avoid that, such as by cutting terminalbonus further … If however insolvency wasunavoidable, this would trigger the operationof the Policyholders Protection Act where the Policyholders Protection Board would in thefirst instance seek to secure a transfer ofpolicies to another insurer. It would be able toprovide financial assistance to achieve that.Alternatively, the business could be placed inliquidation and policyholders would be paidcompensation up to 90 per cent of theguaranteed value of their policy at the point ofliquidation.

70 In the initial scrutiny of the Society’s 2000 returns,undertaken by the FSA on 19 July 2001, it was notedthat the absolute level of coverage for the requiredminimum margin was a matter ‘of concern’ and that,even with the sale of assets to Halifax (which hadimproved the Society’s free assets), ‘the positionremains tight’.

71 On 20 July 2001, Equitable provided their estimatedmonthly solvency figures for April, May and June2001. The figures for 30 April 2001 showed that theSociety had free assets of £2,005 million to cover itsrequired minimum margin of £1,155 million. Thefigures for 31 May 2001 showed that the Society hadfree assets of £1,790 million to cover its requiredminimum margin of £1,140 million. The figures for 30June 2001 showed that the Society had free assetsof £1,780 million to cover its required minimummargin of £1,120 million.

72 Equitable also informed the FSA that:  

Last week I sent you our “ready reckonersolvency” matrix. Using this type ofmethodology we estimate the statutorysolvency position daily and at the low point ofthe market at around lunchtime on 19 July 2001when the FTSE 100 stood at 5320 it is likely thatthe cover ratio was about 1.0, i.e. just coveringthe required minimum margin. As discussed,and is clear from the matrix further equitymarket falls could lead to the requiredminimum margin being breached.

73 On 23 July 2001, in response to the latest version ofCounsel’s opinion on the potential for mis-sellingclaims to be made against the Society, the FSA’sHead of Actuarial Support commented that ‘thepotential liability could still be around £2-3 billion’.

74 Later that day, the Head of Actuarial Supportcommented that the financial implications forEquitable looked ‘quite bleak’, and he said that:  

If, for example, they are likely to incur missellingclaims on all post-1993 policies, then theliability could be around £3-4 billion, whichwould be well beyond their current freereserves on a Companies Act basis of around£1½ billion. If the potential claims extend backto 1988 or even earlier, then the situation isclearly even worse.

Even if the Limitations Act applies (whichseems very odd to me as a layman given that itwas not the fault of the policyholders thatthey could only have been likely to havebecome aware of the alleged non-disclosure in1998 or even later), then the liability could bearound £2½ to £3½ billion, assuming that therewould be a liability in respect of all premiumspaid in the last 6 years. The result is still thenlikely to be insolvency.

The weekend of 28 and 29 July 2001

75 Leading up to, and immediately following, theweekend of 28 and 29 July, there was a great deal ofactivity concerning whether the Society was solventand whether it could continue as a going concern.The details of those events are described in fullwithin Part 3 of this report, and I will not repeat allof them here. However, there are five key eventsfrom this period which I will highlight.

76 First, there was a review of the situation by thethree authorities responsible for financial regulationand stability. On 25 July 2001, a meeting of theTripartite Standing Committee considered the casefor intervention by the authorities and whetherthere existed arguments for an injection of publicfunds into Equitable. The note of that meetingrecorded the following:

[FSA’s Chairman] said that something between£3 [billion] and £5bn would make [Equitable]solvent. [FSA’s Director of Insurance] said thatit was difficult to assess what additionalcontribution to the pot might be necessary tomake a s.425 scheme attractive to [Equitable]policyholders. But while the insurance industrywould probably not be keen on a rescue, itmight be readier to consider this if thegovernment was involved. [FSA’s Chairman]said that if the government put money intothe company, it would be interpreted as aproblem with the past regulatory regime.

77 Secondly, on 26 July 2001 the FSA approached theAssociation of British Insurers to see if an industryrescue could be arranged. The initial response wasthat such a proposal was unlikely to receive thesupport of the industry.

78 Thirdly, on 27 July 2001 the FSA served a Notice onEquitable. The requirement of that Notice, whichwas issued pursuant to section 44(2B) of ICA 1982,was that:

… the Society shall furnish the FSA on 20August 2001 with a report by [a namedcompany] analysing the financial position ofthe Society as at 30 June 2001 (or such laterdate as shall in the opinion of [the namedcompany] be practical) such analysis to be inaccordance with, and contain the informationset out in Appendix A to this Notice.

The FSA explained that their rationale for servingthis Notice was as follows:

In order for us to assess the solvency of theSociety, both to determine the baselinefinancial position against which the proposedcompromise scheme needs to be assessed andto consider which of all options open to theSociety best protects policyholders’ interests,we consider it necessary to have a reportprepared by a firm which is independent fromthe Society.

79 Fourthly, over this period the FSA and the Treasuryconsidered whether Article 4 of Equitable’s Articlesof Association meant that the amount of theirliabilities would reduce in line with their assets.They also considered whether the prudentialregulators possessed powers to prevent Equitablefrom using Article 4 to reduce the guaranteedamounts payable under their contracts.

80 Finally, on 29 July 2001 the Society informed the FSAthat the Board had concluded, that morning, that:

The Society appeared to be solvent on everybasis for calculating solvency.  

The FSA noted that, in reaching that conclusion, theSociety’s Board had taken a ‘rational, worst casebasis’ for assessing mis-selling liabilities of£900 million.

81 Throughout August 2001, the prudential regulatorsand the Society continued to attempt to establishsome certainty on both the status of possible missellingclaims and the quantification of those claims.

82 On 21 August 2001, the FSA returned their attentionto the Society’s 2000 returns, having asked somequestions of Equitable following their initial scrutinyof the returns on 19 July 2001.

The results of the report into the Society’s solvencyposition

83 On 24 August 2001, the FSA were given apresentation of the results of the review ofthe Society’s solvency position as at the end ofJune 2001. The FSA were told that Equitable hadassets above their required minimum margin of£758 million. However, when reporting on thepresentation to his Chairman, the FSA’s LineManager pointed out that:

These figures do not take into account anyexplicit liability for future discretionarybonuses or for compensation to non-GARs.

The Line Manager went on to say that:

In effect, on all three bases, [the company] have quantified the surplus assets that areavailable to pay the mis-selling and, after thathas been paid, to fund future (noncontractual)bonuses. In advance of thefinalisation of the work quantifying the missellingclaims it is not possible to reach adefinitive conclusion on Equitable Life’s abilityto fund those claims. However, based on thepreliminary work that has been done the levelof surplus assets reported by [the company] asbeing available to meet those claims does notgive us any cause for concern.

Disclosure of the side-letter to the IRECO reinsurancetreaty

 84 On 14 September 2001, the Society’s AppointedActuary wrote to the FSA to inform them that aside-letter, dated 1 April 1999, to the FinancialReinsurance Treaty had come to light. He reportedthat this ‘purports to clarify the position if thebalance insured and outstanding exceeds £100msterling’ and said that the Society had sought legaladvice about the implications of the letter, but thatthis had been unclear.

85 Reliance had been placed within the Society’s 2000returns on the financial reinsurance arrangementwhen setting the mathematical reserves. The Treatygiving effect to this arrangement had beenamended for a second time in August 2000, in anattempt to reflect the changed position of theSociety after the decision of the House of Lords inthe Hyman litigation.

86 After this change, the Society took credit in its mainvaluation of £808 million for the financialreinsurance arrangement. The Society’s 2000 returnsdisclosed that its assets exceeded the sum of itsliabilities and its required minimum margin by £411million.

87 On 21 September 2001, Equitable provided theirestimated monthly solvency figures for 31 August2001. Those figures showed that the Society hadfree assets of £1,733 million to cover its requiredminimum margin of £1,053 million.

88 On 24 September 2001, the FSA received a fax fromthe Society, enclosing a copy of the side-letter. Theside-letter said that it was not intended to belegally binding but to clarify the intentions of theparties, that if any claim exceeded £100 million thenthe Treaty would be cancelled by mutualagreement, that the Society would not draw cashpursuant to the Treaty and that the purpose of thearrangement had been to create flexibility for theSociety in reserving.

89 A handwritten note was made on the Society’sfax by an FSA official, which recorded that theside-letter had not been seen before, that theintention to cancel the Treaty if the withheldamount exceeded £100 million was at odds withwhat GAD and the FSA had been told in February1999, and that the undertaking not to draw cashcould invalidate the reinsurance offset to theMathematical Reserves shown in the returns.

90 On 28 September 2001, the FSA met the Society todiscuss the side-letter. The Society said that it hadbeen passed by the former Appointed Actuary tohis successor on 7 August 2001. The day before themeeting, the reinsurer had informed the Societythat it felt that the side-letter gave them the optionto cancel the Treaty if the £100 million trigger levelwere reached.

91 The Society had not accepted this, citing legaladvice it had received that the side-letter was notnecessary to interpret the Treaty. However, theSociety had been concerned that, in the event of adispute between the parties and if that disputebecame subject to arbitration, which would beheard in Ireland where the reinsurer was based, theletter might have some force.

FSA’s exercise of powers pursuant to ICA 1982 torequire the Society to produce a plan for therestoration of a sound financial position

92 By the beginning of October 2001, the FSA hadreached a view of their best estimate of the level ofprovision for mis-selling that Equitable should berequired to hold. On 1 October 2001, the FSA’s Headof Actuarial Support had concluded that:

The overall accounting provision … after takingaccount of the probability of success couldthen be around £300 - 550 million, with a bestestimate likely to be in the range of £400 -£500 million. For the FSA returns, we wouldexpect to see a greater margin for prudence,and probably a contingent liability forpotential recission claims, which might indicatea provision of between £600 and £700 million.

93. On 4 October 2001, the Head of Actuarial Supportcommented on the credit that could be taken forthe reinsurance treaty, saying that:

In view of the letter apparently received fromIRECO saying that they would intend the treatyto be cancelled if the claim ever exceeded£100 million, I think it would be very difficultfor Equitable to take credit for more than thisamount in a “prudent” statutory valuation,where the actuary has to take account of boththe credit and legal risk under this reinsuranceagreement.

94 The following day, Equitable provided the FSA withan update on their solvency position under threedifferent bases. Under the Society’s normalvaluation basis, yet still taking into account ‘the fulleffect of the reinsurance treaty for GAR liabilities’,it showed assets in excess of its required minimummargin of £150 million. Equitable explained that theyhad included in this valuation a provision of £220
million for any mis-selling of non-GAR policies.  

95 In the light of this information, the uncertainty inrelation to the reinsurance treaty, and their ownwork on the quantification of potential mis-sellingliabilities, on 9 October 2001 the FSA exercised thepower to require the Society to produce a plan forthe restoration of a sound financial position. TheFSA stated that:

Section 32(4) of the 1982 Act gives the FSApower to require the production of a plan forthe restoration of a sound financial position inthe event that a company has failed tomaintain the prescribed margin of solvency. Inpresent circumstances the FSA must nowformally ask for the submission of such a planwithin 2 weeks of the date of this letter.

96 On 16 October 2001, the FSA returned theirattention to the valuation basis that the Society hadused in its 2000 returns. The FSA raised a number ofquestions in relation to how Equitable had reservedfor surrender values for their accumulating with-profits business and whether the level of reserveswas consistent with the Society’s policyholders’reasonable expectations. The issues related towhether Equitable had fully explained topolicyholders how they operated the market valueadjuster. The following day, the FSA’s Head ofActuarial Support commented that:

At end-2000, the reserves held were broadlyequal to the guaranteed fund without anydiscounting. Therefore, the surrender value testwas not relevant in the base scenario at thatstage. However, I would agree that in view ofthe fall in equity markets since then, and thediscounting of the guaranteed benefits that isnow being applied, we do need to be satisfiedthat these reserves take account of theunderlying current PRE surrender value.

97 The FSA met the Society again on 22 October 2001.The meeting notes record that Equitable had beenconducting negotiations with the immediate parentcompany of the reinsurer to clarify the situation.The meeting notes also record that the proposalsthat had been put forward by that parent companyas a means to resolve the issue were unacceptableto both the Society and the FSA.98 It was agreed that the FSA would meet the reinsurerbecause of the regulatory significance of the issueand the need to resolve matters, so that anyongoing uncertainty did not introduce furtherinstability into the financial position of the Societyat a time when it was seeking a way ofcompromising the competing claims of itspolicyholders.

99 On 25 October 2001, Equitable provided theirestimated monthly solvency figures for30 September 2001. Those figures showed that theSociety had free assets of £1,340 million to cover itsrequired minimum margin of £1,006 million.

100 On 26 October 2001, Equitable provided the FSAwith their plan for the restoration of a soundfinancial position. The Society’s plan comprised ofthree elements, those being:

• 
  the renegotiation of the IRECO reinsurancetreaty;
• 
  the switching of funds from equities into fixedinterest securities; and
• 
  the Compromise Scheme.

A full description of the Society’s plan is containedin the entry for this date within Part 3 of this report.

101 The FSA met the parent company of the reinsureron 1 November 2001. The parent company statedthat, in their view, the financial reinsurancearrangement had always been intended to be a‘riskless’ transaction. The FSA explained that thathad ‘very definitely not [been] our view at the time,of the basis of the information we were given’.

102 Further discussions to renegotiate the terms ofthe arrangement took place. A draft of theamended arrangement was supplied to the FSA on8 November 2001. On 12 November 2001,consideration was given by the FSA to the effect ofthe Treaty as it now stood in draft. The Head ofActuarial Support stated that he believed that themaximum reserving benefit that the Society couldtake was £250 million, based on the 10% cashpayments allowed under the Treaty. The LineSupervisor responsible for the Society gave his viewthat the Treaty was still ‘little more than windowdressing and the reinsurer has no intention ofassuming any serious risk at all’.

103 On 15 November 2001, the FSA’s Chairman wrote tothe Economic Secretary to the Treasury to informher of the Society’s financial position. The Chairmanexplained the uncertainty which existed over thecredit that could be taken for the reinsurance treaty,and said that:

This problem, together with the effect ofvarious market movements, and the need toreserve for potential mis-selling claimsfollowing delivery of the Opinions of [Counselfor Equitable and Counsel for FSA], result, onour assessment, that the Society could be inbreach of its solvency margin requirement bysome £200m.

104 On 16 November 2001, the Society’s AppointedActuary wrote to the FSA to ask about the offsetthat the Society could take within its returns if thenew Treaty were to be signed. The AppointedActuary suggested that, in his view, a £600 millionoffset was appropriate, based on the amount ofthe reserve (not discounted), but reduced by£100 million to allow for the new additional premiumthat was required by the updated Treaty. The Societyasked the FSA to agree to this credit in writing.

105 On 20 November 2001, it was agreed within the FSAthat the prudential regulators should accept thatthe effect of the Treaty was that an offset could betaken within the Society’s returns but that it wasnot yet clear what the amount of this should be.The amount would be calculated by reference tothe cash available to the Society, which it wassuggested might be in the range of £250 million.

106 On 22 November 2001, the FSA were advised byCounsel that the existence of the side-letter to thereinsurance treaty added nothing to the provisionswithin the reinsurance treaty itself and that therewould have been no need to renegotiate the treatyif the ‘Reinsurance Claims Amount’ had exceeded£100 million. However, on the credit that could betaken for the reinsurance treaty, the FSA recordedthe following:

Could [Equitable] call [in the Reinsurance ClaimsAmount] in cash? [Equitable’s solicitors] said no.[Chief Actuary C] said makes treaty worthlessthen. [Counsel] agreed.Need clarity that [the Reinsurance ClaimsAmount would] be [payable] in cash by IRECOon [liquidation, otherwise] only thing you cantake credit for is the 10%.

107 The FSA informed Equitable, that day, that theyshould not take credit in their returns for thereinsurance treaty of more than £350 million.  

108 On 23 November 2001, the FSA issued a pressstatement about the disclosure of the side-letter tothe reinsurance treaty. The statement said that theFSA:

… took the view that the contents of the letterraised questions about the true value of thereinsurance contract that Equitable Life hadentered into in early 1999 and which wasshown in its regulatory returns. The FSAconcluded that, had it been aware of the letterat the earlier stage, it would not have beenprepared to accept the reinsurancearrangements as providing as much securityfor reserving purposes as was in fact taken.

109 The statement went on to say that the FSA:

… has seen and reviewed the terms of arenegotiated reinsurance agreement and hasconfirmed that it has no objection to them.  

110 However:

… in the light of advice from leading Counsel,the FSA has taken the view that the value thatEquitable Life should reasonably ascribe to thereinsurance contract is lower than it previouslytook. The FSA has made clear to Equitable Life that it must properly disclose the effect of therevised agreement, so that policyholders aremade aware of the impact on Equitable’sfinancial position for regulatory purposes.

111 FSA also stated:

On the basis of the information received bythe FSA, Equitable Life continues to meet itsregulatory solvency requirements even takingaccount of the lower credit for the revisedreinsurance policy.

112 On 26 November 2001, Equitable provided theirestimated monthly solvency figures for 31 October2001. Those figures showed that the Society hadfree assets of £1,395 million to cover its requiredminimum margin of £985 million.

113 There remained a number of issues which were yetto be resolved before the new regulatory regimecame into force, at which time my jurisdiction overthe relevant events ended.

114 Those issues included whether Equitable’s approachto discounting the reserving established for theiraccumulating with-profits policies was consistentwith policyholders’ reasonable expectations. Theregulators also continued the discussions on thecredit which could be taken for the financialreinsurance treaty, an issue which was also by thattime linked to the success of the CompromiseScheme, to which I return later in this Chapter.

The information provided by the FSA

115 Throughout the post-closure period, the FSA werecontacted by many policyholders seekinginformation and advice about the position of theSociety and about their own options. In response tothis, the FSA decided that they would providegeneral information to assist those policyholders.

116 The information provided by the FSA during therelevant period can be divided into three types:general information provided on websites and inpress notices; responses to individualcommunications from concerned policyholders;and the published assessment of the CompromiseProposals that was published in December 2001.

General information

117 On 14 December 2000, the FSA put the followinginformation on their website:

The FSA is:

• monitoring the Equitable’s position closely;
• making sure that policyholders are given timelyand comprehensive information so that theycan consider their options fully;
• requiring the Equitable to have effectivearrangements for dealing with any complaintsthey receive; and
• the Equitable has, with the encouragement ofthe FSA, established a process for helpingpolicyholders to decide whether they shouldtake any immediate action.

Since current Equitable policyholders may beasking other firms for advice, the regulators willshortly be reminding all firms of their obligationsto give suitable advice, taking properly intoaccount the personal circumstances andaspirations of their customers.

118 On 8 October 2001, the FSA noted that, in responseto the question ‘is the Society solvent?’, theirwebsite had stated for some time that:

We have been monitoring Equitable Life’sfinancial position closely, and on the basis ofthe information available to us, we aresatisfied that it continues to meet itsregulatory solvency margin requirements.Nevertheless, Equitable Life made clear in itsannual accounts and in its regulatory return (areport that [they] must make to us), that itcontinues to face some fundamentaluncertainties – for example, in relation to thecost of its liabilities to the GuaranteedAnnuity Rate (GAR) policyholders. Theproposed compromise scheme is designed toaddress those uncertainties.

119 It was said that this was also the line that had beentaken consistently by the FSA’s press office.

Specific responses

120 I have also reviewed the many files of policyholdercorrespondence held by the FSA. Having done so, itis clear to me that, for understandable reasons, theFSA developed and used standard paragraphs toinclude in responses to individual policyholderswho wrote to them following the Society’s closureto new business. On occasion, they also replied onan individual basis, tailoring their reply to thespecific points raised with them.What followslargely refers to the standard paragraphs that wereused by the FSA on many occasions.

121 Prior to the closure of the Society to new business,the FSA often used the following standardparagraph in responses to communications frompolicyholders:

Your letter questions the solvency of theSociety. As regulator, the Financial ServicesAuthority monitors the financial position ofinsurance companies carefully.We are satisfiedon the basis of the information provided to us that, even after having made appropriateprovision to cover benefits on a basisconsistent with the House of Lords ruling, theEquitable continues to satisfy regulatoryrequirements under the Insurance CompaniesAct 1982.

122 Another standard paragraph stated:

… as you may be aware, the Society takes theview that its financial position has now beenweakened and that the future interests ofpolicyholders will be best protected by seekinga buyer for the business. This would enable theSociety to raise additional capital to supportits future business.

123 In relation to early criticisms that the prudentialregulators were failing to prevent the Society fromadvertising for new business in the light of theHouse of Lords’ judgment, the FSA often replied:

… given that the Society continues to meet therelevant statutory requirements and istherefore able to continue to trade, we see noreason why the Society should not continue toadvertise to attract new business.

124 Less than a month prior to closure, the FSA also feltable to deal with the way in which the Society hadacted in relation to its regulatory obligations:  

As regulator, the FSA monitors the financialposition of insurance companies carefully.Weare satisfied on the basis of the informationprovided that the Equitable continues to besolvent and satisfies all relevant regulatoryrequirements under the Insurance CompaniesAct 1982. As the Equitable continues to be agoing concern, complying with the relevantregulatory requirements, we do not share yourview that it should be prevented from marketing its products, which could bedamaging to the business.

125 For natural reasons, the volume of communicationsfrom Equitable’s policyholders greatly increasedwhen the Society closed to new business. The linetaken by the FSA in response to suchcorrespondence included the following standardmaterial:

(i) I would point out that the Society remainssolvent and will continue to pay out benefitsand accept premiums under existing policies;

(ii) I should point out that the company continuesto be solvent and to meet the statutoryrequirements for insurance companies;

(iii) I can assure you that the Equitable remainssolvent, existing policies are still valid and theCompany continues to be able to meet itscontractual obligations to policyholders; and

(iv) The Equitable remains solvent, existing policiesare still valid and it continues to be able tomeet its contractual obligations to itspolicyholders.

126 In response to correspondents seeking specificinformation about the position of the Society, inJanuary 2001 the FSA replied:

You asked for some reassurance concerningthe future security of your investments withthe Equitable. The Equitable remains solvent,existing policies are still valid and it continuesto be able to meet its contractual obligationsto its policyholders. Of course, the FSA alsocontinues to monitor closely the operations ofthe Equitable in accordance with our powersunder the Insurance Companies Act 1982 andthe Financial Services Act 1986.

127 In February 2001, the FSA wrote:

It might be helpful if I first clarify that while theEquitable announced on 8 December 2000that it would from that day close to newbusiness, the Equitable was solvent andremains so, complied with all relevantstatutory solvency requirements for insurancecompanies, and was able to meet itscontractual obligations to its policyholders.

128 From June to August 2001, one of the standardparagraphs used by the FSA was:

We are satisfied, on the basis of the latestfigures supplied by the company, that itcontinues to meet its solvency marginrequirements. The company has made it clearin its Annual Report and in its regulatoryreturns, that it continues to face somefundamental uncertainties.

 129 Following the policy value cuts in July 2001, the FSAwould reply to correspondents, saying:

Equitable Life, like many companies, is havingto cope with very difficult investmentconditions. The position is that policies havenotionally been growing in value at anannualised interim rate of 8 per cent. However,because of the current investment climate, thereturns on the with-profits fund over the lastcouple of years have been minimal. Thenotional increase in policy values has thereforebeen eating away at the company’s free assets.The board has therefore decided it is time toact to bring policy values back into line withthe value of the assets that back them, and toreset the interim rate of return at a sustainablelevel. The guaranteed elements of any policyvalues will not be affected.

130 In August 2001, the FSA informed a policyholderwho asked about possible compensation beingmade available to mitigate the effects of the policyvalue cuts:

You ask whether anything is being done tocompensate policyholders for the reduction inpolicy values. This reduction was to bring thevalue of policies on maturity or surrender intoline with the value of the underlyinginvestments which have fallen considerably asa result, in part, of recent falls in stock marketvalues. This was to ensure that those leavingthe Society were not paid more than a fairshare of the funds. Our understanding is thatthe Equitable’s overall policy values, whichinclude an element in respect of expected finalbonus at maturity, were expressly stated not tobe guaranteed except when the policy maturesor at other contractual dates when funds canbe withdrawn without penalty.

131 The standard response from the FSA, when askedwhat the reasons for the policy value cuts were andwhether regulatory failure had played any role inthe events at the Society, was:

I am sorry that you feel the information youreceived from us regarding the Equitable LifeAssurance Society (the Equitable) was incorrectin light of the recent announcement about thereduction in policy values. It might be helpful ifI clarify why this reduction has occurred.The Equitable announced that it would have toreduce pension policy values by 16 per cent andnot award any growth for the first six monthsof 2001 because of:

•  heavy falls in stock markets over the last18 months;
• the need to align policy values so they donot exceed the value of the investmentsunderlying them; and
• the number of policyholders taking theirbenefit out on retirement

The Equitable is not the only life assurancecompany reducing final bonuses because offalls in the stock market.

132 On 5 January 2001, the FSA also wrote in thefollowing terms to a policyholder, concerning whatmight happen should Equitable become insolvent:

However, should the need arise, there is ascheme designed to assist with the transfer ofpolicies or arrange compensation.

The immediate objective of the scheme wouldbe to arrange for your contract to betransferred to another provider to ensurecontinuity of cover as the case may be. If thatwere not possible, the scheme provides forcompensation to be paid, generally of 90% ofthe contractually guaranteed benefits at thetime of the insolvency.

133 On the role of the regulators, the FSA explained topolicyholders that:

The Financial Services Authority… has, inaccordance with its statutory objectives, beenactively working in a number of areas toprotect the interests of the Equitable’spolicyholders.We have been carefullymonitoring the Equitable to ensure that itcontinues to meet the requirements under theInsurance Companies Act 1982 and complieswith the rules of the Personal InvestmentAuthority.We are working with the Equitableto try to make sure that clear and appropriate information is available to policyholders asdevelopments happen. And that the Equitablecontinues to give support and advice to itscustomers.

134 The FSA also was often asked for advice as to whatan individual policyholder should do in the light ofthe ongoing uncertainty surrounding the future ofthe Society. A standard reply given was:

Our advice to policyholders has not changed.Policyholders will need to think carefully aboutthe options open to them, and theconsequences of those actions.We would alsorecommend policyholders consider carefullywhether to take independent advice on theirposition. In considering your options you willwish to be aware it is often possible to transferor surrender policies. However, where that ispossible, surrendering or transferring withprofitspolicies at points other than oncontractual dates may result in policy valuesbeing reduced. Contractual dates might bematurity, retirement or other dates which maybe specified in the contract. Policyholderswithdrawing funds at such specified dates arenot affected by these adjustments, nor aremost of those with unit linked policies. You willneed to check the terms of your policies orwith the Equitable to establish the position asit relates to your policies.

135 Finally, while the proposals for the CompromiseScheme were being developed, those whocontacted the FSA were often told that:

The main effect of the closure to new businesswas that at the time, the Equitable thought itwould have to hold a higher proportion of itsfunds in more secure investments, such as gilts,which might have led to a slight reduction inreturns. The Equitable has since announced plans to buy out rights to an annuity atguaranteed rates, which it believes wouldprovide a degree of certainty for policyholdersgoing forward. The Equitable also believes thatthe increased certainty would allow it torelease statutory reserves held to cover theGARs and, combined with the amountspayable by Halifax, this would restore thecompany’s investment freedom for the future,thereby enabling it to operate more like anopen fund.We understand that details of theproposals will be announced over the summer.

The FSA’s consideration of Equitable’sbonus declaration for 2000 and the July2001 policy value cuts

136 At several points over this period, the prudentialregulators raised the matters of the level of benefitsthat Equitable were paying out on their policies, theamount of bonus that would be declared for theyear 2000 and the interim rate to be used goingforward, and the relationship between policy valuesand asset shares.

137 In their report to the FSA on reserving and relatedissues, GAD said that they could not say whetherthe current level of a 10% market value adjustmentapplied to non-contractual surrenders was thecorrect one. GAD’s report noted:

However, we understand from figures supplied[by Equitable’s auditors to Prospective Bidder A] last month, that Equitable are overpaying (onmonies leaving the fund) at 30.09.00 at the rateof £2.3bn (across the whole portfolio) and thissuggests that some correction to the level ofpayouts is overdue. In the normal course, theSociety would seek to recover thisoverpayment in future years, but in thesituation they now find themselves in, thiswould be to the particular detriment of theremaining policyholders.

GAD’s report continued:

The Insurance Companies’ Regulations and theactuarial guidance do not require companiesto reserve for Terminal Bonus in statutoryvaluations, and most companies/societies takeadvantage of this exemption.When TerminalBonus is paid on a claim, the cost is met fromthe Society’s free assets. However, as shown …above, we do not believe the Equitable haveany free assets of any size. There is therefore adanger that if the Equitable allow out-goingpolicyholders to leave the fund on terms whichare too generous, there could then beinsufficient assets available to meet theguaranteed benefits of the remainingpolicyholders. The whole situation is verydelicate, and needs to be handled carefully.

138 On 21 December 2000, GAD suggested to theFSA that they should discuss with Equitable theyear-end bonus declaration and the impact of thison the Society’s reserves. Also on that day, GADsuggested that Equitable should be questioned onthe current level of payouts, and how those payoutscompared to asset shares. GAD also suggested tothe FSA that the Society should be asked to explainwhy, according to its auditors’ figures, the ‘“deficiton the smoothing account to recover in future”stood at £2.3bn. at 30.09.2000’. GAD advised theFSA that this:

… suggests that the underlying amountspayable on termination are currently too high.Answers to these questions will help us tounderstand the dynamics of the business andthe ramifications of those leaving the fund onthe continuing policyholders.

139 The regulators raised the question of the bonusdeclaration with Equitable on 16 January 2001. GAD’snote of thatmeeting recorded that the Society wasexpecting not to declare any bonus that year, as it didnot have sufficient emerging surplus. GAD also notedthat Equitable were reviewing the interimbonus of9% which was being applied tomaturing policies.

140 On the bonus declaration for 2000, the FSA notedin a meeting held on 20 February 2001 that: ‘The[Appointed Actuary] proposed to postpone the2000 bonus notice until after the vote on theaccommodation. If there was a positive vote itmay be possible to offer a [guaranteed] bonus toeveryone for 2000 of possibly 4%, (although as3.5% is guaranteed under some GAR policies thereal additional cost of this bonus was effectivelythe same as a 1% bonus across the board)’.

141 On 30 April 2001, the FSA realised that Equitable’sCompanies Act annual report and accounts hadbeen published.Within those accounts, it was saidthat the Society had decided to maintain theinterim rate of bonus at 8% until further notice. Itappears that the FSA gave no further thought tothose matters until the issue of the July 2001 policyvalue cuts emerged.

142 At the time that Equitable submitted their returnsat the end of June 2001, the Society wrote to theFSA to inform them that its Board intended toaddress the situation which existed, namely thatpolicy values exceeded asset shares.

143 On 10 July 2001, the FSA received copies of fourEquitable Board papers on the issue. A fulldescription of these papers is included within therelevant entry for this date in Part 3 of this report.Following Equitable’s announcement, made on16 July 2001, that the Society’s Board had decided tocut policy values by 16%, the Treasury asked the FSAa number of questions. In response to the Treasury’s questions ‘Do you consider saying anything aboutyesterday’s announcement?’ and ‘Did you considerurging EL to make it sooner, or saying somethingyourselves beforehand?’, the FSA said:

We considered carefully whether it would behelpful for the FSA tomake an announcementin parallel with that fromEquitable Life.Weconcluded that there was nothing that wewished to say proactively since this was anannouncement by the company. However, weprepared lines to take in response to enquiriesand were in close touch with the company toreview the proposed terms of its statement toensure that it was appropriately expressed. Theannouncement wasmade as soon as practicableafter the board had decided on its course ofaction, so an earlier announcement was never apossibility. It should also be remembered thatpart of the reason for the need for suchextreme action was the continuing decline inthe financial markets at a time when EquitableLife policies were continuing to attract notionalannual growth of 8 per cent taking the value ofthe policies and the assets further out of line.

In response to the Treasury’s question ‘How doesthe size of yesterday’s revaluation compare withmarket movements generally over a directlycomparable period?’, the FSA said:

The adjustment to policy values, as comparedwith the year end position, was of 16 per cent.The FTSE 100 closed at about 6220 on31 December 2000; on 17 July 2001 it closed at5430, a fall of about 13-14 per cent. However,at the year end, policy values were alreadysome way ahead of the value of the underlyingassets because of the continued application ofan 8 per cent interim rate of return. The overalleffect is to reduce policy values to close to thevalue of the underlying assets at the present time.

The development of the CompromiseScheme and the FSA’s consideration ofthat Scheme

144 Throughout the post-closure period, the Societysought the means to stabilise its financial positionin the light of its precarious financial position andthe competing claims of different groups ofpolicyholders. In particular, the Society sought toresolve any possible claims for mis-selling frompolicyholders who did not have policies withguaranteed annuity rates and to mitigate thepotential detrimental impact on its solvencyposition of the open-ended liabilities arising fromtop-ups, which those policyholders with policieswhich contained guaranteed annuity rates werecontractually allowed to make.

145 Having analysed the various options open to it, theSociety decided that the best means of ensuringsuch stability was to compromise the claims ofpolicyholders through a scheme of arrangementunder the Companies Act 1985.

146 The preparations for this Scheme were undertakenthroughout the period covered by this Chapter andit is impractical to seek to summarise thosedevelopments here, although as can be seen fromPart 3 of this report, the Society kept the FSAregularly informed as to the progress on puttingsuch a scheme in place.

147 The role of the FSA in such a scheme was explainedby the FSA in their published assessment of theSociety’s proposals. It was noted that while ‘theCompanies Act does not give the FSA a formal rolein the process… it has general regulatory powers…to take action in relation to the Compromise if itconsiders it appropriate in order to protect theinterests of policyholders’.

FSA assessment of the Compromise Scheme

148 On 19 November 2001, the FSA wrote to Equitableconcerning their proposals for a CompromiseScheme. This followed an extensive dialoguebetween the prudential regulators and GAD, on theone hand, and the Society and its advisers on theother, which is set out within Part 3 of this report.

149 The prudential regulators listed a number ofmatters that remained to be resolved to theirsatisfaction but concluded that, subject to theresolution of these matters, the FSA ‘would becontent for its view to be recorded in the Schemedocumentation in the following terms’, namelythat:

The Scheme has been formulated by theSociety, which has satisfied itself about thefairness of the offer and the detail of theterms. The Society is also responsible fordetermining and disclosing its financialcondition. The FSA’s review has been directedto deciding whether it should exercise powersto intervene to prevent the Scheme being putto policyholders on the grounds that, in doingso, the Society was acting without due regardto the interests of policyholders. The FSA hasdetermined that it should not do so, andconsiders that the Scheme is one which it isappropriate for the Society to put topolicyholders. The FSA will publish more detailof its views on the Scheme beforepolicyholders vote.

150 This formulation was used by Equitable in section7.7 of the information pack that they sent to alltheir members to explain the background to theproposals and to provide information about thevarious options.

151 The FSA subsequently, as it said that it would do,published a formal ‘assessment’ of the Schemeproposals, which is reproduced in full in Part 4of this report. The assessment, published on7 December 2001, summarised the view of theFSA thus:

The FSA is content that, in relation to therelevant groups of guaranteed annuity rate(GAR) and non-GAR policyholders, the level ofincrease to policy values is a fair offer inexchange for the GAR rights and potential missellingclaims that would be given up.Whilethere are variations from person to person,within each relevant group, we are contentthat there are no categories of policyholderwithin the groups who would receivedisproportionately greater or lesser benefits.

152 The FSA then described their role in relation to thecompromise arrangement and explained that theyhad no formal role in the procedure under section425 of the Companies Act 1985. However, the FSAexplained that they could seek to be heard if thecompromise were to be put to the court for formalapproval after the vote by policyholders. The FSAwent on to say:

As the FSA has made clear, we firmly believethat a successful compromise would, inprinciple, offer the best prospect of bringingstability to the with-profits fund and improvingthe outlook for concerned policyholders.

153 After having set out their view as to the principalconsiderations to which both GAR and non-GARpolicyholders should have regard, the FSA dealtwith ‘some important wider points thatpolicyholders should take into account’.

154 The first of these was entitled ‘continueduncertainty’ and the FSA explained that:

Without the Compromise, the outlook for allpolicyholders would remain much moreuncertain. In already difficult marketconditions, the with-profits fund would remainseriously unstable…

Equitable Life would need to continue to keepreserves against the range of competing rightsand claims that would have been resolvedunder the Compromise. It would also need toadopt a more restrictive investment policy,which could affect policyholders’ returns overthe long term. There would also be a greaterrisk of extensive and costly litigation to sort outthe various claims for mis-selling that wouldotherwise be settled by the Compromise. Andthose claims would in turn have to competewith the cost to the fund of meeting the GARs.All these costs would have to be met out of thewith-profits fund. It is also likely that many ofthe remaining non-GAR policyholders wouldtake the view – that some others have alreadytaken – that they should take their money outrather than stay in a weaker fund.

In order to be able to manage the business sothat it continues to comply with regulatoryrequirements, Equitable Life could well, as theappointed actuary has made clear, find itnecessary to take an extremely cautiousapproach to its management of the withprofitsfund and to setting future bonus policy,in order to ensure that those leaving the fundin the near future, whether contractually orotherwise, do not take more than their fairshare of the fund. If bonus rates had to be cutfurther, this could mean that all policyholderscould find themselves materially worse offthan if the Compromise had gone ahead.

155 After explaining that another consideration to beborne in mind if the proposals were not agreed wasthat ‘the benefit of the additional £250 millionHalifax money would be lost, as would any chanceof the further £250 million that is also contingenton certain future business targets being met’, theFSA dealt with the alternatives to the proposals:

Some policyholders have suggested thatwinding up Equitable Life would be better, eventhough Equitable Life is solvent. The FSA doesnot agree. For a start, this would affect allEquitable Life policyholders, not just the withprofitspolicyholders who would be affected bythe Compromise. If a winding up order weremade, we would expect a liquidator tocontinue to run the with-profits fund and toattempt to assess and pay claims in the shortterm.

However, a liquidator would probably beunable to declare any final bonuses, so thefund available to both GARs and non-GARswould be smaller. A liquidator would thenattempt to transfer the policies to anotherinsurer, if a willing recipient could be found.The value of a policy could be reduced on sucha transfer. If a transfer were not practicable,then a liquidator would need to value allpolicies, on a basis agreed by the court, inorder to make a distribution of the availableassets. Significant costs arise on a liquidation,and any lump sum payments to policyholdersmight be taxed.

There are additional consequences of aliquidation in the event of insolvency.Wewould expect the Financial ServicesCompensation Scheme (“FSCS”) to protect theinterests of policyholders, in the first instanceby seeking to assist the liquidator to transferthe business to another insurer. As analternative, the Court might be asked toreduce policyholders’ contractual benefits, orcrystallise them, in order to restore solvencyand stability. If a transfer were not possible,the FSCS is able to compensate policyholdersbut any compensation would be limited to90% of the value of the policy. The fact thatthe future returns or other benefits under apolicy were guaranteed in certaincircumstances, does not necessarily mean thatthe FSCS can pay compensation for thoseguarantees. This is because the FSCS is requiredto consider whether the benefits under apolicy may be excessive.

156 The FSA then concluded by dealing with the effectson other policyholders that an individual’s votemight have.

157 The FSA’s concluded view on the detail of theScheme was that ‘a successful compromise would,in principle, offer the best prospect of bringingstability to the with-profits fund and improving theoutlook for concerned policyholders’.

158 The Compromise Scheme was sanctioned by theCourt on 8 February 2002, following a vote of theSociety’s policyholders in favour of its terms.

Other strands of regulatory work duringthis period

159 During the period covered by this Chapter, the FSAwere also involved in a number of other strands ofwork concerning the supervision of the Society.

160 These included:

(i) the appropriateness of the use by the Societyof market value adjusters which it applied inrespect of the funds built up by policyholderswho wished to transfer out of the Society toanother pension provider – in the light of theconcerns expressed by the Office of Fair Trading(OFT) about whether the use of such adjusters,which it saw as a penalty, was contrary to theUnfair Terms in Consumer ContractsRegulations;

(ii) the sale of part of the Society’s infrastructureand non-profit business – to which I havealready referred in Chapter 2 of this report;

(iii) consideration as to whether compensationfrom the Policyholder Protection Board (oraction by it to effect the transfer of theSociety’s with-profits business to anotherprovider) would be available if the Societybecame insolvent, given that the Society’sArticles of Association appeared to limit itsliabilities to the assets it possessed; and

(iv) attempts to gain an understanding of thepotential liabilities that the Society faced as aresult of any mis-selling that may have occurredin respect of those policyholders whose policiescontained no guaranteed annuity rates – andthe provision of compensation, by way of arectification scheme, to those policyholderswith guaranteed annuity rates who had beendenied the opportunity to apply such rates totheir fund, when taking benefits during theperiod in which the Society had operated itsdifferential terminal bonus policy.

The OFT and the market value adjuster

161 On 12 December 2000, the OFT wrote to the FSA.They explained:

We are considering whether we need to takeenforcement action in relation to reports thatEquitable Life has imposed a new charge of10% on transfers of assets out of the Society.We are beginning to receive complaints andenquiries about this charge. The relevant termsand conditions could be unfair if they give theSociety discretion to make new charges or tovary existing ones. The Director General of FairTrading has powers to prevent the use of unfairterms, by seeking an injunction in the HighCourt. The Office is prepared to move swiftlyon the matter to protect the interests ofconsumers. However, we know insufficientabout the basis on which Equitable is makingthe charge to justify formal action at thisstage.Whatever light you can throw on thequestion would therefore be most welcome.

162 This had been prompted by policyholdercomplaints. GAD provided advice on the letter tothe FSA. This advice said that:

… the Equitable would very likely becomeinsolvent if they were to remove thisadjustment at the present time andexperienced a large number of surrenders. Thisis a result of the combination of GAO costs, anegative investment return in the present year,the final bonus additions for which noprovision is required under the regulations, andunrecovered “deferred acquisition costs”. Ihope that FSA will therefore not insist on themremoving or reducing this adjustment factor onsurrenders without considering the impact ontheir solvency.

163 The FSA’sManaging Director commented on the OFTapproach, expressing particular concern that, if theOFT were to take the view that the Society’s marketvalue adjuster amounted to an unfair contract term,‘the position could become highly problematic’.

164 This issue continued to be considered by the FSA. Legal advice provided internally to the FSA on21 December 2001 stated:

… it would seem to be odd were we to betaking action against [Equitable] on thegrounds that the 10% deduction was contraryto the Unfair Terms in Consumer ContractsRegulations (particularly where similarreductions appear to have been imposed inthe past by [Equitable] without adverseregulator comment). I would also think that itwould be odd, given the above considerations,for the OFT to consider taking action underthose regulations against [Equitable], thoughthat of course is a matter for the OFT.

165 The advice ‘therefore’ concluded ‘that the “exitcharge” imposed by [Equitable] is unlikely to becontrary to the Unfair Terms in ConsumerContracts regulations’.

166 The FSA’s response to the OFT of 21 December 2001explained that:

Equitable announced last week that its “exitcharge” would be increased to 10% from itsprevious level of charges which averagedaround 5%. On the basis of informationavailable to the Government Actuary’sDepartment, we understand that, evenfollowing this increase, surrender values ofEquitable policies are not out of line with theindustry average. The FSA will be monitoringthe adjustments made by Equitable and wehave powers to intervene at any time, if weconsider the figure to be excessive.

167 On 16 January 2001, at a meeting between the FSA,GAD and the Society, Equitable:

… explained that the present 10% MVA is[needed] to cover the additional cost of[GAOs] arising following the [House of Lords’] judgment (probably around 5%), along with therelatively poor investment return last year(around 2.5%), and the need to recover allinitial expenses incurred (around 2.5%). Theyhave made a robust response to the OFT onthis topic. The MVA is applied of course to thefull value which was increased on an interimbasis by around 4% last year, as compared withan actual investment return on the fund ofaround 2-2.5%. Meanwhile, they are not keento draw any further attention to the MVA andits link to investment conditions in view of thepossible adverse publicity. They stressed to usthat the MVA is not intended to act as apenalty; rather the objective is that paymentson noncontractual termination should be fairto both outgoing and remaining policyholders

168 On 19 January 2001, the OFT’s provisional views,which had been informed by the response of theSociety to their query about the market value, werecommunicated to the FSA. The FSA recorded thoseviews as being that the OFT accepted the‘explanation we gave them and the criteria thatEquitable apply in calculating a suitableadjustment’, while the OFT were not being in aposition to form a view as to whether the 10% levelapplied by the Society was a reasonable one interms of the unfair contracts legislation. However,‘the bad news’ was that the OFT ‘took exception’ tothe terms of the policies which provided that theSociety had absolute discretion to make suchadjustments.

169 On 7 February 2001, the FSA wrote to the OFTabout their concerns. The FSA noted that the OFT’s:

…concern is not so much about the applicationof an mva in itself, but rather the way in whichany adjustment is calculated. You indicatedthat you might be looking to ask [Equitable] totake steps to amend the wording of its policydocumentation to explain more precisely thebasis on which adjustments would be made… Ithink that achieving your objective by way of acontractual change may present somedifficulties and you will understand ourconcern, for prudential reasons, that nothingshould be done to undermine [Equitable’s] (orany other life office’s) ability to adjust contractvalues at early termination in appropriatecircumstances.

170 The OFT replied on 15 February 2001, saying:

[We] are clear that the Regulations apply here.We cannot agree with the argument that themva terms are fair or fall outside our scope totake action under the Regulations if they areoperated fairly. The question is whether theterms have the potential to be used unfairly inthe future or mislead customers, and weconsider that they have. Equitable will need, inorder to meet the requirements of theRegulation, to limit the scope of its “absolutediscretion” and conform its conditions to thefair practices that it says it applies and the fairprinciples that are enforced by regulation,though these principles may need furtherelucidation. Similarly, the scope of the FSA toregulate Equitable and Equitable’s presentpractice in operating the relevant terms, donot remove the problem or confer any kind ofexemption…Whether a standard term is unfairdoes not depend on an assessment of factorssuch as the practices and potential remit of any regulators, the likelihood that the courtswill overturn the unfair term when it ischallenged, or the current practices andpolicies or culture of the business using theterms.

171 The OFT concluded by saying:

I note your concern that nothing should bedone to undermine Equitable’s ability to adjustcontract values at early termination inappropriate circumstances. However the effectof the Regulations is that the relevant termsshould not enable Equitable to make unfairadjustments. The width of the terms is withoutdoubt challengeable under the Regulationsand could therefore be seen as unenforceable,whereas fair terms would not be. It seems to usessential therefore for Equitable to face thisconcern and that it would meet both yourprudential concerns and ours for Equitable todo so by revisiting the terms to clarify andobjectify the expectation that investors canlegitimately have.

172 In meetings subsequent to this exchange, the FSAand the OFT continued to disagree about the issue.In a report to the FSA Board given on 15 March 2001,it was said:

Policyholders had been complaining to theOffice of Fair Trading that the adjustmentsmade to the policy values on surrender (whichwas increased from an average of 5% to 10%after the closure announcement) werecontrary to the unfair contract termslegislation. As a matter of policy, we share theconcerns that adjustments should not beexcessive and serve materially to disadvantageone group of policyholders over another.However, for prudential reasons, it isimportant that any life office has sufficient flexibility to protect its insurance funds. OFTaccepted that a 10% penalty was not unfairbut were concerned about the ‘absolutediscretion’ reserved to the Society todetermine surrender values.We have workedclosely with both the OFT and Equitable onthis and assisted them [to] reach agreementabout a way forward. OFT will not seek tochallenge the relevant powers, and in return,Equitable will seek to improve the informationabout MVAs available to policyholders,including the reasons why they may be applied.The biggest short-term concern is thatcontinuing falls in equity prices may leadEquitable to want to raise the MVA …

173 On 3 April 2001, the OFT informed the FSA that theOFT had already begun enforcement action againstEquitable, following more than 60 complaints aboutthe way they used the market value adjuster. TheOFT said:

Equitable has explained how it exercises thisdiscretion in practice but it is clear that there isno transparency and consumers cannot takean objective view of how it will be used.Wethink Equitable may be able to meet ourconcerns by giving an undertaking to limit theexercise of the discretion so that the term isused fairly and in a way that is – within thelimitations imposed by varying marketconditions – predictable and objectivelyverifiable by consumers. However, we wouldneed to undertake a good deal of researchbefore we could be confident that theundertaking effectively met our seriousconsumer protection concerns.

174 From 1 May 2001, the FSA took over responsibilityfrom the OFT for complaints made under the unfaircontract terms legislation. Prior to this, on 17 April2001, the FSA’s Chairman had written to the OFT,saying:

I am sure you are correct to suggest that forOFT to pursue these cases would risk cuttingacross the review of with-profits businesswhich I announced in February. Since the FSAwill shortly gain powers under the UTCCRegulations I think it does make sense for us totake on these complaints, and we shall behappy to do so.

175 By the time that my jurisdiction over the relevantevents ended, those complaints were still underconsideration by the FSA.

Contingency planning and winding-up

 176 The chronology of events set out in Part 3 of thisreport details how the other issues arose, thedegree of regulatory involvement in each, and theway in which these issues were resolved, if theywere, during the period covered by this report.

177 Consideration was given on almost every day of theperiod covered by this Chapter as to the optionswhich the prudential regulators and the Societyfaced. The FSA identified at an early stage the needfor contingency planning and analysis of thepossible methods and implications of winding theSociety up.

178 The FSA secured the services of a secondee whowas an expert in insurance insolvencies to adviseand assist the FSA to consider these options. Thisresulted in a significant volume of analysis.Whatrapidly became clear, however, was that there waslittle by way of precedent, the rules were extremelycomplex, and the actual mechanics of winding upwere very uncertain, but likely to be prolonged. It isnot practicable to replicate here all the entrieswhich set out this activity. Those are set out in Part3 of this report.

Liability for mis-selling

179 On 8 May 2001, the Society’s Chairman provided theFSA with an initial draft of Counsel’s opinion on thepossibility of mis-selling claims to be made by non-GAR policyholders. The FSA said that they wouldneed to consider the implications of this opinionfor the Society’s solvency position. The FSA and theSociety met the following day, continuing theirdiscussions on the issue.

180 On the possible costs of mis-selling and theSociety’s solvency position, the FSA recorded that:A significant additional reserve would almostcertainly lead to the Society not covering itsRMM. The Appointed Actuary said that ifrequired the Society could find the amountrequired in the worse case scenario (the £1.5bn)but this would mean that the Society wouldhave to move entirely out of equities and intogilts.

181 On 5 July 2001, the Society informed the FSA that ithad not reached a firm view on how it would actbut had concluded that solvency could bemaintained by switching almost the entire fundfrom equities to bonds. The FSA’s Director ofInsurance commented that the FSA needed to get abetter ‘handle’ on Counsel’s opinion regarding missellingcompensation and that the sums which hadbeen mentioned of between £1,000 million and£1,500 million sounded very alarmist.

182 On 6 July 2001, the Society’s auditors telephonedthe FSA to discuss Counsel’s opinion, which hadsuggested that the Society could face significantmis-selling claims.

183 At a meeting of the prudential and conduct ofbusiness regulators to discuss Equitable on 18 July2001, it was agreed that:

• 
  the FSA should ask Counsel to produceprovisional advice on mis-selling;
• 
  the FSA should also ask the Society about itsstrategy for pensions mis-selling claims onpublication of Counsel’s opinion;
• 
  the FSA did have powers to prevent the Societypublishing their Counsel’s opinion but that itwas unlikely to be in the interests ofpolicyholders to exercise those powers; and
• 
  the FSA should ask the Society about its abilityto reserve for mis-selling claims.

It was noted that work would be needed toquantify claims and that the Society would needadequate contingency planning to cope with arange of possible outcomes.

184 This work continued throughout the rest of theperiod covered by this Chapter. For example, theFSA commissioned work by consulting actuaries toassess the value of possible mis-selling claims,calculated against both the Society’s and the FSA’slegal advice as to the Society’s potential exposure.Discussions between Counsel for the Society andCounsel for the prudential regulators remainedongoing.

185 Prior to an emergency meeting on 29 July 2001 todiscuss the results of the Society’s Board meeting ofthat same day which discussed whether the Boardconsidered the Society to be solvent, the Society’sChairman informed the FSA that the ‘worst case’basis for the value of mis-selling liabilities was £900million.

186 Estimates of the potential liabilities to which theSociety might be exposed ranged from £250 million(see the entry for 29 July 2001 in Part 3 of thisreport) to £5,000 million (see the entry for 25 July2001 in Part 3 of this report). Those liabilities wereeventually compromised under the scheme ofarrangement which the Society concluded pursuantto the provisions of the Companies Act 1985.

Conclusion

187 In this Chapter, I have set out a summary of themain themes and work strands related to thesupervision of the Society that the prudentialregulators and GAD were involved in during thethird period covered in this report.

188 I now turn to consider what the events and actionsthat have been summarised in the last threeChapters of this report – and set out more fully inPart 3 of this report – disclose. Before doing so, Imust address certain submissions I have receivedwhich dispute my approach to the standard I shouldapply when assessing those events and actions.