Conclusion

1 At the very beginning of this report, in its Foreword, I explained that the issues raised within this report go to the heart of some current debates about the nature of financial regulation and what citizens might reasonably expect from such regulation.

2 Of course, it is an objective shared by all that it would be preferable to avoid, where that is possible, situations where many hundreds of thousands of citizens find themselves in financial difficulties not of their own making.

3 Financial regulation exists to make a contribution to achieving such an aim. However, as successive Parliaments have recognised, such regulation cannot prevent all company failures or financial loss arising therefrom.

4 In my first report on the prudential regulation of the Society, I reported that I had found there to be a:

… fundamental mismatch between the nature and expectations of the prudential regulatory regime under which [the regulators] were required to operate during the period in question, and the understanding and expectations that policyholders and others appear to have had of that regulatory system^[1].

5 In terms both of what it is reasonable generally to expect from the system of financial regulation and of what standard should be applied by me to the review of the actions of those operating that system in this particular case, a minority of complainants certainly hold views which would suggest that such a mismatch continues to exist.

6 However, in considering the various submissions that I have received from the public bodies whose actions have been the subject of this investigation, I have also been struck by another fundamental mismatch.

7 Those submissions demonstrate a huge gulf between the duties and powers that Parliament in fact conferred on those operating the system of prudential regulation and the responsibilities in relation to those functions that the relevant regulators and their advisers are now prepared to accept were imposed on them.

8 I have explained in Chapter 5 of this report that one of the four cornerstones of the system of prudential regulation which existed at the time of the events recounted in this report was regulatory reform in the wake of high-profile insurance failures or other such problems. Indeed, the regulatory regime for the prudential regulation of insurance companies was largely established through legislation in 1973 that was a direct response to the failure of Vehicle & General.

9 The tribunal that was established by the Government of the day to inquire into the circumstances which had led to that failure concluded that the regulators had taken an overly restricted view both of the powers which Parliament had bestowed on them and of the circumstances in which the use of those powers should be considered^[2]. That tribunal found that, for almost four years, there had existed grounds for intervention action in respect of the company, action which should have been taken but which was not even considered.

10 That system of regulation, as it was supplemented and amended over time, was replaced on 1 December 2001 by the system which is now operational and which is contained within the Financial Services and Markets Act 2000. However, while the two regimes are governed by different legislation and informed, perhaps, by different approaches, difficulties continue to be experienced by financial firms. The contribution of those responsible for regulating those firms, in terms of the prevention or mitigation of those difficulties, also continues to be the focus of attention.

11 In the report of its internal inquiry into the supervision of Northern Rock during the period prior to its nationalisation, which was published at the end of April 2008, the FSA concluded that it could not provide assurance that the prevailing framework for the assessment of risks had been appropriately applied in respect of Northern Rock. The FSA also identified other failings which were described as ‘the most significant combination of shortcomings’^[3]. It was found that the risk ‘assessment of Northern Rock … as “low probability” was key to many elements of the subsequent supervision of the firm’.

12 I have not investigated either the historical regulation of Vehicle & General or the more recent supervision of Northern Rock, although my attention has been drawn to both cases on a number of occasions towards the end of the investigation which led to this report. For current purposes, I take the findings of both the tribunal and the FSA at face value.

13 Nevertheless, it seems to me that there are parallels between these other cases and the conclusions to which I have come within this report in respect of the prudential regulation of the Society.

14 I have found that, in relation to the Society, grounds existed on many occasions for the use of the powers of intervention which the prudential regulators possessed. However, little or no consideration was given by those regulators to whether it might be appropriate to use those powers. That echoes the findings of the Vehicle & General tribunal.

15 I have also found that, despite the information before the relevant regulators, any concerns which should have been raised by that information did not materialise in relation to Equitable. The Society was seen by those regulators as low risk, because of its long history and central place in actuarial tradition, because of its market position, and because of its good reputation. Such an assessment was, as appears to have been the case with Northern Rock, key to the way in which the regulation of the Society was undertaken.

16 There are other ways in which those other cases resonate with my findings in relation to the prudential regulation of Equitable – such as the apparent failure by the FSA to record the content of meetings with Northern Rock – but those are perhaps matters for others – and perhaps history – to consider.

17 It seems to me that the central lesson that can be learned from those cases – and perhaps the only way to address the fundamental mismatches that I have found on the part both of some complainants and of the relevant public bodies – is the need for absolute clarity as to what can and cannot be expected from the system of financial regulation.

18 Key to achieving such clarity are three things: a clear Parliamentary intention, systems and processes that are designed to deliver that intention, and a shared understanding as to the limits to the protection that the system offers to investors both before and after problems arise, as they inevitably will.

19 I make no suggestion as to what is the appropriate or optimal form of, and approach to, financial regulation. That is a matter for Parliament.

20 Nevertheless, whatever form or approach is adopted should be clearly articulated both within the relevant legislative framework and in any information provided about the system of regulation as to what it can or cannot deliver. Such information should be available to those – whether as investors, as regulated entities, or simply as legislators and taxpayers – who are potentially affected by such regulation.

21 Devising policies and approaches to implement the policy underlying the system of regulation – whatever that policy is – is critical to the success of such a system. The development of principles or philosophies, and of administrative systems of verification and oversight, will doubtless aid such effective delivery of Parliament’s intention.

22 However, such approaches to regulation should be consistent with what Parliament intended. It would be entirely unsatisfactory if Parliament were to legislate for a particular form or level of protection that was negated or reduced by the adoption of restricted and narrow interpretations of the duties and powers that Parliament has imposed in order to see its intention properly administered and effectively discharged.

23 Moreover, all those participating in – or with responsibilities for supervising from without – the financial system, including those investing or considering making such investments, should understand their own rights and responsibilities and thus be enabled to take appropriate action to mitigate those risks which cannot be removed by a system of regulation.

24 It seems to me that market stability and confidence in financial services can only be harmed where problems arise in a context in which no general understanding exists as to whether or not the system of regulation aims to prevent such problems from arising or as to whether a safety net exists to remedy any financial losses sustained.

25 I am aware of the views of others who believe that deficiencies in the system of regulation, and not the way in which that system was operated in the particular case of the Society, are more to blame for the circumstances which led to the Society to close to new business in December 2000.

26 However, I have found little evidence that would support such an assessment. The aim of the system of regulation that was in force under the Insurance Companies Act 1982 was clear enough. The means afforded by Parliament to the prudential regulators in order to deliver that aim were robust and could have been used, but were not used, in relation to the Society.

27 In reviewing the development of this regulatory regime, I was struck by a recurring theme in the Ministerial explanations to Parliament as to the basis for the powers that it was being asked to provide to the relevant regulators.

28 Sir Geoffrey Howe (as he then was), the Minister introducing what became the Insurance Companies (Amendment) Act 1973, told the House of Commons on 21 May 1973 that:

The purpose of the Bill is to improve the protection given to insurance policy holders. It is another example of the measures being introduced by the Government under the general heading of consumer protection. It is clear that we must do all we sensibly can not only to protect the policy holder but also to maintain the name and reputation of our insurance industry which does so much for our invisible earnings.

29 When the Policyholder Protection legislation, which established a scheme to provide compensation where insurance companies failed, was introduced, the then Secretary of State for Trade, the late Peter Shore, told the House, on 18 June 1975, that the legislation had:

… one central purpose and justification – to see to it that policyholders do not suffer major loss and hardship when an insurance company fails. Let me say straight away that I consider that my main objective, in supervising the industry, is to see that insurance companies do not fail … But the fact is that insurance companies have failed over many years, and in the past two years, in particular, a number of companies have got into difficulties as a result of the deterioration in the general economic situation and particularly the fall in stock market values and the decline in the property market.

I shall do my utmost to prevent failures in the future, but, if and when they occur, my major concern, and I believe that of this House, must be for the victims of such failures. Life insurance is the major form of saving in this country. For many people a life insurance policy represents their only substantial investment. The average citizen relies very heavily indeed on his insurance policies.

30 On 2 February 1981, in introducing legislation to implement the provisions of the first European Directive, subsequently to be consolidated within the 1982 Act, Sir Reginald Eyre, the then Minister responsible for prudential regulation, explained the approach to insurance regulation within the UK as being based on the doctrine of ‘freedom with publicity’ – like membership of the European Communities, another of the cornerstones of the system of prudential regulation covered in this report – and said:

Quite properly, the freedom I have referred to has its limits; the Secretary of State has a clear duty to intervene if it appears that all is not well. The need for supervision of the insurance industry is one of record. There have been cases in the past where failures of insurance companies have done policyholders and interested third parties great harm, and, indeed, done the industry no good. Although no system of supervision can avoid completely all risks of difficulty or failure of an insurance company, Government responsibility for a systematic approach is to be found not just in the United Kingdom, but throughout the countries of the developed world and in many others.

31 Ample means to deliver the central aim of regulation, as articulated by all those Ministers – the protection of policyholders – were given by Parliament to those responsible for regulating the insurance industry.

32 The central story of this report is that this robust system of regulation was not, in respect of the Society, implemented appropriately – that is, consistently, fairly, and with proper regard to the interests of those directly affected – by the prudential regulators and those providing assistance and advice to those regulators.

33 Assessing the risks relevant to a particular insurance company cannot be appropriately achieved through relying on its longevity or reputation. Verification of the financial position of such a company is not achieved if clear indications of difficulty or other warning signs are ignored or not followed through to a proper resolution. Ensuring that current and potential investors have sufficient information to enable them to make informed choices about their finances requires the published information about companies to be accurate and complete.

34 My findings in this report show that the prudential regulation of the Society during the relevant period failed – and failed comprehensively. That was not a system failure, but a failure properly to implement in the particular case of the Society the system of regulation that Parliament had enacted.

35 Shared understandings as to the purpose of, and limits to, financial regulation and as to the relevant rights and responsibilities of all those affected by such a system depend on the proper implementation of Parliament’s intention. That did not happen in this case.

36 As I noted in Chapter 4 of this report, on behalf of complainants EMAG submitted that:

Policyholders have lost large sums of money as a result of the maladministration by the Regulators to the extent that it is questionable whether they might not have been better served by no regulation at all.

37 The comfort taken by investors that a system of regulation exists to protect their interests cannot be lightly dismissed – but it should have a realistic basis. Ensuring that such comfort is realistic requires clarity as to what regulation is for, as to how it will be undertaken, and as to its limits.

38 This report deals with events and a regulatory framework that are both in the past. It is for Parliament to consider whether any lessons for the present – or for the future – can be drawn from the story that has been told in this report.

Footnotes

1 4th Report, Session 2002-03, The prudential regulation of Equitable Life (HC 809), Part 1, paragraph 10.

2 Report of the Tribunal appointed to inquire into certain issues in relation to the circumstances leading up to the cessation of trading by the Vehicle and General Insurance Company Limited, (HC 133), 15 February 1972.

3 The supervision of Northern Rock: a lessons learned review, FSA Internal Audit Division, March 2008.