Introduction

1 This report sets out the results of my investigation into the prudential regulation of The Equitable Life Assurance Society in the period prior to 1 December 2001. This is the third report that my Office has produced in respect of that regulation.

2 I announced my intention to conduct this investigation – as I noted in the Foreword to this report, the second investigation conducted by my Office – and the reasons for that decision in a report that I laid before Parliament on 19 July 2004, entitled A Further Investigation of the Prudential Regulation of Equitable Life? (HC 910). Excerpts from that report are reproduced in Part 4 of this report.

3 That report was published following a consultation exercise I conducted in the aftermath of the publication of the report of an independent inquiry, the Penrose Inquiry, and with the purpose of seeking views from interested parties as to whether I should conduct an investigation in respect of a broader time-period than was covered in the report of my first investigation and with a wider jurisdiction than that which governed the earlier investigation.

4 I derive my powers from the Parliamentary Commissioner Act 1967, as subsequently amended (the 1967 Act). My role is to conduct investigations and to determine complaints referred to me by Members of the House of Commons, which are made by those who claim to have sustained injustice in consequence of maladministration on the part of bodies within my jurisdiction through action by or on behalf of those bodies taken in the exercise of their administrative functions.

5 Where I find that a person aggrieved has sustained injustice in consequence of maladministration, I seek to secure a remedy for that injustice.

6 The terms of reference for the investigation leading to this report were:

To determine whether individuals were caused an injustice through maladministration in the period prior to December 2001 on the part of the public bodies responsible for the prudential regulation of the Equitable Life Assurance Society and/or the Government Actuary’s Department; and to recommend appropriate redress for any injustice so caused.

7 Those who have complained to me about the matters covered by this report alleged that the public bodies responsible for the prudential regulation of insurance companies and the Government Actuary’s Department, which advised and assisted those regulators, acted with maladministration in failing for considerably longer than a decade properly to exercise their regulatory functions in respect of The Equitable Life Assurance Society.

8 The complainants claim to have sustained financial and/or other injustice as a result of that alleged maladministration. The remedy they seek is full redress for the financial losses that they say they have incurred in consequence of the alleged maladministration; they also seek a remedy for the other injustice they claim to have sustained.

9 In accordance with section 10(1) of the 1967 Act, I have sent a copy of this report to all those Members of the House of Commons who have referred individual complaints to me about the subject matter of this report. In accordance with section 10(2) of the 1967 Act, I have sent a copy of this report to the principal officers of those bodies about whose actions those complaints were made.

10 I am also laying this report before both Houses of Parliament, pursuant to section 10(4) of the 1967 Act, as, for a number of reasons, I consider it to be in the public interest to do so.

11 First, I have received referrals of complaints about the subject matter of this report from Members of the House of Commons acting on behalf of their constituents in respect of 1,018 individuals. 1,480 other people have also contacted me direct to complain about similar matters, many of whom sent a copy of their correspondence to their Member of Parliament or have otherwise involved those Members.

12 The events which form the basis of those complaints have had an effect on many thousands of other individuals both in the United Kingdom and elsewhere. My report therefore affects the interests of a considerable number of people and a large number of Members of Parliament from all political parties and from all parts of the United Kingdom have contacted my Office to express their views.

13 Secondly, the actions I have investigated leading to the production of this report have been (and in some respects continue to be) the subject of a number of inquiries, investigations, and other proceedings – in the domestic courts, within relevant professional bodies, at the European level and before other Ombudsmen.

14 My intention is that my report will provide a clear explanation of the role of the prudential regulators and contain an authoritative account of the acts and omissions of those regulators and their advisers in respect of the relevant events.

15 Thirdly, the issues raised by the complaints that prompted my investigation have raised a considerable amount of interest within Parliament and relate to the performance of regulatory functions which, while the statutory regime relevant to my investigation is no longer in force, go to the heart of some current political debates – about the nature of financial services regulation, about what consumers and taxpayers might reasonably expect from such regulation, and about the relationship between public bodies and citizens in the fields of banking, pensions and life insurance.

16 My report therefore addresses questions of wide social and political importance and its contents might assist Parliament in their further deliberations on these issues.

The subject matter of the report

17 The investigation which led to this report has centred on allegations of regulatory failure on the part of those responsible for the prudential regulation of insurance companies in the period prior to 1 December 2001, as those general responsibilities were discharged in the case of The Equitable Life Assurance Society. In the rest of this report, that mutual life insurance company is referred to as ‘Equitable’ or ‘the Society’– although in some of the direct quotations reproduced in this report, other acronyms commonly used by others have been retained.

Equitable

18 Equitable was founded as the ‘Society for Equitable Assurances on Lives and Survivorships’ in 1762. In August 1892, it was incorporated in the United Kingdom as a private unlimited company to be known as ‘The Equitable Life Assurance Society’. As a mutual life insurance company, Equitable has no shareholders. Instead, it is owned by those who effected its with-profits policies. With-profits policyholders effectively stand in the position of proprietors, sharing in any profits made or losses incurred in running the business. Equitable is generally accepted to be the oldest surviving mutual life assurance company in the world.

19 On 8 December 2000, Equitable announced that it would stop writing new business with immediate effect. Since then, the Society has undergone a difficult period and has implemented cuts in the policy values of its with-profits policies – or the income derived from its with-profits annuities.

20 The operation of the Society’s differential terminal bonus policy in respect of a representative policy for which the default benefit was an annuity paid at a guaranteed rate had become the subject of a judicial decision of the House of Lords on 20 July 2000 in Equitable Life Assurance Society v Hyman ([2002] 1 AC 408). That policy, which Equitable had adopted since January 1994, involved the paying of different levels of terminal bonus to policyholders exercising their right to take an annuity at the guaranteed rate than were paid to policyholders not exercising such a right. The House of Lords held that this policy was unlawful.

21 In the aftermath of the House of Lords’ decision, the position of Equitable was discussed at a tripartite meeting between the Treasury, the Bank of England, and the FSA held two days prior to the announcement of the Society’s closure to new business. At that meeting, Treasury officials explained their view that the problems faced by the Society had been caused by a unique set of circumstances which had contributed to the Society’s position being distinct from that of other life insurance companies.

22 The four most important factors identified in that discussion were:

• first, that Equitable had for many years operated a policy of full distribution of any surplus through bonuses to its with-profits policyholders and a policy of not building up a free estate, leaving the Society with a comparatively low level of free assets;
• secondly, that Equitable, being a mutual, had no access to additional, shareholder capital;
• thirdly, that Equitable had offered relatively generous and flexible guarantees on certain types of policy; and
• finally, that the proportion of the Society’s business to which those guarantees applied was much higher than was the case for other companies.

23 At the time that Equitable closed to new business, it was thus considered by the prudential regulators that the bonus distribution policy of the Society and also the level and extent of its guaranteed annuity rate policies – which enabled policyholders to secure an annuity with their pension fund at a specified, guaranteed rate as opposed to the then current annuity rates set by the Society or available on the open market – were of central importance to the Society’s problems.

24 The announcement by Equitable of its closure to new business had been prompted by the withdrawal of the last potential bidder from the process that had been launched to seek a buyer to acquire the Society following the decision of the House of Lords in the Hyman case.

25 In a letter sent by Equitable to all its policyholders on 12 December 2000, those events and the background to them were summarised by the then President of the Society as follows:

As most policyholders will be aware, on 8 December 2000 the Board announced that it had been unable to find a purchaser for the Society and had decided to stop writing new business … I must stress that the Society remains solvent and will continue to pay benefits and accept premiums under existing policies …

I am greatly saddened by the need to close the Society … but the Board decided … that this was the only realistic option. I apologise most sincerely to you … that this has come about. The intention of the sale process had been to make good the loss of growth for with-profits policies from 1 January to 31 July 2000 which followed the House of Lords’ ruling. In the event, this loss of value is unlikely to be restored, although we remain committed to generating the greatest possible value from the sale of some of the Society’s operations and providing the best possible ongoing service.

26 On 19 December 2000, during the first debate in the House of Commons on the closure of Equitable to new business, the sponsor of that adjournment debate, Mr Richard Ottaway MP, said that:

On the role of the regulator, it is the view of many in the industry that the Equitable has been treated differently by successive regulators … It is clear that something had to give. It was not possible for some policyholders to have guaranteed policies with guaranteed annuities, while other categories of policy holder were not so entitled, without there being some difficulty …

What was the regulator’s view? When it looked at policyholders’ contracts, did it think that the directors were adopting a policy that was nowhere mentioned in the contract? If not, why not?

27 Other complaints soon began to be made. Those complaints alleged that failures by those responsible for the prudential regulation of Equitable had caused or contributed to the position in which the Society had found itself when it had closed to new business.

Insurance regulation

28 In the period since 1988, the regulation of insurance companies within the United Kingdom has been subject to different statutory regimes within two distinct time periods. The first period ran from April 1988 to December 2001. In this period, the regulatory regime was effectively split along functional lines and was based on two separate statutes: the Insurance Companies Act 1982 – which concerned primarily the prudential regulation of insurance companies – and the Financial Services Act 1986 – which concerned the regulation of the conduct of investment business, including the marketing activities of life insurance companies.

29 Responsibility for the prudential regulation of insurance companies – which was primarily related to supervision of the solvency of such companies and their ability to meet and continue to meet their liabilities to policyholders and to fulfil the reasonable expectations of those policyholders or of potential policyholders – lay throughout this first period with central Government Departments.

30 During the period prior to 4 January 1998 relevant to this report, the prudential regulator was the Department of Trade and Industry (the DTI) and its predecessors; from 5 January 1998 to 1 December 2001, the prudential regulator was Her Majesty’s Treasury (the Treasury). From January 1999 until 1 December 2001 aspects of the day-to-day prudential supervision of insurance companies were contracted out to the Financial Services Authority (the FSA) – which, in this role, acted on behalf of the Treasury.

31 Furthermore, throughout the period relevant to this report legal advice to the prudential regulators was provided by in-house lawyers and, until 26 April 2001, actuarial advice was provided by the Government Actuary’s Department (GAD). Thereafter, actuarial advice was provided to the FSA by actuaries directly employed by the FSA, some of whom had previously worked for GAD.

32 Actions taken by all of the bodies with statutory responsibility for prudential regulation during the first period are within my jurisdiction, where those actions are taken in the exercise of administrative functions of such bodies. GAD, however, was not within my jurisdiction until the beginning of this investigation (see paragraphs 18 and 21 of Chapter 3) and was only brought within my investigative reach on a limited basis, to enable me to conduct this investigation.

33 I may only investigate action taken by GAD on or before 26 April 2001 in the giving of advice concerning the exercise of administrative functions under Part II of the Insurance Companies Act 1982 or any other enactment concerned with the regulation of insurance companies.

34 The FSA’s actions are only within my jurisdiction in so far as those actions relate to the prudential regulation of insurance companies during the period in which the FSA undertook this regulation on behalf of the Treasury. I have no power to conduct investigations in respect of any other of the actions of either GAD or the FSA.

35 Conduct of business regulation throughout this first period was delegated to a system of industry and practitioner-based, self-regulatory organisations under the supervision of a designated agency. This agency was at first called the Securities and Investments Board but became the FSA. The self-regulatory organisations of which the Society was a member during the period covered by my investigation were, until 1994, the Life Assurance and Unit Trust Regulatory Organisation and, from 1994, the Personal Investment Authority. None of the bodies with statutory responsibility for conduct of business regulation are or were within my jurisdiction.

36 The regime that was operational during this first period and which entailed this functional split between prudential and conduct of business regulation was replaced on 1 December 2001 by the current integrated regulatory regime, governed by the Financial Services and Markets Act 2000.

37 Since then, in this second period, the regulatory regime has combined all aspects of insurance regulation within the remit of one regulator – the FSA, which now regulates the insurance industry in its own right. The FSA, acting in its own right, is not within my jurisdiction and so, consequently, complaints about action taken as part of the regulation of any insurance company on or after 1 December 2001 are not ones that I have the power to consider.

38 I now complete this introduction by explaining the structure of my report.

The structure of the report

The Parts to the report

39 My report is in four Parts (or volumes): this, Part 1, describes the background to my investigation, summarises the evidence and representations submitted to me by the parties to the complaints, explains the tests I have applied in determining those complaints within the general and specific contexts of the subject matter of this report, sets out my key findings of fact, and contains my determinations as to whether maladministration occurred and, if so, whether it has resulted in any unremedied injustice.

40 Part 2 of the report contains a factual description of the historical development of the regime that was relevant to the prudential regulation of life insurance companies during the period prior to 1 December 2001.

41 Part 3 of the report contains a detailed chronology of events relating to the prudential regulation of the Society during the relevant period.

42 Finally, Part 4 of the report contains some key primary documents, reproduced in whole or in part, which I consider are either key to a full understanding of the matters that I have investigated or which help place my determination of the relevant complaints in a wider context.

43 We have also prepared a guide to the main report and summary of findings and recommendations, which is published as Part 5 of this report.

The Chapters in this Part of my report

44 There are fourteen other Chapters in this Part of my report:

Chapter 2 sets the scene for the investigation I have conducted, focusing on the events which form the background to, and the context for, my investigation, and also on the other reviews, inquiries and litigation which have taken place (or which continue to take place) in respect of Equitable.

Chapter 3 explains the involvement of my Office in respect of the events related to Equitable and which led to my decision to conduct this investigation. It also outlines the legal and administrative framework for the investigation and describes the process that I have used to conduct it.

Chapter 4 sets out the general and detailed complaints that have been made to me about the prudential regulation of the Society. It also sets out the initial response to those complaints of the public bodies whose actions were the subject of complaint.

Chapter 5 sets out the basis for my determination of the complaints. It describes my general approach to investigating complaints of injustice sustained as a consequence of maladministration; and sets out both the general principles of good administration and public law and the specific legal and administrative framework of prudential regulation applicable to my consideration of those complaints. It concludes with a summary of the key obligations of the prudential regulators and/or GAD which are relevant to this investigation.

Chapters 6, 7 and 8 set out a summary of the way in which the prudential regulation of the Society was undertaken in three time periods:

l the first period being prior to 20 June 1998;

l the second period being from 20 June 1998 to 8 December 2000, when the Society closed to new business;

l the third period being the post-closure period from 8 December 2000 to

1 December 2001, when my jurisdiction ends.

Chapter 9 contains the preliminary assessments which I have made in respect of disputed questions concerning what standard of regulation it would be appropriate to apply when reviewing the acts and omissions of those undertaking the prudential regulation of the Society, and what powers were available to those regulators.

Chapter 10 sets out the results of my review of the evidence I have obtained and contains my findings of fact.

Chapter 11 sets out my determinations as to whether the acts and omissions of the prudential regulators and/or GAD constitute maladministration.

Chapter 12 sets out my determinations as to whether any such maladministration has led to injustice to those who have complained to me.

Chapter 13 contains my disposal of each complaint within the terms of reference for the investigation, setting out which I have upheld in full, which I have upheld in part, and which I have dismissed.

Chapter 14 considers questions of remedy and contains my recommendations.

Chapter 15 contains my concluding remarks.