The background: The Equitable Life Assurance Society

Introduction

1 In this Chapter, I set the scene for the investigationI have conducted, focusing on the events whichform the background to, and context for, this report. I also explain which other reviews, inquiriesand litigation have taken place (or which continueto take place) in respect of Equitable.

2 This Chapter is structured in the following way:

• in paragraphs 3 to 10, I describe the constitutionof the Society;
• in paragraphs 11 to 18, I summarise the nature ofthe business Equitable conducted during theperiod covered by this report;
• in paragraphs 19 to 66, I explain the Society’sdistinctiveness in certain respects within thewider context of the United Kingdom lifeinsurance market at the time;
• in paragraphs 67 to 69, I describe the reputationthat the Society had gained at the relevanttime;
• in paragraphs 70 to 96, I summarise the eventswhich led to the closure of Equitable to newbusiness on 8 December 2000;
• in paragraphs 97 to 123, I describe the principalevents relevant to this report which haveoccurred following that closure to newbusiness;
• and in paragraphs 124 to 167, I set out theprofessional and regulatory reviews, inquiries,complaints and litigation which have takenplace or been made (or which continue to takeplace or to be made) in respect of, or relatingto, the closure of Equitable to new business.

Equitable

The constitution of the Society

3 I explained in Chapter 1 of this report thatEquitable, founded in 1762, is generally believed tobe the oldest surviving mutual life insurancecompany in the world. The Society was registeredwith its current name as a private unlimitedcompany on 18 August 1892.

4 Equitable’s constitution is contained within theMemorandum and Articles of Association, whichset out the objectives of the Society and whichmake provision for who may become a member,the rights and responsibilities of those members,and the Society’s governance and organisation.

5 Throughout its history, the Society has beenowned by its members. As a mutual life insurancecompany, its participating policyholders becamemembers of the company and shared in any profitsmade or losses incurred in running the business ofthe Society. However, not all of its with-profitspolicyholders are members of the Society. Onlythe person who effects a with-profits policy is amember of the Society and, where such a policy iseffected by two (or more) people, only the firstnamed(living) person is a member.

6 The Society is governed by a Board of Directors,which is appointed by the members. Throughoutthe period covered by this report, the executivedirectors on the Board were mainly actuaries and,amongst other things, they represented both theSociety’s finance and actuarial functions. None ofthe non-executive directors was an actuary (exceptduring the period between 1991 and 1993, when the Society’s former Chief Executive, who was anactuary, joined the Board as a non-executivedirector). During the period relevant to this report,the Society’s Chief Executive was always an actuary.  

7 The Society has no shareholders, so the scope for conflict between the interests of policyholders and shareholders which can occur in a proprietary life insurance company does not arise.

8 The Society’s annual general meetings are open to its members and consider standard items, including the election of directors. Matters not included in that standard agenda are treated as special business. The voting rights of individual members are defined in articles 24(3) and 24(4) of the Society’s Articles of Association. On a poll, each member is entitled to one vote for every £1,000 of the sum assured of the with-profits policies that member holds, limited to a maximum of ten votes.

9 The Society’s Articles of Association during the period covered by this report made provision for an ‘Actuary’ to carry out a valuation at least triennially. The Society was the first life insurance company to use the title ‘Actuary’, having introduced the term in the 18th century.

10 The initial holders of this post (particularly William Morgan) are credited with much of the early development of actuarial science. With the passage of time, the designation ‘Actuary’ (and later ‘General Manager and Actuary’) became the Society’s title for its Chief Executive – although this is no longer the case.

The nature of the Society’s business

11 In the 1950s, Equitable were a relatively small mutual company, selling largely retirement plans – in particular, to university staff under the Federated Superannuation Scheme for Universities. This source of business disappeared in the early 1970s, when the Federated Scheme took the management of its pension business in-house.

12 The Society at that time embarked on a new strategy of active marketing to the upper end of the pensions market, concentrating on high networth individuals. It developed new products, a sales force and a branch network.

13 That new strategy was successful, and growth between 1970 and 2000 was substantial. According to the Society’s published accounts, at the end of 1970, 1988 and 2000 the total value of funds under management was, respectively, £113 million, £4,163 million and £33,899 million.

14 The Society’s business was largely pensions business. Equitable did write some non-pensions business, ranging from endowments to school fees policies, but this was far less financially significant.

15 Equitable sold both individual and group pensions business. Individual products were mainly aimed at the market for high net-worth self-employed individuals, and, in particular, self-employed professionals. The Society also provided pension annuities to individuals on their retirement or to trustees to provide an income when scheme members retired.

16 Group products were sold to trustees of occupational pension schemes and included investment products aimed at small to medium size occupational schemes. Those products were also sold as additional voluntary contribution arrangements for larger schemes, including both the National Health Service and Principal Civil Service pension schemes.

17 While the Society wrote other sorts of pensions business, it was best known for its with-profits products. The option of a broadly-based fund where the Society made the investment decisions and the results were smoothed was attractive to many investors. As a result of this and of the Society’s concentration on pensions business, the majority of the business it sold constituted withprofits pensions.

18 Over time, Equitable developed other products to help maintain their position. The Society was one of the first offices to introduce with-profits annuities and income drawdown products. It also allowed combinations of with-profits and unitlinked investments within the same policy.

The distinctiveness of Equitable

19 In addition to being regarded as the oldest mutual life insurer in the world and as important to the early development of actuarial science, the Society was distinctive in other ways related to the nature of its business and its commercial policies.

20 The pension savings products sold by Equitable were generally more flexible than other products available in the market. In particular, under its most popular pension policies the Society did not require policyholders to make regular or minimum premium payments every year.

21 In addition, policyholders did not have to choose a specific retirement age when purchasing a policy. This meant that those who retired ‘early’ with an Equitable policy typically avoided some of the penalties that could be imposed by other insurers, so that those policyholders were free to retire at any age that was permitted under what were then the Inland Revenue rules relevant to the product.

22 Another way in which it was distinctive was the nature of the guarantees contained within the Society’s products. The Society provided a range of guarantees on its with-profits pension products, although those of its policies issued in later years did not contain all of those guarantees. However, unlike some other life insurance companies at the time, the Society did not impose explicit charges for these guarantees via an addition to the premium charged or a deduction from each policy’s share of the assets of the with-profits fund.

23 The Society provided three main types of guarantee. Although many life insurance companies provided similar guarantees, Equitable differed in their application of those guarantees. Such guarantees were also provided on an unusually high proportion of the Society’s business and a significant proportion of that business contained all three guarantees.

24 The first guarantee provided by the Society was that policyholders would receive full benefits on retirement, without penalty. However, while most other insurance companies generally restricted this guarantee to one particular age, usually selected by the policyholder at the outset, Equitable provided this guarantee at a wide range of ages.

25 The second guarantee provided by the Society was in the form of a guaranteed investment return, which meant that the guaranteed benefits available to policyholders (based on the sum assured) would grow at a minimum rate each year whatever the Society’s actual investment performance had been. This guaranteed investment return was not included within new policies sold from 1996 onwards.

26 Equitable differed from most other companies because the level premium policy structure of those other companies normally meant that only future premiums paid at the initial level would benefit from guarantees in the original policy. Most other companies had ceased to offer guaranteed investment returns by 1990, although some continued to offer them into the mid-1990s.

27 However, with the Society, future premium payments in respect of policies which already contained this guarantee (including recurrent single premium policies where policyholders had the right, but not the obligation, to pay further premiums) continued to benefit from this guarantee.

28 The third guarantee provided by the Society was in the form of the guaranteed annuity rates it wrote into some of its policies. Those guaranteed the rate at which the proceeds available at retirement (based on the sum assured plus associated bonuses) would be converted to pension – and thus the minimum amount of pension available at retirement.

29 The Society stopped providing guaranteed annuity rates on new policies from June 1988, although new members of some existing group schemes continued to be provided with policies containing guaranteed annuity rates until the early 1990s.

30 The guaranteed annuity rates provided by the Society were more generous than those provided by most other companies. Those guarantees were also more flexible, as they gave policyholders the option to apply the guarantees over a wide range of ages rather than the more usual practice of applying them at a single age.

31 Under the terms of most of the Society’s policies containing those guarantees, including the comparatively high proportion of recurrent single premium policies, benefits purchased by future premiums would also enjoy the same guarantees. In this respect, the Society differed from most other companies who restricted the amount of future premium payments that could benefit from such guarantees.

32 At the time of the changes made by the Society to remove guaranteed annuity rates and, subsequently, to remove guaranteed investment returns from the policies it wrote, no new fund was established by the Society. Thus the assets held in respect of the different classes of policy thereby created were held in one fund.

33 Nor was there a separate bonus series declared or any differentiation in treatment between the various classes of individual pension policyholders in terms of the level of bonuses declared by Equitable, despite the changes in policy terms and the associated guarantees that had occurred.

34 Equitable differed from other life insurance companies in other ways. One example was that, from the 1987 bonus declaration onwards, the Society began to illustrate in annual bonus statements, under the heading of ‘Present value of the fund’, the policy value for each policyholder, including the value of terminal (or ‘final’) bonus.

35 Those bonus notices explained that the amount of final bonus payable was not guaranteed and that it might vary as financial conditions altered. Those notices also said that, when benefits were ultimately taken, the amount of final bonus could be less than the final bonus illustrated. Other companies typically provided less information than this, or focused only on the guaranteed benefits.

36 Another example of the Society’s distinctiveness was its bonus policy introduced from 1989. Equitable stated that this reinforced their philosophy of providing a ‘full and fair’ return to policyholders. The Society treated its with-profits policyholders as participating in a managed fund^[1],which allowed them to benefit from investments in a wide range of assets^[2].

37 In the Society’s accounts for 1992, its then President said:

In the Equitable we pride ourselves onallocating earnings from our investments across all classes and durations of contact in as fair and consistent a manner as possible. The fundamental philosophy is that each generation of policies should receive benefits commensurate with the earnings produced during its lifetime.

Beyond the bounds of normal commercial prudence, it would be alien to our culture to hold back benefits from one generation to build reserves for a future generation.

38 Equitable thus did not maintain an estate – that is, assets in excess of the amount needed to meet policyholder benefits, including terminal bonus. Apart from maintaining what was sometimes referred to as a ‘revolving estate’ to provide some working capital, the Society said that it made a full distribution to its participating policyholders.

39 The Society also considered that all its policyholders should get a fair return, which reflected investment earnings during the period of their membership, whilst avoiding short-term fluctuations in those earnings.

40 Prior to 1989, Equitable aimed to achieve this using a bonus system similar to that of other life insurance companies writing with-profits business, in that the Society declared different levels of terminal bonus for policies maturing at different durations since commencement.

41 For the 1989 bonus declaration, the Society changed its bonus system and introduced the concept of a ‘total policy fund’ for each policy, which started at the amount of the sum assured and subsequently grew by an amount that represented accumulated bonuses, including terminal bonus.

42 In order to do this, the Society decided to allocate a single growth rate, adjusted for tax, as appropriate, to the total policy fund of all policies, irrespective of policy duration or the guarantees they contained.

43 The total policy fund equalled the policy value illustrated to policyholders each year. Also, each year, the guaranteed funds of each policy (which, at the outset, equalled the sum assured) were increased by the addition of the guaranteed investment return and any declared reversionary bonuses. The amounts of the guaranteed funds were shown in the statements sent to policyholders each year.

44 The rate of growth of the guaranteed funds was intended to be lower than the rate of growth applied to the total policy fund. Thus, under the Society’s new system, final bonus represented the amount required to lift the guaranteed benefits up to the total policy fund value.

45 Policyholders were also told in the Society’s Annual Report and Accounts and, from 1993, in its With-Profits Guides, about the investment returns earned on the with-profits fund in the year and, starting with the 1989 Annual Report and Accounts, policyholders were also informed of the returns which had been allocated to their total policy funds.

46 A further example of its distinctiveness related to the Society’s approach to the adjustment of policy values, equal to the total policy funds, applicable on surrender.

47 Where policy values, including terminal bonus, were in excess of the market value of underlying assets, it was common for life insurance companies to use market value adjusters in order to restrict the benefits paid to policyholders who withdrew from the fund at times other than at maturity, death or retirement. It was also common for such companies to penalise policyholders who were in theoretical breach of contract by surrendering their policy before the contractual retirement or maturity date.

48 In common with other life insurance companies, at certain times Equitable applied market value adjusters to reduce payouts on non-contractual withdrawals from the with-profits fund. The Society’s stated aim when applying such adjusters was to protect remaining policyholders. This was achieved by paying surrender values that approximated to the market value of the underlying assets of each policy if this amount were less than the value of its total policy fund.

49 However, unlike other companies, Equitable said that they did not use market value adjusters unduly to penalise surrendering policyholders. For this reason, the approach Equitable adopted was to apply market value adjusters only if significant numbers of policyholders were judged to be seeking to take advantage financially of the withprofits fund.

50 The Society said that this was done to ensure that continuing policyholders were not disadvantaged by withdrawing policyholders being paid more than their fair share, measured by market value, of the underlying assets.

51 The Society’s practice in this respect during the 1990s was more generous than that of most other life insurance companies. Before November 1992, most of its surrender values were not adjusted – although some, involving large amounts payable to individual policyholders and all those in respect of group schemes, did suffer such adjustments.

52 From November 1992, adjusters were applied to all surrenders at various levels until such adjusters were withdrawn in March 1997. Adjusters were reintroduced in July 2000 and then applied to all surrenders.

53 Yet another example of the distinctiveness of the Society relates to the fact that it did not pay commission to third parties for the introduction of a potential investor to the Society’s sales force and was said by the Society to be a reason for its low expenses.

54 The combination of these distinctive features of the Society’s business was not in itself problematic. However, as the external environment changed, the combination of those features eventually would have profound effects.

55 Briefly in late 1993 and early 1994 and continuously from April 1995 onwards, the Society’s guaranteed annuity rates became generally more favourable than its then current annuity rates.

56 As a result, the application of a single growth rate to the total policy fund in respect of all policies would have meant that those policyholders whose policies contained guaranteed annuity rates could receive a greater proportion of the surpluses than was, in the Society’s view, compatible with its stated approach to ‘full and fair’ distribution.

57 In order to deal with this situation, the Society introduced what came to be known as the differential terminal bonus policy’ to enable it to continue to reflect the Society’s philosophy of ‘full and fair’ distribution to all its policyholders in its bonus policy.

58 Under the differential terminal bonus policy, the amount of final bonus payable when a policyholder took benefits under a policy would be dependent on the form in which those benefits were taken – that is, either a guaranteed annuity of a specified type or a current annuity where a wider choice of benefits was available, such as index-linked or jointlife annuities.

59 In particular, if the guaranteed annuity were taken, the level of terminal bonus was reduced from the rate that otherwise would have applied – restricting the amount of the annuity so that its value equalled the value of an annuity available at the then current rate, in respect of which the full amount of terminal bonus was awarded.

60 The operation of the differential terminal bonus policy, however, did not reduce the amount of the resulting annuity to below the amount provided by the application of the guaranteed annuity rate to the amount of the guaranteed fund value.

61 Notes to the Annual Statements provided to policyholders, included from the Statements for the year ending 31 December 1995 and subsequently, gave a brief description of the differential terminal bonus policy^[3]. However, at that time no other indication was given to the Society’s policyholders of the effects of that policy.

62 Whether the operation of the differential terminal bonus policy was consistent with the understanding that the Society’s policyholders had developed of the terms of their policies and the nature of the Society’s approach was a question which was central to what those policyholders might reasonably expect from the Society.

63 At all times relevant to this report, it was commonly accepted that the reasonable expectations that the policyholders of a withprofits life insurance company possessed would be influenced by, among other matters, the illustrations, marketing material and other information that had been provided to them.

64 There was therefore a direct link between the Society’s method of illustrating benefits and the expectations that its policyholders would have as to what benefits they would receive in normal circumstances.

65 The introduction of the differential terminal bonus policy in this context thus added to the distinctiveness of the Society. While some other companies also adjusted terminal bonuses in a similar way in the type of circumstances which faced the Society from 1995 onwards, those companies tended to illustrate benefits to their policyholders without including terminal bonus in the illustrations and often had separate bonus series for policies with and without annuity rate guarantees.

66 This meant that the expectations of their  policyholders may have developed in a different way from those that the Society’s policyholders were likely to possess.

The Society’s reputation

67 While the Society was distinctive in important ways, some of which were, in combination, to have significant adverse consequences in due course, the Society had a generally excellent reputation until the differential terminal bonus policy began to be questioned and challenged.

68 During the 1980s and 1990s, Equitable had built up a reputation for good customer service, provided by skilled and efficient staff. The Society had said that it had invested significant resources in developing its administration systems^[4], which were at the time generally considered to be efficient and were, for example, used to administer contracts for other insurers, as well as those systems being sold to third parties.

69 Equitable also told policyholders that the Society’s expenses were low compared to other offices due to these efficient systems^[5]. In addition, Equitable had developed good management information systems that were said to allow regular and detailed monitoring of expenses and investment policy. Equitable were generally seen as a market leader, albeit one that was, in certain respects, out of step with the rest of the industry.

The events leading up to closure to new business

70 As I have noted in paragraph 57 above, with effect from 1 January 1994 and in a context of reducing interest rates and of improving longevity^[6], the Society introduced what became known as its differential terminal bonus policy.

71 That policy was introduced in order to deal with the cost of meeting the guaranteed annuity rates within its older policies, which had become more advantageous to its policyholders and thus more onerous for the Society than the current annuity rates otherwise available.

72 Interest rates continued to fall during the 1990s. The actuarial profession undertook work to review industry practice in the light of the fact that guaranteed annuity rates generally were then, in that low interest rate environment, starting to exceed current annuity rates.

73 In June 1998 and in the light of the profession’s work, GAD, with the permission of the prudential regulators, surveyed the approaches of life insurance companies to reserving for annuity guarantees.

74 The analysis undertaken by GAD of the results of that survey found that, while eight companies gave general cause for concern in terms of the approach adopted by those companies to this question, Equitable and one other company were notable exceptions to industry practice and were of particular concern.

75 This was because those two companies did not hold adequate reserves to cover the liabilities which existed in respect of these policies and GAD were concerned about their ability to meet their statutory solvency requirements once they did so reserve.

76 From October 1998 onwards, the Society, the prudential regulators and GAD entered into extensive discussions about the regulatory requirements concerning reserving for annuity guarantees and the consequent need for the Society to establish significant reserves to cover the liabilities which arose from its policies which contained guaranteed annuity rates.

77 In 1999, Equitable entered into a financial reinsurance arrangement with IRECO, a reinsurer based in Dublin, in order to seek to mitigate the impact of the reserving requirements to which the prudential regulators and GAD had now insisted that the Society had always been subject.

78 That arrangement, which had been ‘backdated’ to 31 December 1998 and was first relied on in the Society’s regulatory returns for 1998, was contingent on the Society maintaining its differential terminal bonus policy.

79 Whilst now reserving as GAD required, the effect of the way that the Society treated the arrangement with IRECO in the calculation of its long term liabilities was to reduce that amount by £809 million as at the end of 1998, and by £1,098 million as at the end of 1999.

80 In the meantime, complaints had begun to be made to Equitable and to the Personal Investment Authority Ombudsman about the Society’s operation of the differential terminal bonus policy.

81 On 15 January 1999, in response to those complaints about the legitimacy of their approach, Equitable instituted a legal action against a representative guaranteed annuity rate policyholder, Mr Hyman, to seek confirmation from the Court that the Society’s approach was lawful and within the discretion of its Board. The Society funded Mr Hyman’s costs. The policy document which was at the centre of those proceedings is reproduced in Part 4 of this report.

82 According to papers lodged with the Court, Mr Hyman had been chosen as the representative defendant because he was the only policyholder from among those who had made formal complaints to the Personal Investment Authority Ombudsman who had already taken retirement benefits.

83 On 9 September 1999, the High Court ruled that the Society was entitled to operate its differential terminal bonus policy, but Mr Hyman was given leave to appeal.

84 On 21 January 2000, the Court of Appeal gave judgment against Equitable by a majority of two to one. The Society was granted leave to appeal to the House of Lords and was permitted by the Court in the interim to continue to operate its differential terminal bonus policy pending that appeal – subject to the assurance that, if the Court of Appeal’s decision were to be upheld, Equitable would pay additional sums in respect of any retirement or maturity after the date of the decision of the Court of Appeal.

85 On 20 July 2000, the House of Lords handed down its decision and held that Equitable could not apply different rates of bonus depending on whether or not a policyholder took benefits based on guaranteed annuity rates. The House of Lords also held that the Society could not pay lower bonuses to policyholders with annuity rate guarantees as a class than those paid to the class of policyholder whose policies did not contain such guarantees. The differential terminal bonus policy could no longer be applied.

86 The decision of the House of Lords had a significant and immediate financial impact on the Society. The decision of the House of Lords meant that the Society could not ‘ring-fence’ groups of existing policyholders from its effects. The increased costs to the Society had to be charged to the entire with-profits fund, and shared among all those holding at that date all types of with-profits policies, whether or not those policies contained an annuity guarantee.

87 In the absence of the operation of the differential terminal bonus policy, the ability to take benefits in guaranteed annuity rate form became significantly more attractive. The Society was now required to apply, without reduction of terminal bonus, the guaranteed annuity rate to the total policy funds of those policyholders whose policies contained such rates where they elected to take benefits in this form. This meant that it had become more likely that policyholders would so elect.

88 Equitable now had significantly increased liabilities against which they held much reduced assets. This was in part because the financial reinsurance arrangement, for which credit of £809 million and £1,098 million, respectively, had been taken by Equitable within their regulatory returns to the prudential regulators in respect of 1998 and 1999, could no longer be relied upon.

89 As the continuation of that arrangement had been conditional upon Equitable maintaining the differential terminal bonus policy, which the House of Lords had held to be unlawful, the financial reinsurance arrangement now needed to be re-negotiated, which it was subsequently. The Society thereafter relied upon that arrangement again within its 2000 regulatory returns, although the credit taken was reduced to approximately £500 million.

90 The decision of the House of Lords had other effects. In the words of the Society’s press release of that day, that decision also would ‘increase the Society’s statutory reserves and that will diminish the Society’s capital strength and reduce its investment freedom’.

91 In the face of all this, the Society immediately announced that it was seeking a buyer, saying that:

Despite the Society’s long commitment to mutuality, the Board has concluded that members’ interests will be best served by the sale of the business to an organisation capable of providing capital support and therefore ensuring continued investment freedom. The proceeds of [a] sale to such a parent will mitigate the reduction in benefits that with profits policyholders not taking [guaranteed annuity rate] benefits would otherwise suffer.

92 On 26 July 2000, Equitable further announced that, in the light of the decision of the House of Lords, the Society had set new final bonus rates. For with-profits policies where benefits were taken in guaranteed annuity form, the Society said that those policies would ‘receive higher benefits than would have been available under the Society’s previous approach’. For with-profits policies which did not contain an annuity guarantee, or where the guaranteed annuity was not selected, the Society said:

These policies will receive lower growth in the current year than would otherwise have been the case as a result of the need to cover the increased GAR benefits. There will thus be no growth on these policies’ funds from 1 January 2000 to 31 July 2000…’ ^[7].

However, the Society went on to say that a particular aim of the sale of the business was to replace this loss of growth of policy funds.

93 One further result of the House of Lords’ decision was that it now appeared that policyholders with policies containing guaranteed annuity rates who had taken benefits between 1 January 1994 and 19 July 2000 had been presented with information about their options which had been incorrect.

94 In response to this problem, in December 2000 the Society launched a Rectification Scheme, with the objective of putting policyholders in the position they would have been in had final bonus rates been set in accordance with the principles set out within the House of Lords’ decision at the time at which they had taken benefits.

95 The announcement on 8 December 2000 that Equitable had closed to new business with immediate effect, following the failure of an attempt to effect a sale of the Society’s business to another insurer, came as a shock to many of its members and to outside observers.

96 Equitable had been viewed as a well-regarded institution with a venerable and proud tradition. However, the attempt at sale still failed. While many companies had expressed some interest in purchasing the Society, none put in a formal bid after examination of the Society’s financial position.

The aftermath of closure to new business

Regulatory response

97 The closure of the Society to new business also attracted a regulatory response. The FSA – the body by then responsible under contract for exercising on behalf of the Treasury and the Personal Investment Authority (one of the conduct of business regulators) various regulatory powers in respect of insurance companies such as Equitable – issued a press notice on 8 December 2000.

98 In this notice, the FSA said that:

The Society has worked closely with the… FSA since its decision to put itself up for sale.We have been in particularly close touch since it became apparent in recent days that an offer for the Society might not, in the event, be made. As the management of the Equitable said after the House of Lords judgment, the institution’s special circumstances meant that a sale was in the best interests of policyholders, as it would provide the investment flexibility necessary to permit long-term continuation of business as normal. The Society will now need to review its investment strategy and, as is normal in a closed fund, this is likely to lead to a progressive move away from equities to lower risk investments over time.

99 The press notice continued:

The FSA has stressed the importance of the Equitable providing comprehensive and timely information to its policyholders so that they can consider their options fully… The FSA will continue to monitor closely the operations of the Equitable. The Society continues to meet the statutory solvency requirements.

Sale of parts of the business

100 The Society continued to make efforts to mitigate the impact of the House of Lords’ decision on its financial stability and future prospects. On 22 December 2000, it was announced that the Society’s wholly-owned subsidiary, the Permanent Insurance Company Limited, was to be sold – which it subsequently was, to Liverpool Victoria Friendly Society.

101 On 5 February 2001, Equitable announced that, through a deal agreed with Halifax Group, the Society had raised capital by reinsuring its nonprofit and unit-linked business (including index-linked policies, but excluding annuities) and by selling its sales force, its asset management function, and its customer services division.

102 As a result, additional future payments, conditional on sales performance and on the implementation within a set timescale of a scheme of arrangement under section 425 of the Companies Act 1985 (commonly known as a Compromise Scheme), were to be made to the Society.

103 Despite these sales of parts of its business, the Society continued to face significant financial uncertainty in a context of difficult market conditions, with the stock market falling by 10% during 2000 and by a further 15% during 2001. Those conditions were reflected in a market value adjuster applied to non-contractual exits, which had been set at 10% from when the Society closed to new business, and which was increased on 16 March 2001 to 15%.

104 On 28 February 2001, the new Chairman of the Society said, in an open letter to policyholders that:

… the [with-profits] fund is intact and solvent and has been strengthened by the Halifax first instalment of £500m. However, the potentially open-ended nature of the [guaranteed annuity rate] policies means that the position is unsatisfactory for all policyholders and investment freedom is constrained. A compromise agreement… will allow us to stabilise the [guaranteed annuity rate] costs and will trigger a further large payment from the Halifax. The combination of these should restore the investment freedom of the fund.

Policy value cuts

105 On 16 July 2001, Equitable announced to the Society’s policyholders that the Board had decided to reduce final bonuses on all with-profits policies.

106 The total policy funds of each with-profits pension policy were reduced by an amount equal to 16% of their value as at 31 December 2000, with reductions made of 14% in the value of all non-pension withprofits policies. Those cuts reduced previously notified accumulated terminal bonuses but could not reduce benefits on any particular policy below the level of its guaranteed fund. Similar cuts to the benefits to be paid under with-profits annuities were also made at a later date.

107 That decision had been taken, Equitable said, following analysis of the Society’s cash flows, premiums, the rates of policies maturing and being surrendered, and the value of investments underlying the fund – and after assessment had been made of the Society’s obligations to all its policyholders in the context of the ‘fundamental uncertainties’ which Equitable now faced.

108 The press release issued by the Society to accompany this announcement explained that the rationale for these reductions in policy values had been informed by ‘the need to ensure fairness between all policyholders’ and that these reductions had been ‘vital for the long-term interests of the Society and its policyholders’.

Equitable explained that:

The decision was taken, and could not be delayed, because:

• Stock markets have fallen heavily over the last 18 months;
• Maturity values now significantly exceed the value of the investments underlying maturing policies; [and]
• As a mature fund, a large number of policyholders are currently retiring and taking their benefits.

The Compromise Scheme

109 In September 2001, Equitable published proposals for a scheme of arrangement under section 425 of the Companies Act 1985 through which, in the words of the press release which accompanied the publication of the detailed proposals, ‘all withprofits policyholders [would] give up some rights in exchange for increases in their policy values’. As already noted, such arrangements are often referred to as Compromise Schemes.

110 Equitable explained that the ‘key points’ of the Society’s proposals were:

• that they were based on the four principles of ‘fairness, clarity, mutuality, and legality’;
• that all policyholders were ‘being asked to give up some rights in exchange for greater certainty, more investment freedom, and the possibility of higher investment returns in the future’;
• that the proposals would settle the guaranteed annuity rate issue through the provision to those policyholders who held policies with such guarantees of, on average, ‘an increase of 17.5% in their policy values in exchange for giving up their rights’ to the guaranteed rates;
• and that those with-profits policyholders without policies which attracted such guarantees would ‘receive an increase of 2.5% in their policy values in exchange for giving up any rights to make claims against the Society’ which arose from the costs of the guarantees.

111 On 20 September 2001 (the day on which the Society published its proposals for consultation on its Compromise Scheme), the FSA made a statement on the proposals, in which it was said that:

We firmly believe that a successful compromise would offer the best prospect of bringing stability to the with-profits fund and improving the outlook for worried policyholders. We think that today’s proposals offer a sensible basis on which Equitable Life can consult its policyholders…

Our concern is to ensure that the interests of all Equitable Life’s policyholders are properly taken into account. We are keeping Equitable Life’s financial position under continuous review. We have also obtained independent legal advice on the issue of whether Equitable Life may be exposed to potential claims for compensation by non-[guaranteed annuity rate] policyholders with a realistic chance of success… Our formal assessment of the final scheme later this year will examine whether, for each relevant group of policyholders, the proposal put to them is a fair exchange for the rights they are being asked to give up. If that test is passed, we will also look to see that the scheme does not give disproportionately greater benefits or disbenefits to some policyholders.

112 On 1 December 2001, the Society sent to its policyholders the Compromise Scheme proposal documentation (the ‘Circular’). The Circular made clear that, although the Society remained solvent at that time, it faced a number of ‘serious problems’ that the scheme would help to address. The key benefits to policyholders of the scheme were described in the Circular as being:

• [guaranteed annuity rate – GAR] policyholders as a group will receive fair value for the loss of their GAR Rights and the waiver of their GAR Related Claims
• Non-GAR Policyholders as a group will receive fair value for the waiver of their GAR-Related Claims;
• the financial strength of the Society will be improved and the Society will have a more flexible investment policy than it would have if the Scheme did not become effective;
• all policyholders (including the Society’s nonprofit annuitants) will have greater certainty going forward in that their contractual benefits will have greater certainty of being paid;
• and £250 million will be made available by Halifaxto the Society’s With-Profits Fund if the Scheme becomes effective on or before 1 March 2002.^[8]

113 Policyholders were advised that the statements and information set out in the Circular superseded the information, statements and opinions contained in the consultation documentation and otherwise made available by or on behalf of the Society in the past. Policyholders were therefore advised to rely only upon the information in the Circular when making their decision as to how to vote.^[9]

114 On 10 December 2001, the FSA published their formal assessment of the Society’s proposals. This followed correspondence with the Society during the previous month – in which the FSA had signalled that, subject to the resolution of outstanding points, they saw no regulatory obstacles to the successful sanctioning of the Compromise Scheme. That assessment is reproduced in full in Part 4 of this report.

115 The press notice accompanying the FSA’s assessment of the Compromise Scheme – which is also reproduced in Part 4 of this report – quoted one of its Managing Directors as saying:

The FSA has already said that a successful compromise would, in principle, offer the best prospect of bringing stability to Equitable Life’s with-profits fund and so improving the outlook for policyholders. Having taken into account all the relevant considerations, we have concluded that the proposed Compromise now put forward is a fair offer for the rights and claims given up…

The FSA is not required to approve the proposed Compromise but it does have powers to take action in order to protect the interests of policyholders. We have concluded that, taken in the round, the Compromise is a fair offer and we saw no reason to intervene to stop the proposals being put to policyholders.

The FSA’s assessment of the proposed Compromise does not constitute a recommendation by the FSA as to how individuals should vote; our view reflects the merits of the scheme overall. Individual policyholders must of course decide how they themselves vote in the light of their own individual circumstances.

116 Following the votes of affected policyholders in favour of the Compromise Scheme, on 8 February 2002 the High Court gave its sanction to that Scheme. This bound all those who were members of the Society at that date to its terms.

Further policy value and other cuts

117 Despite the action taken by the Society to stabilise the with-profits fund, to improve the financial strength of that fund, and to provide policyholders with greater certainty that their contractual benefits would continue to be paid, further cuts followed the Compromise Scheme. First, these were in the form of a maturity adjuster. In announcing this, Equitable said that:

… with effect from 15 April [2002], the maturity value for a UK pension policyholder choosing to take maturity now will be the indicative policy value calculated allowing for the new bonus announcements, adjusted down by 4%. The maturity value of a policy will not be lower than the guaranteed value of that policy.

In July 2002, the level of the maturity adjuster was increased to 10%.

118 The extension of similar reductions to with-profits annuities was announced later in 2002, resulting in significant reductions in annuity payments over the following two years. This was the result of the recognition that it would no longer be possible to delay the reductions to final bonus equivalent to those previously made for other groups of policies.

119 A letter sent by the Society on 15 November 2002 to its with-profits annuitants to announce those reductions in their income set out the scope of the various cuts that had been made since the decision of the House of Lords in the following way:

Since 20 July 2000, our decisions on bonuses have been particularly affected by the falling value of investments in stocks and shares, the costs of the guaranteed annuity rates… and increases in the money we set aside for potential claims for compensation. Following the House of Lords decision in July 2000, we had to reduce the value of with-profits policies. We did this, other than for withprofits annuities, by reducing the policy value by 5% at that time. We made significant further reductions in July 2001, April 2002, and July 2002. This means, allowing for bonuses, our other with-profits policyholders have suffered an overall reduction of about 20%.

120 That letter continued by explaining to annuitants that:

So far we have largely protected you from these falls. In fact, you and other with-profits annuitants have generally received a positive investment return of about 14% over the same period… It was possible for us to phase the cuts to with-profits annuities in the hope of improved financial conditions. Unfortunately, because conditions have not improved we can no longer keep doing this. This basically means that with-profits annuities, like yours, are now out of line by about 30%.

121 The Society’s letter then set out the action that would be taken by Equitable to remedy this position during the following year – being a reduction in the total value of with-profits annuities ‘by up to 20%’, the declaration of a zero rate of return for all such annuities in respect of 2002, and an increase from 1% to 1.5% in the annual adjustment made to the value of each annuity. The letter also said that there would be further reductions in a year’s time for most annuities.

Further developments

122 The Society has continued to seek ways of bringing stability to its remaining business. Following approval by the Court, the Society effected the transfer of the bulk of its non-profit annuity business, with reserves of £4.6 billion, to Canada Life – completing this transfer on 12 February 2007. On 1 June 2007, the Society completed the sale of its subsidiary company, University Life, to Reliance Mutual. The Society announced on 2 January 2008 that the transfer to Prudential of its with-profits annuity book, with reserves of £1.7 billion, had been completed.

123 In the Society’s Annual Report and Summary Financial Statements 2007, considered at its annual general meeting on 19 May 2008, its Chairman and Chief Executive both said that:

2008 is likely to be a key year in deciding the longer term future of the Society. The Society can run its existing policies to maturity or it may be able to transfer them to one or more third parties who can provide the prospect of better outcomes for policyholders. The options should become clear during 2008… The Society is now stable and secure and it can foresee running its business, paying policy benefits as they fall due, for many years. The Society will remain closed to new business and will gradually run down as policies mature. This is known as ‘run-off’.

In 2008 we are inviting other companies to say what they could do to improve the prospects for policyholders. If we believe that one or more can provide a better option for policyholders than run-off, we will choose the best proposal and recommend it to you. We emphasize that no such change would take place without the approval of members.

Reviews, inquiries, complaints and litigation

124 Other developments occurred in the aftermath of the Society’s closure to new business on 8 December 2000. Since then, a number of reviews and inquiries have been undertaken into the professional and regulatory aspects of the events which led to that closure. Complaints and litigation have also been initiated.

The FSA review of regulation and the Baird Report

125 On 22 December 2000 – two weeks after the  closure of the Society to new business and following an announcement that day by the Treasury that such a review would be established – the FSA published the terms of reference for an internal review they would undertake.

126 Those terms of reference included consideration of how the various functions the FSA had exercised on behalf of those given statutory responsibility for the regulation of insurance companies had been discharged in relation to the Society. That review led to the Baird Report (see paragraphs 129 to 132 below).

127 The FSA explained the thinking behind the establishment of the review thus:

The [FSA] Board believes that it is good discipline to learn the regulatory lessons from episodes such as this while acknowledging the fact that the Equitable remains solvent and has not failed. Under these circumstances, the Board has asked the FSA’s executive management to produce a full account of its regulation of Equitable Life for its consideration. It will cover the period from 1 January 1999 until… closure to new business on 8 December 2000. It will also set out the background and events leading up to the FSA assuming formal responsibility for prudential insurance regulation on 1 January 1999.

128 The terms of reference for this review were to cover:

• the FSA’s discharge of the functions (under the Insurance Companies Act 1982) which it undertakes as delegate for HM Treasury;
• and  the Personal Investment Authority’s… discharge of its functions as a recognised self regulating organisation (under the Financial Services Act 1986).

and the resulting report would:

• describe the background and events leading up to the FSA’s assumption of responsibility for the prudential regulation of the Equitable Life on 1 January 1999;
• describe the course of supervisory work from then until the Society’s closure to new business on 8 December 2000; [and]
• identify any lessons to be learned.

129 The Baird Report was published on 17 October 2001 when it was laid before Parliament by Treasury Ministers. The Report concluded that the Society’s policy of deliberately maintaining a low free asset position through the full distribution of profits to each generation of policyholders and in writing historic business on a large scale containing very generous guarantees had contributed to the weak financial position of Equitable, which had accordingly developed over many years.

130 The Baird Report found that the specific difficulties which Equitable had faced had crystallised following the decision of the House of Lords, which had rendered unlawful the differential terminal bonus policy which the Society had adopted to manage those difficulties. In paragraph 6.1.4, the Report concluded that:

The scale of Equitable Life’s potential liability from the unmatched interest rate exposure, which it created when it wrote its [guaranteed annuity rate] business, and the scale of the future profits it had already taken into account combined to leave Equitable Life seriously exposed to any further financial shock.

131 In making its overall assessment of the discharge by the FSA of its regulatory responsibilities under contract during the relevant period, the Baird Report stated, in paragraphs 6.2.4 and 6.2.5, that:

… applying hindsight, it is fair to say that, by 1 January 1999, the “die was cast” and we have seen nothing which the FSA could have done thereafter which would have mitigated, in any material way, the impact of the outcome of the Court case as far as existing policyholders were concerned, or made any material beneficial difference to the final outcome so far as Equitable Life was concerned.

That said, our assessment does identify a number of things which the FSA could have done better. There were occasions when both the prudential and the conduct of business regulators did not spot issues to be addressed or, having spotted them, did not follow them up… One of the reasons why issues were missed was the poor level of communication and coordination between the two arms of regulation, prudential and conduct of business…

132 The Baird Report went on to make a number of recommendations in order that lessons might be learned from the Society’s experience and that future life insurance regulatory practice might be improved. The FSA have implemented those proposals.

Professional reviews

133 Meanwhile, there had been two further developments related to the professional aspects of the relevant events.

134 First, on 21 December 2000, the actuarial profession had announced that it was setting up an independent committee of inquiry to look at the events surrounding the closure of Equitable to new business and at the implications of those events for that profession. This committee – the Corley Committee – reported subsequently on 28 September 2001, making general recommendations concerning the adequacy of relevant professional guidance.

135 Secondly, on 10 January 2001, the accountancy profession had announced that the part played by the Society’s auditors would be subject to enquiry by that profession. Upon reaching the opinion at the conclusion of that enquiry that there were grounds upon which a Joint Disciplinary Tribunal could make an adverse finding concerning the firm in question, a formal complaint was then presented and a Tribunal appointed to determine the complaint.

136 The proceedings had been stayed while those against whom that complaint had been made were involved in other proceedings. Following the conclusion of those other proceedings, the hearing into the complaint took place during 2007 and the findings of the Disciplinary Tribunal Panel are, at the time of writing, awaited.

Parliamentary inquiry: the interim report of the House of Commons Treasury Select Committee

137 On 27 March 2001, before the Baird Report was  published, the House of Commons Treasury Select Committee published an interim report. The main conclusions and recommendations of the Committee, as they relate to the subject matter of this report, included the following:

(i) that Equitable’s ‘risky decision in 1993 not to build up a reserve to cover the cost of Guaranteed Annuity Rate (GAR) liabilities was a crucial turning point’;

(ii) that it was unclear ‘why the issue of GAR liabilities and reserving was not considered by the prudential insurance regulator at least by 1993, rather than only in 1998’ and that this should be pursued;

(iii) that the prudential regulators should be asked to ‘reconsider whether it was right to accept the reinsurance contract given its terms, and whether it was prudent to allow such a contract to have accounted for half of the Equitable Life’s statutory reserves’ set up to meet the cost of annuity guarantees;

(iv) that the Society had ‘demonstrated that the information provided to policyholders, through the statutory accounts, and to the regulator, through the regulatory return, differed substantially in their treatment of the GAR liabilities and the consequential reserving that had been undertaken. As a result, policyholders were not able easily to establish the true position of the company…’;

(v) that those regulators ‘should … consider whether the assessment made by Equitable Life, and indeed by themselves, of whether the eventual House of Lords ruling could have been predicted, was justified…’; and

(vi) that it was ‘important that the role of the regulator since 1993, when Equitable Life began to operate a policy of terminal bonus differentiation, should be analysed in order for the regulatory lessons to be properly learnt, for policyholders to fully understand the history of the affair and for Parliament to undertake its scrutiny of this topic properly and fully…’.

Conduct of business complaints

138 The effect of the Compromise Scheme was that only those who were no longer members of the Society on 8 February 2002 could proceed with complaints to Equitable and then to the Financial Ombudsman Service (or to the courts) alleging misselling on the part of the Society in relation to the guaranteed annuity rate issue.

139 On 23 May 2003, the Financial Ombudsman Service published determinations on three lead cases that required Equitable to compensate for mis-selling certain categories of policyholders whose claims had not been extinguished by the Compromise Scheme. I am told that payment of this compensation has been completed (with the exception of a small number of cases still with the Financial Ombudsman Service or the courts).

Litigation by the Society against its former directorsand auditors

140 In April 2002, Equitable commenced formal litigation against certain of their former directors and Appointed Actuaries who held office between 1996 and 2000 and also against their former auditors. The claims made by the Society were based on allegations concerning:

(i) the Society’s guaranteed annuity rate policies and its differential terminal bonus policy;

(ii) the risks as to the legality of that policy and the management of those risks;

(iii) the Society’s accounting for guaranteed annuity rate policies within its Companies Act accounts; and

(iv) its contingent liability and risk disclosures in relation to the Hyman litigation within the Society’s Companies Act reports and accounts.

141 The High Court hearing commenced in April 2005. In September 2005, the Society announced that it had agreed with its former auditors that the Society’s case against them would be discontinued and that each side would pay its own costs.

142 Over the following two months, the Society announced that it had reached further agreements for the discontinuance of cases against some of the remaining defendants.

143 In December 2005, following service of written closing submissions by all parties and immediately prior to the final court session, the Society announced that it had agreed terms to discontinue the cases against the remaining defendants. There was thus no determination of, or agreement about, the matters at the heart of the case.

The inquiry led by Lord Penrose

144 The Report of the Equitable Life Inquiry, which had been led by Lord Penrose, was published on 8 March 2004. That Report had been commissioned on 31 August 2001 by Treasury Ministers, who announced that they had established this independent inquiry. The terms of reference for that inquiry had been:

To enquire into the circumstances leading to the current situation of the Equitable Life Assurance Society, taking account of relevant life market background; to identify any lessons to be learnt for the conduct, administration and regulation of life assurance business; and to give a report thereon to Treasury Ministers.

145 The contents and principal conclusions of the Penrose Report are well known and I do not repeat those here. In summary, in so far as his Report considered matters related to regulatory action within my jurisdiction, Lord Penrose concluded that there were six ‘areas of specific concern about the regulatory response to the Society’s practices’.

146 He also concluded that those areas of concern had had a bearing on the solvency of the company as that solvency position had been presented to the public. Those areas of concern are set out in paragraph 166 of chapter 19 of his Report, and related to:

• the interest rate differential (between the bonus rate projected forward and the rate of return used to discount liabilities back to present values) between 1990 and 1997;
• the quasi-zillmer adjustment (through which acquisition costs for recurrent single premium business were annuitised) from the early 1990s;
• implicit items for future profits employed in and after 1994;
• the subordinated debt;
• the [guaranteed annuity rate] liability valuation; and
• the financial reinsurance treaty.

147 In paragraph 240 of chapter 19 of his Report, Lord Penrose then set out five ‘key findings’ about the regulation of the Society, as part of a wider list of such findings which also related to other aspects of the Equitable situation. The relevant findings were that:

• Regulation was based on an over-reliance on the appointed actuary, who in the case of the Society was also the chief executive over the critical period from 1991 to 1997, despite a recognition of the potential for conflict of interest inherent in this position;
• The regulatory returns and measures of solvency applied by the regulators did not keep pace with developments in the industry, in particular the trend towards unguaranteed and unreserved for terminal bonus. Thus regulatory solvency became an increasingly irrelevant measure of the realistic financial position of the Society;
• The significance of policyholders’ reasonable expectations under the legislation was understood by the regulators, who had also developed over time a good appreciation of the factors involved. There was, however, no consistent or persistent attempt to establish how [policyholders’ reasonable expectations] should affect the acknowledged liabilities of the Society;
• The regulators also failed to give sufficient consideration to the fact that a number of the various measures used to bolster the Society’s solvency position were predicated on the emergence of future surplus. In the case of the reinsurance agreement, it is not clear on what basis the Society was permitted to take the credit against its potential annuity guarantee liability that it did; and
• There was a general failure on the part of the regulators and GAD to follow up issues that arose in the course of their regulation of the Society, and to mount effective challenge of the management.

148 In giving the Government’s formal response to the Penrose Report, the then Financial Secretary to the Treasury explained to the House of Commons on the day that the report was published that:

Lord Penrose makes it clear that the Society’s former management adopted a series of “dubious” practices, many of which it concealed from its own Board, its policyholders, and the regulators. This, he argues, led to the situation in which the Society found itself in July 2001.

149 The Financial Secretary said that Lord Penrose had come to a ‘central finding’, which was that ‘principally, the Society was the author of its own misfortunes’.

Events following the publication of the Penrose Report

150 Since the publication of the Penrose Report, a number of developments have occurred. Those developments include the following two events:

(i) on 15 July 2004, 873 ‘trapped annuitants’ launched a legal action against the Society. During the proceedings, the number of claimants fell and the action has recently been settled by way of a confidential agreement with the 401 annuitants remaining in that action; and

(ii) on 22 March 2005, the Financial Ombudsman Service announced that it would not consider what it referred to as ‘Penrose-related complaints’ against the Society – citing jurisdictional obstacles, the existence of other proceedings and investigations on some aspects of the subject matter of the complaints, that some of the complaints would be more suitable for resolution in the courts, the likelihood that no worthwhile outcome would be achieved by an investigation due to the ‘earlier substantive conclusions of the regulator on these matters’, and the wider implications for the Society and for the interests of its remaining policyholders of any investigation which might result in an order for compensation to be paid only to some policyholders at the expense of others.

Recent developments

151 Two further significant developments have occurred during the closing stages of my investigation: the first being a Decision made on 30 January 2007 by a Panel of the Disciplinary Tribunal of the actuarial profession, following a hearing of charges brought against certain actuaries who had held senior posts within the Society.

152 The second was the publication on 4 June 2007 of the Report on the Crisis of the Equitable Life Assurance Society by a Committee of Inquiry of the European Parliament, established following two petitions made by United Kingdom citizens to that Parliament.

The actuarial professional tribunal

153 In the August 2004 edition of its magazine The Actuary, the actuarial profession had published – as the profession’s rules required it to do – a summary of the allegations which formed the basis for a referral to a disciplinary tribunal by a professional investigating committee of the cases of four actuaries who had formerly held senior positions at the Society. Those charges concerned their conduct of the affairs of the Society in respect of the part of the period from 1988 to 2000 relevant to each actuary.

154 In March 2006, a Panel of the Disciplinary Tribunal constituted under the profession’s 1995 disciplinary scheme ordered that the charges against one of the actuaries should be dismissed with no order for costs, following confirmation by the investigating Equitable Life: a decade 30 of regulatory failure committee that it did not intend to offer any evidence in respect of that actuary at any subsequent meeting of the tribunal.

155 After consideration of the defences submitted by two of the other actuaries, charges in relation to the submission of regulatory returns by those actuaries, who also faced other charges, were also withdrawn by the investigating committee prior to the hearing. Those charges were not considered by the panel – which found, in the absence of evidence being submitted, that there was no basis on which they could make an adverse finding in these respects.

156 A panel of the disciplinary tribunal then heard the other charges brought by the investigating committee against the remaining three actuaries at a hearing held during November and December 2006. The relevant standard of proof required was the criminal standard; in other words, the panel had to be satisfied beyond all reasonable doubt before it could find a charge proven.

157 The decisions made at the conclusion of that hearing were published in a written determination on 2 March 2007. The panel found in respect of the first actuary – Mr Roy Ranson, who had held the post of Appointed Actuary of the Society from 1982 to 1997 – that, in the words of the Executive Summary of the determination:

(i) in implementing a stated philosophy of providing a full and fair return to policyholders, holding no estate apart from a revolving estate providing working capital, and treating policyholders as participating in a managed fund, the actuary had, over a long period of time, consistently failed to apply an appropriate smoothing policy, had failed to provide appropriate information to the Society’s board to enable proper consideration to be given to the consequences of his recommendations and had failed to maintain the publicised relationship between the investment reserve and total policy values notified annually to policyholders;

(ii) in addition to the points above, the information provided to policyholders created a misleading impression of the Society’s financial strength. The Society’s board was provided with little information showing the relationship between the totality of the policy values including accrued terminal bonuses as notified to policyholders and the Society’s actual asset strength. No evidence was provided to the panel to indicate any proper degree of financial analysis undertaken by the Society during the period under examination; [and]

(iii) there had been ‘a failure to properly distinguish, in spite of the significantly different terms and conditions, between the pension policies issued prior to 1988 and those subsequently issued, both in internal analyses of the financial performance and in communications to policyholders. The panel found this failure created the basis for the subsequent problems of the Society. This failure, compounded by the unresponsiveness of management to signals and questioning of the policy adopted, in the light of changing circumstances, was viewed by the panel as irresponsible. The introduction of the differential terminal bonus policy and its implications under different economic scenarios was not properly addressed either in the board or in the communications to policyholders’.

158 The panel found that the matters outlined above constituted a breach of the standards of integrity, competence and professional judgement which other members of the profession and the general public might reasonably expect of a member of the profession and determined that Mr Ranson should be expelled from membership of the Institute of Actuaries.

159 The panel found in respect of the second actuary – Mr Christopher Headdon, who had held the post of Appointed Actuary of the Society from 1997 until early 2001 – that:

(i) a charge that he had failed to take appropriate action, on becoming aware of what appeared to be a breach by Mr Ranson of professional conduct standards and/or professional guidance notes and had caused or contributed to such breaches, should be dismissed;

(ii) a charge that he had failed to provide full information to the Society’s board on the financial position of the Society and failed to advise the board accurately on its policyholders’ reasonable expectations was found to constitute misconduct to the extent that it was upheld. The part of the complaint that was upheld related to ‘a failure to notify and warn the board of the potential consequences for the Society of the valuable guarantees contained in certain policies on which the Society was continuing to accept increments, and of the existence of the differential terminal bonus policy and the likely policyholder reasonable expectations problems arising fromthe failure to communicate that policy sufficiently to policyholders’. This was found to constitute misconduct; and

(iii) a charge that he had failed to disclose to the prudential regulators the signing, in April 1999, of a side-letter to a reinsurance agreement, which ‘was possibly relevant to the value attributed to such agreement in the regulatory returns’, was found to constitute misconduct.

160 The panel decided that Mr Headdon should be admonished in respect of the two charges on which misconduct was found. Had he held a current practising certificate, which he did not, the panel stated that it would have suspended any such certificate for three years.

161 The panel found in respect of the third actuary – Mr Alan Nash, who had been the Society’s Managing Director and Actuary at the time of the court proceedings which had culminated in the House of Lords’ judgment – that:

(i) a charge that he had ‘failed to ensure that the board was properly informed and advised in circumstances where the aggregate policy value of the Society’s policies as reported to policyholders consistently exceeded the value of its assets’ was not proven, partly because ‘the excess of maturity payments which had reduced the Society’s financial strength was a consequence of decisions predating [his] tenure’; and

(ii) a charge that he had authorised and signed ‘a letter to policyholders dated 1 February 2000, upon which policyholders were likely to rely, that allegedly misrepresented the Society’s position in the event of its appeal to the House of Lords failing’ was proven and constituted misconduct, because ‘the letter, in an effort to provide an unambiguous assurance for the future, went further than was appropriate under the sensitive circumstances’ and, albeit that legal advice had been obtained, he had remained responsible for the content of that letter.

162 The panel admonished Mr Nash.

The European Parliament report

163 On 18 January 2006, the European Parliament announced that it would establish a Committee of Inquiry into the situation at Equitable. The mandate of this Committee was to:

• investigate alleged contraventions or maladministration in the application of Directive 92/96/EEC, now codified by Directive 2002/83/EC, by the United Kingdom’s competent authorities in relation to Equitable Life, notably as regards the regulatory regime and the monitoring of the financial health of insurance undertakings, including their state of solvency, the establishment of adequate technical provisions and the covering of those provisions by matching assets;
• assess, in this respect, whether the Commission has properly fulfilled its duty to monitor the correct and timely transposition of Community law and identify whether systematic weaknesses contributed to the situation that has arisen;
• assess allegations that the UK regulators consistently failed, over a number of years, and at least since 1989, to protect policy holders by exercising rigorous supervision of accounting and provisioning practices and the financial situation of Equitable Life;
• assess the status of claims by non-UK European citizens and the adequacy of remedies available under UK and/or EU legislation for policy-holders from other Member States; and
• make any proposals that it deems necessary in this matter.

164 The report of the Committee was published on 4 June 2007 and was debated and endorsed by a plenary session of the European Parliament on 19 June 2007. The recommendations of the report were adopted by the Parliament with 602 votes in favour, 13 votes against and 64 abstentions.

165 The report made certain recommendations related to the role of the European Commission, to the way in which the United Kingdom had transposed European Directives into domestic law, and to the role of Committees of Inquiry within the institutions of the European Union. Those recommendations are not directly relevant to the subject matter of this report.

166 However, in addition and under the heading ‘Remedies’, the report’s recommendations included the following two statements:

(i) … in view of the UK Government’s failure to comply with the requirements of the Third Life Directive and given the absence either of accessible legal redress through the courts or of effective alternative means of redress, the committee firmly believes that the UK Government is under an obligation to assume responsibility. The committee therefore strongly recommends that the UK Government devise and implement an appropriate scheme with a view to compensating Equitable Life policyholders within the UK, Ireland, Germany and elsewhere; [and]

(ii) … the committee urges the UK Government and all affected parties to accept and implement appropriately any recommendations the UK Parliamentary Ombudsman may make with regard to Equitable Life. The committee recommends that the Irish, German and other host Member State authorities actively assist their citizens in implementing those recommendations.

167 At the time of writing, no response has been made by the United Kingdom Government to the relevant recommendations of the report of the Committee of Inquiry or to any other aspects of that report.

Footnotes

1 This view was set out by two actuaries employed by the Society in a paper, ‘With Profits Without Mystery’, presented to the Institute of Actuaries and to the Faculty of Actuaries in 1989 and 1990. This paper was, much later, to become the most famous exposition of the Society’s approach.

2 See also, for example, Section C of the Society’s With-Profits Guide as at 1 July 1997.

3 For example, for the year ending 31 December 1995, the note said ‘the total fund values include amounts of final bonus which are not guaranteed and may vary. In addition, where the policy provides a guarantee of terms on which annuity benefits can be secured, the final bonus then payable will take account of the cost of providing that guarantee. The fund available at retirement may therefore be less than the total shown, but would not be less than the guaranteed value’. In 1997, some categories of policyholder received only an abbreviated note. No notes were included in the statements for the years ending 31 December 1993 or 31 December 1994.

4 See, for example, the Annual Report and Accounts as at 31 December 1989: The President’s Statement, pages 3 and 10, and the Annual Report and Accounts as at 31 December 1991: The President’s Statement, page 3.

5 See, for example, the Annual Report and Financial Highlights as at 31 December 1997: The President’s Statement to Members, page 4.

6 Which affected the annuity rates that were generally available to a policyholder when benefits under a pension policy were taken.

7 Internally, on 27 July 2000 Equitable described the broad effect of these changes as being: ‘For the main classes of business, current policy values before 20 July 2000 for contractual benefits were achieved by rolling forward the 31 December 1999 values by a given growth rate. The Board has decided that a reduction in policy values of around 5% is necessary and this will be achieved by giving no growth for the first seven months of this year and resuming the appropriate interim overall rate of return with effect from 1 August 2000’. In relation to with-profits annuities, Equitable said that: ‘such policies cannot be transferred and thus a more gradual approach can be taken to adjusting rates. Therefore a reduction of 1% p.a. will apply in the growth rates for with-profits annuity contracts to avoid too sharp a discontinuity in income levels’. The Society also changed its terms for non-contractual exits from the with-profits fund by introducing a 20% deduction to final bonus.

8Page 17 of the Circular.

9 Page 5 of the Circular.