The complaints I have received and the Government's initial response to those complaints

Introduction

1 In this Chapter, I set out the general and detailed complaints that have been made to me about the prudential regulation of the Society; and the initial response to those complaints of the public bodies whose actions were the subject of complaint.

2 This Chapter is structured in the following way:

• in paragraph 3, I set out the number of complaints which have been made to me concerning the prudential regulation of the Society;
• in paragraphs 4 to 7, I set out the general complaint which alleges maladministration on the part of those public bodies whose actions have been the subject of investigation;
• in paragraphs 8 to 32, I set out the 18 heads of complaint alleging specific acts and omissions on the part of those public bodies which it is said constitute maladministration;
• in paragraphs 33 to 51, I summarise the submissions that have been made to me, both by complainants and by those authorised to act on their behalf, in support of those complaints of alleged maladministration;
• in paragraphs 52 and 53, I set out the injustice which it is claimed has resulted from maladministration and the remedy which is sought by complainants in respect of this injustice; and
• in paragraphs 54 to 154, I summarise the initial response to these complaints of the public bodies whose actions were the subject of complaint:

(i) paragraphs 59 to 61 provide a summary of the response of the public bodies;

(ii) paragraphs 62 to 75 deal with some general matters;

(iii) paragraphs 76 to 153 address each specific head of complaint; and

(iv) paragraph 154 responds to the injustice claimed.

The complaints made to me

3 As noted in paragraph 11 of Chapter 1 of this report, I have received 898 referred complaints in respect of 1,008 people and I have received 1,309 direct representations from a further 1,480 individuals about the prudential regulation of Equitable. Information about the people who have contacted me about the subject matter of this report is set out in Part 4 of this report.

The maladministration alleged

The general complaint

4 As noted in Chapter 1 of my report, the terms of reference for my investigation 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.

5 The terms of reference were agreed with those representing the lead complainants (see paragraphs 41 and 42 of Chapter 3) and, on 14 December 2004, those terms of reference were distributed to all the parties to the complaints and also published on my Office’s website.

6 From all the complaints I have received, three broad areas of complaint emerge from the many submissions we had read and considered. Those concern complaints about, first, the general organisation of the system of prudential regulation; secondly, about the way that this system had been applied generally towards Equitable; and, thirdly, about the specific handling by the prudential regulators and GAD of various aspects of the detail of the Society’s business during the relevant period.

7 The general complaint made was that:

… the public bodies responsible for the prudential regulation of insurance companies (successively the Department of Trade and Industry, Her Majesty’s Treasury and the Financial Services Authority…) and the Government Actuary’s Department (GAD) failed for considerably longer than a decade properly to exercise their regulatory functions in respect of the Equitable Life Assurance Society and were therefore guilty of maladministration.

The detailed heads of complaint

8 Eighteen detailed complaints were made – although, as will be seen, some of those heads of complaint contained more than one allegation. Those heads of complaint were labelled complaint A to complaint R.

9 Complaint A was that the prudential regulators had not been sufficiently resourced, and had not all possessed the necessary skills, to contribute effectively to the overall regulatory process and to exercise responsibly their discretionary powers as intended by Parliament and by the European Union. It was alleged that administrative decisions as to resourcing, priorities and methods had contributed to a position in which the prudential regulators had not properly undertaken their functions in respect of Equitable.

10 Complaint B was that the prudential regulators had failed to liaise and to co-operate effectively with those responsible for the regulation of the conduct of business by insurance companies. In particular, it was alleged that the prudential regulators had failed to ensure that proper assessments had been made of the Society’s individual practices and its communications with policyholders, and of the expectations that those practices and communications had generated, in the light of the information that was, or should have been, known to the prudential regulators.

11 Complaint C was that the prudential regulators had not operated the regulatory regime as it was intended to be implemented by Parliament and in conformity with EC Directives. It was alleged that those regulators instead had chosen to regulate Equitable with a ‘light touch’ – a concept not evident from or provided for under the Insurance Companies Act 1982 and the European Third Life Directive, nor one consistent with these statutory provisions.

12 It was further alleged that the approach to the prudential regulation of Equitable had been exceptionally and unjustifiably lenient when compared to that adopted with other companies, with inadequate investigative site visits and lack of liaison with conduct of business regulators. Much more rigorous standards of supervision and better co-operation with conduct of business regulators had been adopted for smaller and unit-linked companies, it was alleged. That, it was said, demonstrated that the prudential regulators had applied a two-tier standard of regulation.

13 Complaint D was that the prudential regulators and GAD had allowed successive Chief Executives or Managing Directors of the Society simultaneously to hold the post of Appointed Actuary, despite recognising the potential for a conflict of interest. This, it was alleged, had not been compatible with the basis of the regulatory regime.

14 Complaint E was that the prudential regulators and GAD had failed to keep pace with developments in the pensions and life insurance industry and to assess and adapt their methods to reflect those developments. This, it was alleged, had been particularly critical in a situation in which narrow, technical interpretations of regulatory solvency were becoming an increasingly irrelevant measure of any insurer’s realistic financial position as the industry moved more and more towards non-guaranteed bonus declarations.

15 Complaint F was that GAD had recommended Equitable as a pension plan or additional voluntary contribution scheme provider in its advice to the administrators of the Principal Civil Service Pension Scheme and to other public sector pension schemes. This, it was alleged, had led to a lack of proper separation of its responsibilities and to a clear conflict of interest between GAD’s role in providing advice to government bodies in relation to public sector pensions and in assisting the prudential regulators of the Society. This conflict of interest, it was said, had compromised the proper discharge of GAD’s regulatory functions.

16 Complaint G was that, from the mid-1980s until 1997, the prudential regulators had failed to evaluate the potential effect of guaranteed annuity rates on the solvency of Equitable in a context where current annuity rates were falling steadily, in line with the Bank of England’s base rate, to below contracted guaranteed annuity rates.

17 It was alleged that the prudential regulators had learned explicitly in November 1993 of the degree of Equitable’s exposure to risks associated both with the guaranteed annuity rate issue and with the Society’s lack of prudent reserves. It was said that the regulators’ failure to take action then or to impose reserving until 1999 had played a direct part in the closure of Equitable to new business and to subsequent cuts in policy and annuity values. The prudential regulators had not prepared a study on the extent of guaranteed annuity rates in the industry until 1997: which, it was said, was a decade too late.

18 Complaint H was that, from about 1990 onwards, the prudential regulators and GAD had failed to give sufficient consideration to the fact that some of the measures used to bolster Equitable’s solvency position were predicated on the emergence of a future surplus. It was alleged that, as a consequence, those regulators and GAD had not properly assessed the overall impact and adequacy of those measures. It was further alleged that the prudential regulators had also allowed Equitable to mis-use the term ‘surplus’ and had failed to consider the use of that word in the context of policyholders’ reasonable expectations.

19 Complaint I was that, over this same period, the prudential regulators had allowed Equitable to publish financial results and projections that were misleading in that they had not reflected the Society’s true position. In particular, Equitable had been allowed habitually to report growth rates alongside bonus rates, which had given the impression of a prudent margin for error, whereas the true position was that:

• assets had been consistently less than policy values so that higher rates of growth were needed to cover any given rate of bonus; and
• as part of the growth had been needed to cover expenses and the contractual liability for conventional annuities, the growth available to meet with-profits bonuses had always been materially less than the rate quoted in Equitable’s literature, which had never been made clear.

20 Complaint J was that, during this same period, the prudential regulators and GAD had failed to act when Equitable had adopted what Lord Penrose described as practices of ‘dubious actuarial merit’. Those practices, it was alleged, had included valuing future liabilities at an inappropriate rate of interest between 1990 and 1996; treating selling costs as an asset; making no provision for guaranteed annuity rates until much too late; valuing a financial reinsurance policy (which proved to be of no value) at over £800 million; allowing credit for ‘aspirational’ (i.e. effectively unrealisable) assets; responding too slowly to widely evidenced changes to mortality expectations; and the issuing of a subordinated debt valued at £346 million, which was not counted as a liability.

21 Complaint K was that on several specific occasions, as set out in the Penrose Report, the prudential regulators and GAD had ignored or failed to act on information that might have led to formal or informal regulatory action against Equitable, thus also failing to alert new investors to the risks of investing. It was alleged that those occasions included when the Society’s Board papers were sent to GAD by the appointed actuary on 11 June 1991, and when information was provided to GAD on 10 September 1992 which showed that, for the years 1989 to 1991, the aggregate policy values had very significantly exceeded the value of the underlying assets.

22 Complaint L was that, over a period of many years, the prudential regulators and GAD had permitted Equitable to operate an unsound business model, of which those regulators and GAD had been aware. It was said that the Society had made public its policy of reliance on ‘goodwill’ in a 1989 actuarial paper With Profits Without Mystery1#, but the prudential regulators had never addressed the issue or challenged the Society about it or about the consequences of the model.

23 Instead, it was alleged, the prudential regulators and GAD had allowed Equitable to operate their model, which had entailed declaring bonuses in excess of admissible assets, while at the same time operating without a significant estate and with a smoothing fund persistently in deficit. It was said that this had been a major contributory factor to the Society’s development of what Lord Penrose had quantified as a £3,000 million asset deficit at the time of closure to new business and to the losses incurred by all those who held policies on 16 July 2001.

24 Complaint M was that the prudential regulators had failed to ensure any satisfactory correlation between the total of declared policy values and the Society’s admissible assets in a context where Equitable, uniquely in the industry, had declared total policy values that had included terminal bonuses and had, without exception, always paid all claims (both contractual and non-contractual) in accordance with those declarations.

25 Complaint N was that Ministers and officials had decided that regulatory activities in relation to safeguarding policyholders’ reasonable expectations were to be based solely on the regulatory returns, but had failed to put in place adequate procedures and Regulations to enable this to be achieved. It was alleged that this failure had been particularly critical in respect of Equitable, which had had unique practices which elicited policyholders’ reasonable expectations.

26 Complaint O was that the prudential regulators and GAD had allegedly failed over many years properly to monitor and assess the Society’s asset position and its practices in the light of policyholders’ reasonable expectations. Those regulators and GAD, it was said, had not properly determined policyholders’ reasonable expectations or acted to protect them as intended by Parliament and to the standards set by European Directives.

27 Complaint P was that, during the course of the litigation which had led to the House of Lords’ decision in the Hyman case, the prudential regulators had allegedly failed in their duty to all policyholders in respect of policyholders’ reasonable expectations and had postponed consideration of issues related to assets and reasonable expectations, both for guaranteed annuity rate and non-guaranteed annuity rate policyholders, until after the decision of the House of Lords (on 20 July 2000).

28 In addition, it was said that the prudential regulators had totally failed to assess properly either the impact or the scope of the Hyman decision and to evaluate the range of scenarios for Equitable following it. Those regulators, it was alleged, had failed to take appropriate action to mitigate the adverse affect of the decision on the majority, non-guaranteed annuity rate policyholders, and on new investors into the same with-profits fund.

29 The judgement of the prudential regulators that there had been a 99.9% probability that the Society would be sold demonstrated that, despite the extensive information that those regulators had possessed, they had failed to understand the parlous state of Equitable, which had been apparent to all prospective bidders.

30 Complaint Q was that, in March 2001, the prudential regulators had permitted Equitable to declare a bonus for 2000 and an interim bonus for 2001 that were both inappropriate and unjustifiable given the then state of the Society’s finances, thus raising misleading expectations about the true state of Equitable just prior to significant across-the-board cuts that were imposed only four months later. Instead, it was alleged that the Society’s asset deficit of 13% at year-end 2000 in a closed fund should have precipitated regulatory intervention at that time.

31 Complaint R was that, in July 2001, by permitting policy value adjustments worth more than £4,000 million in the form of an inequitable uniform percentage cut across all with-profits policies, rather than the fairer alternative of reducing policy values by cutting only non-guaranteed bonuses, the prudential regulators had allegedly failed to protect policyholders’ reasonable expectations.

32 It was further alleged that the prudential regulators had also refused to comment meaningfully on this to policyholders while discouraging independent financial advisers from giving proper advice to policyholders.

Submissions made by complainants in support of those complaints

33 In support of those complaints, I received many hundreds of letters from complainants and from those making direct representations to my investigation team. In addition, certain policyholder action groups (see paragraph 39 of Chapter 3) submitted a vast amount of evidence in support of the complaints outlined above.

34 It is not practicable to set out here every argument, submission or piece of evidence that has been submitted to us since the investigation which led to this report began, nor to describe the contents of all the documents that were sent to me in support of these complaints. However, we have read each letter sent to us and have considered whether the contents of all the communications we have received warrant inclusion in the report or follow-up through some other means.

35 I will now do two things: first, I will set out in their own words some of the general and specific points made to me by those who have complained to me. These describe, in a representative fashion, what those people have told me have been the effects on them of the events at Equitable and set out their feelings about what has happened. Secondly, I will summarise the key submissions made to me by policyholder action groups on the heads of complaint set out above.

What individual complainants told me

36 The lead complainants provided a considerable amount of information about the effect of the events at Equitable on them. Comments they made included:

(i) that ‘the effects of actual and anticipated losses have caused me to sell a large house and move to a smaller property and to general cut-backs on expenditure, holidays, motoring, eating out, and assisting my children’;

(ii) that ‘while I was looking forward to a comfortable retirement, this has now been shattered. It is a worry and is constantly on one’s mind. When I wake up during the night this is the first thing that enters my mind’; and

(iii) that ‘I have lost confidence and trust in all pension producers and the government’s watchdog. After working hard all my life and putting together what I thought were adequate plans for my retirement many years in advance, I feel I have been let down’.

37 The knock-on effects and worry and distress caused by the financial uncertainty that complainants have suffered were also, they argued, compounded by actual financial losses of varying degree and with differential impact sustained by complainants. The largest sum that a complainant estimates that they have lost amounts to three-quarters of a million pounds; while the smallest amount of loss claimed is less than six hundred pounds.

38 Complainants generally claimed that the prudential regulators were to blame for the situation, although many also expressed anger at the Society’s management. They said, for example:

(i) This saga has undermined my confidence in the regulatory apparatus administered at taxpayers’ expense to supervise the U.K. financial system and protect its users. I am also totally disillusioned with the conduct of government;

(ii) I feel emotionally affected, angry, as if I have been robbed. I feel the regulatory system has let me down. I was prepared for investment risk but not systemic risk which I felt was covered by the regulator. I will never trust an insurance company again and have advised my children against trusting one;

(iii) I have lost confidence in the ability and competence of long-term financial planners and regulators; and

(iv) Not only have I been affected financially but I feel badly let down by the regulatory bodies who should have ensured that investors interests are protected. The Government encourages us to save for the future and yet fails to regulate by the appointed bodies.

39 Many complainants expressed more than disappointment in the role played by the prudential regulators and their advisers – arguing that the actions or inaction of those bodies had been the primary cause of the situation. One told me:

I submit that the Treasury/FSA failed to consider, or were culpably negligent in considering the effects on new or continuing investors, of the severe lack of reserves… and failing to require disclosure, or sufficient provision for this at least by the beginning of 1998.

The company was allowed to advertise and tout for further business on the basis of “leadership in the UK pensions market” and was awarded by Standard and Poor their prestigious AA (Excellent) rating on the basis of the content of their accounts and returns.

I relied on the above and the fact that the company gave no commission and boasted of their low costs and charges. I also believed I had the full protection intended by regulation in making my choice of company.

40 Another complainant said:

The DTI did not impose effective control over the Society. The consequence of this allowed the Equitable to declare bonuses not covered by the assets of the Society from 1989 to 2000. As a further consequence of this, the Equitable retained its AAA rating and thousands of innocent members carried on pouring millions of pounds into a sinking ship. If there had been the slightest inkling that there was anything wrong, I would have changed to another insurance company to provide an annuity for my retirement.

41 Other complainants also placed the blame for the injustice they claimed to have sustained at the door of the prudential regulators. Such submissions included those from:

(i) a man in his 80s, who told me that he had ‘bought an Annuity in 1994. Prior to doing so, and prompted by another company’s salesman, I had suggested to Equitable that their financial position might not be secure. I was given a Standard and Poor analysis, which gave an AA+ rating and must therefore have been based on incomplete information given to them. Annual reports were equally misleading. GAD must have known the true situation and they and DTI should not have allowed this to happen. As a result, my pension was reduced last year by £3,000 pa and we have had to sell our house and buy a much cheaper one. Further reductions are still being made’;

(ii) a man in his 70s, who told me that ‘before placing my contracts with the Equitable I undertook considerable market research and took particular note of past performance, expense ratios and Standard and Poor’s ratings relating to financial strength. The Equitable Life also assured me that information required on regular returns made to the Department of Trade and Industry, the then regulator, had been provided and that the DTI’s requirements had been fully met’;

(iii) a man in his 60s, who told me that ‘the regulatory bodies – the FSA, the Department of Trade and Industry, the Government Actuary’s Department and Her Majesty’s Treasury – failed in their duty to rigorously monitor the activities of Equitable Life. The information which was garnered was not made available to potential investors. It is my contention that the regulators failed in their duties to safeguard the interests of actual and potential investors and alert them to the financial weakness of Equitable Life thus depriving them of making informed choices; ergo compensation is due’; and

(iv) a woman in her 60s, who told me that ‘what has really upset me is that I did not purchase a time share or something like a pyramid scheme for “women empowering women”. I purchased a pension scheme run by a supposedly respectable insurance company. I researched this company in the Financial Times, Standard and Poor’s, Money Management, and the Sunday broadsheets, which all gave the company glowing reports. Now to get this money back I will have to go back to work for years’.

The key submissions made in support of their complaints by those representing complainants

42 In addition to the many individual submissions I have received, certain action groups who were authorised to represent the lead complainants and who, more generally, represented those current or former Equitable policyholders and annuitants who had complained to me in support of the complaints.

43 In February 2005, the Equitable Members’ Action Group (EMAG) made a lengthy submission to me, in which it set out its views on each of the heads of complaint covered by the investigation^[2].

44 I consider that EMAG’s submission, while not covering every submission that has been made to me by or on behalf of complainants, sets out broadly the key arguments put forward in support of their complaints. The following excerpt from the concluding section of that submission is worth quoting at length.

45 EMAG said that:

Our understanding is that the regulatory system was set up with reliance on a regulatory return by the insurance company, scrutiny of that return and reliance on the professional independence of the Appointed Actuary to inform the Regulators of failings in prudent management and above all concerns about Policyholders’ Reasonable Expectations. It was to be a system based upon “freedom with disclosure”. This strikes us as fair enough BUT:

1. With developments in the industry the shift from guaranteed to non-guaranteed bonuses should have been noticed as actually happening as… GAD had predicted and the information sought in the regulatory returns suitably adapted to the new circumstances.
2. The scrutinies should have been carried out with punctiliousness and care. On occasions they were not carried out at all or only very inadequately.
3. Allowing the Chief Executive of Equitable to be the Appointed Actuary for many years completely destroyed his professional function.
4. There was no proper disclosure about the realistic financial state of Equitable to the public in the Companies Act accounts. The regulatory returns provided no additional information which would have been of any use to a member of the public. The idea of “freedom with disclosure” was therefore completely undermined.

46 EMAG continued:

We submit that there has been serious maladministration and that that maladministration continues. We further submit that such maladministration led to a number of consequences resulting in financial losses to the policyholders who invested in the Society.

It is common ground that Equitable’s problems were deep-seated going back to the start of providing guaranteed annuity rate policies and losses of their reserves in the early 1970s…

The non-availability of files has made it difficult to track the behaviour of the Regulators in the 1980s but there is real evidence of failure from the late 1980s onwards. The failure to scrutinise the 1987 and 1988 regulatory returns came at a crucial time says Lord Penrose. Equitable was already over-bonusing by then.

[A GAD] paper in 1988 had warned of the dangers to policyholders’ reasonable expectations if companies were allowed to shift from guaranteed to non-guaranteed bonuses. Equitable was doing just that effectively shifting their business out of the purview, as practised, of the Regulators. It is, at that point, that the Regulators should have started to act to bring Equitable back into their effective oversight. For no good reason they failed to do this.

From then on as a result of the Society having used up all its reserves the position of solvency for the purposes of covering guaranteed bonuses became more and more problematical with very doubtful devices being allowed to be used to cover the position.

47 Turning to the role of the prudential regulators, EMAG continued:

This together with the shift described above should have impelled the regulators to strong action to protect policyholders. Their failure to do so allowed Equitable to misrepresent their financial strength and to suck in huge numbers of new policyholders into what was becoming a Ponzi scheme where capital is sucked in to cover current revenue deficits.

The Regulators not only failed to inquire more deeply into the financial affairs of Equitable but they ignored the evidence that was presented to them: With Profits Without Mystery, the board papers given to [GAD] and [the Appointed Actuary’s] message about over-bonusing over the three years 1989 to 1991.

The Regulators cut themselves off from a source of information vital to their policy by allowing the roles of Chief Executive and Appointed Actuary to be combined for most of the 1990s. This was an inexplicable mistake.

If the Regulators had bothered to take an overall view of the Company they would have seen that many were joining the company as a result of false pretences. They could have taken steps to control and limit the bonuses being announced so that a truer picture of the Company was presented to the public.

Equitable would not have pulled in all this new money and would have remained a much smaller but healthier company instead of becoming a cancerous growth on the pensions industry. The guaranteed annuity rate problem would have remained unsolved but at least the cost of the problem would have fallen on the guaranteed annuity rate policyholders and been alleviated by hedging and a proper ring-fencing scheme. It is ironic that with fewer non-guaranteed annuity rate policyholders the need to solve the guaranteed annuity rate problem would have been much more acute and in need of resolution if the non-guaranteed annuity rate total pension funds were not to be removed. The guaranteed annuity rate problem could have been simply resolved in 1988 by the Regulators insisting on a separate fund being set up.

Whether or not the Regulators had controlled the allocation of bonuses they could at least have ensured that Conduct of Business conducted an inquiry into bonus notices and other promotional literature when it would have been seen that serious misrepresentations were being made.

There was also the question of the “technically efficient” but deceitful products such as the [with-profits] annuities and the Managed Pension where no effective action has or is being taken.

48 Summarising the more detailed submissions made elsewhere in their paper, EMAG noted:

We have described the period of the Hyman litigation and the pitiful absence of decent legal advice. We have mentioned how the FSA failed to intervene to protect the non-guaranteed annuity rate [policyholders] who then represented 75% of the membership of the company. We have commented on the total failure to do anything after the Court of Appeal judgment. Finally there was the decision to allow Equitable to continue to trade in the hope of finding a buyer allowing even more policyholders to be pulled in. The failure of the Regulators to make any attempt to protect or compensate these late joiners has come in for particular criticism by Lord Penrose.

Since the FSA has taken over regulation from HM Treasury, it is difficult not to see that “protection of policyholders” has been ditched in favour of protection of the insurance industry and the public purse. There are many, many policyholders who have lost a substantial part of their savings.

49 EMAG concluded by arguing that:

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

50 I also received further submissions from or on behalf of the other action groups. Those submissions include:

(i) Equitable Life: Penrose and Beyond: Anatomy of a Fraud – written by Dr Michael Nassim and submitted to me on behalf of both Equitable Life Trapped Annuitants and the Equitable Late Contributors’ Action Group (as well as other papers written by Dr Nassim);

(ii) a submission by the Equitable Late Contributors’ Action Group related to events that occurred after the Society’s closure to new business; and

(iii) evidence, also given by the Investors’ Association to the European Parliament Committee of Inquiry, written by Mr Michael Josephs.

51 The fact that I have not quoted here from these or any other documents does not denote that I have had no regard to their contents. I have had regard to all the evidence submitted to me from whatever source.

The injustice claimed

52 All those who have complained to me claimed to have sustained financial and other injustice as a result of alleged maladministration by those responsible for the prudential regulation of Equitable. Speaking on behalf of all those who complained to me, the lead complainants stated that:

The complainants invested in Equitable Life on theon the basis of its published literature (in some cases supplemented by the claims of its salesmen) on the understanding that it was a properly financed company which was effectively regulated by the Government.

They did not know that the Society habitually declared and paid bonuses in excess of its earnings and did not provide properly for its liabilities, all of which was known to the regulators but with which the regulators failed to deal effectively.

As a direct consequence of regulatory failure each complainant lost 16% (or 14% for life policies) of their policy values on 16 July 2001 and in some cases they lost more in market value adjustments and other costs and penalties upon subsequent departure. Had the regulators effectively undertaken their responsibilities, the crisis at Equitable Life would have been prevented by earlier intervention and appropriate remedial action.

The remedy sought

53 The complainants sought full redress for the financial losses they claimed to have incurred in consequence of the maladministration they alleged and for the other injustice they claimed to have sustained.

The initial response of the public bodies

54 As I have explained in paragraph 23 of Chapter 3 of this report, I am required by section 7(1) of the Parliamentary Commissioner Act 1967 to afford to the principal officer of the department or authority concerned and to any other person who is alleged in the complaint to have taken or authorised the relevant action an opportunity to comment on any allegations contained in any complaint pursuant to which I propose to conduct an investigation.

55 On 9 December 2004, I afforded the principal officers of four public bodies – the Treasury, the FSA, GAD and the DTI (which is now the Department for Business, Enterprise and Regulatory Reform) – such an opportunity. I received a joint response on 3 March 2005 from three public bodies – the Treasury, the FSA and GAD.

56 The DTI confirmed that, as statutory responsibility for the prudential regulation of insurance companies had passed in 1998 from that department to the Treasury, it wished to make no separate submissions to my investigation from those made by the Treasury. It was explained that this was in line with the normal conventions concerning the transfer of government functions and Ministerial responsibility.

57 The joint response took the form of two documents. The first document set out the view of the public bodies whose actions were the subject of complaint as to the key aspects of the regime that pertained to the prudential regulation of Equitable during the period covered by my investigation. That document is reproduced in full as an annex to Part 2 of this report.

58 The second document contained detailed responses to the general and specific complaints contained in the published terms of reference for the investigation. That document is reproduced in full within Part 4 of my report.

Summary of response

59 I will now summarise the initial response of the public bodies to the heads of complaint set out above as those responses were set out in the second document submitted by the public bodies. I will also summarise the response of the public bodies on questions of injustice.

60 In summary, the initial joint response of the Treasury, the FSA and GAD to the complaints alleging maladministration was that:

(i) there had been no failure on the part of any of the prudential regulators or GAD properly to exercise their functions in respect of Equitable. At all times those regulators and GAD had acted reasonably and properly, in the context of and having regard to the regulatory regime as it had been at the relevant time;

(ii) the nature and scope of that regime had been determined by legislation and by regulatory policies which informed and were adopted under the applicable legislation. At all times, the policies adopted had been proper ones and had been the result of choices which Parliament and Ministers had been fully entitled to make; and

(iii) none of the complaints made by the complainants disclosed reasonable grounds for concluding that any of the public bodies responsible for the prudential regulation of Equitable or GAD had been guilty of maladministration.

61 Before responding to each of the specific complaints set out in the terms of reference for my investigation, the public bodies made some general observations about two matters: first, about the degree to which the contents of the Penrose Report were relevant to my investigation and, secondly, about the nature of the relevant regulatory context.

Two general observations made by the public bodies

The Penrose Report

62 The public bodies contended that almost all of the specific complaints that were the focus of my investigation had been derived from the Penrose Report. It was the view of the public bodies that the contents of the Penrose Report could not be used to support a case of maladministration, for two reasons. The first reason given was that the observations and criticisms made by Lord Penrose had been made with the benefit of hindsight, which had been permitted by the terms of reference of his inquiry.

63 By contrast, the joint response noted that, in carrying out my investigation, I had to consider the relevant events and actions solely in the light of the circumstances and knowledge of those involved at the relevant time. The public bodies said that this constituted a critical difference between the nature of the exercise which Lord Penrose had carried out and that of my investigation.

64 The public bodies also contended that the criticisms which had been made in the Penrose Report of particular decisions and actions that it was alleged had been taken, or omitted to have been taken, by the prudential regulators and GAD in exercising their functions were in fact few.

65 The public bodies noted that I would wish to form my own view of whether those criticisms were both well founded and relevant to this investigation. Whether those criticisms were accepted or not, the Treasury, the FSA and GAD took the view that they were dependent on the use of hindsight and that, if hindsight were disregarded, there was no reasonable basis for a finding of fault.

66 The public bodies contended that the second reason why the Penrose Report could not be used to support a case of maladministration was that, although that Report had (with the benefit of hindsight) been on occasion critical of the performance of the prudential regulators and GAD, its criticisms had been essentially directed at the regulatory regime which was in force at the relevant time rather than at particular decisions and actions taken, or not taken, in operating that regime.

67 The public bodies argued that the gist of those criticisms was not that the prudential regulators and GAD had failed properly to discharge their functions under the regime as it stood; but rather that the regulatory regime as it had stood was, in the view of Lord Penrose, unsatisfactory in various respects and required to be changed.

68 The public bodies contended that it was evident from his Report that the regulatory approach advocated by Lord Penrose would have required a much greater degree of intervention and intrusion by the prudential regulators than had obtained, or had been seen as politically desirable or appropriate, at the relevant time.

69 The public bodies also submitted that criticism of the regulatory regime as it had stood was not material for the purposes of my investigation. In judging whether maladministration has occurred, it was said that my investigation would not be concerned with whether the regulatory regime that had existed was the optimum one, or with the merits or demerits of the policies adopted.

70 Instead, the issue would be whether, given the regime that existed, and the policy choices made, there had been a culpable failure on the part of the prudential regulators or GAD to apply the provisions and policy of the regime.

The regulatory context

71 The public bodies then turned to the regulatory regime and told me that, in a situation where policyholders’ interests are alleged to have been harmed or put at risk, it was unsurprising that some policyholders would believe that they had been ‘let down’ by the prudential regulators.

72 The joint response explained, however, that no system of prudential regulation could prevent, nor should it be designed to prevent, all financial difficulties that might be experienced by insurance companies operating in a competitive market economy.

73 Prudential regulation of insurance companies instead required a balance to be struck between protecting policyholders against the risk that a company would act imprudently on the one hand and, on the other, allowing the maximum freedom to the company and its management to pursue their chosen commercial strategy in the way they considered best.

74 The public bodies contended that the way in which that balance was to be struck was a matter of policy for Parliament in enacting the applicable legislation, and, within the statutory framework laid down by Parliament, for the Government of the day to decide, reflecting values and priorities as set by Ministers.

75 They told me that it followed that any assessment of whether the prudential regulators and GAD had properly exercised their functions could only be made by reference to the statutory framework of powers and duties which governed the prudential regulation of insurance companies during the period covered by the investigation and to the policy context in which prudential regulation took place – especially in their view as regards the degree of intrusiveness seen as appropriate and the level of public resources allocated to such regulation.

The initial response of the public bodies to the detailed heads of complaints

Complaint A – the prudential regulators had not been sufficiently resourced, and had not all possessed the necessary skills, to contribute effectively to the overall regulatory process and to responsibly exercise their discretionary powers as intended by Parliament and by the European Union.

76 The public bodies submitted that the two allegations – that the prudential regulators were not sufficiently resourced and that they lacked the necessary skills – were both wholly unjustified. It was said that resources were finite and decisions as to their allocation had been policy decisions; Ministers had taken a reasonable view at the time relevant to my investigation that the balance of resources that were deployed was correct.

77 From the 1980s to 2001, the cost of prudential regulation (and the number of staff employed by the DTI and GAD in undertaking it) increased significantly in real terms, against a prevailing climate of pressure on costs and of deregulation. While it could always be argued that it would have been desirable to allocate more resources, there was no objective basis for concluding that the decisions taken at the time on resourcing prudential regulation were improper.

78 In relation to skills, the public bodies said that an early policy decision had been taken to outsource to GAD the actuarial expertise needed by the prudential regulators, a decision confirmed by reviews in 1978 and 1983. That was not an improper delegation of prudential regulation. The public bodies noted that Lord Penrose in his report had recognised that GAD had had access to developing thought in the profession. Steps had also been taken (such as secondments or longer postings) to improve the skills and resources that were available within the DTI and then the Treasury.

79 In summary, the public bodies contended that decisions as to resourcing, priorities and methods were not administrative decisions but were discretionary decisions which involved policy objectives and that there were no grounds for suggesting that those decisions had been improperly taken.

Complaint B – that the prudential regulators had failed to liaise and to co-operate effectively with those responsible for the regulation of the conduct of business by insurance companies.

80 The public bodies contended that this complaint did not specify any concrete instance in which there had supposedly been a failure of liaison or co-operation by the prudential regulators with the conduct of business regulators. Nor, it was said, did complainants specify any particular steps which the prudential regulators should have taken at any particular time but did not take.

81 The public bodies said that the relevant regime had not required extensive co-ordination as the two regulators addressed separate issues within their own areas of policy and focus.

82 The view of the public bodies was that there had been no failure of liaison between the two sets of regulators. They noted that Lord Penrose had recognised that there had been routine exchange of information in the 1980s and that interaction on a more formal footing had begun from 1992 onwards. During the period in which the FSA had had day-to-day responsibility for both prudential and conduct of business regulation, the public bodies said that arrangements had been put in place to encourage liaison between both sets of regulators.

83 The public bodies noted that, while Lord Penrose had said (with hindsight) that there had been insufficient liaison, he had given no specific examples other than in the autumn of 1999, which the public bodies took to refer to communications between the two regulators in September 1999 over bonus notices. In the view of the public bodies, however, that episode did not reveal any failure of liaison but rather a potential gap in the regulatory framework which pertained at that time. That gap was not as a result of any improper decision by the prudential regulators, but reflected the then prevailing system of regulation and the way the prudential and conduct of business regulators had been required to operate prior to their full merger within the FSA.

Complaint C – that the prudential regulators had not operated the regulatory regime as it was intended to be implemented by Parliament and in conformity with European Directives. Those regulators instead had chosen to regulate Equitable with a ‘light touch’ – a concept not evident from or provided for under the Insurance Companies Act 1982 and the European Third Life Directive, nor one consistent with those statutory provisions.

84 The public bodies submitted that neither allegation under this head of complaint – that the prudential regulators had operated a ‘light touch’ contrary to the provisions of United Kingdom statutes and European Directives and that, compared to other companies, the approach of those regulators towards Equitable had been exceptionally and unjustifiably lenient – was well founded.

85 In relation to ‘light touch’, the position of the public bodies was that the regime applied (whose guiding principle had been ‘freedom with publicity’) was precisely that which informed and was enabled by the relevant statutory provisions; in addition, it was their position that the relevant domestic legislation at all times had complied with European Directives.

86 In relation to the allegation of a ‘double standard’ applied to the prudential regulation of Equitable, the public bodies wholly rejected this. They noted that the regime had targeted resources through a priority rating system. In most years, Equitable had been assigned a rating of 33, indicating that there had been sufficient concerns to warrant early attention or other reasons to require scrutiny early in the cycle. These ratings had been assigned on the basis of objective criteria, taking account of key indicators (including coverage for the required solvency margin).

87 In the 1990s, Equitable’s required minimum solvency margin had been reasonably well covered, as had been reflected in their ratings, which were in line with those given to other companies with similar levels of cover. Supervision had not been limited to scrutiny of the returns alone, but had included site visits (which relied on co-operation and were not ‘investigative’), which had been introduced in 1991 on a three-year cycle. Equitable had been visited in 1992, 1994 and 1996, within the three-year cycle.

88 The public bodies stated that the priority ratings given to the Society and the frequency of visits to it showed that Equitable had been treated no differently from other companies. If anything, the public bodies argued, the intensity of exchanges between GAD and the prudential regulators, and between those regulators and Equitable, had been higher than for other companies of a comparable priority level during the 1990s.

Complaint D – that the prudential regulators and GAD had allowed successive Chief Executives or Managing Directors of the Society simultaneously to hold the post of Appointed Actuary, despite recognising the potential for conflict of interest. This had not been compatible with the basis of the regulatory regime.

89 The public bodies denied that there had been successive Chief Executives or Managing Directors of the Society who had simultaneously held the post of Appointed Actuary; this had only applied to one person from 1991 to 1997, they said.

90 Nevertheless, those bodies said, the prudential regulators had regarded the dual role as undesirable and had sought to discourage it; but it had not been contrary to established industry norms and other companies also had been in that position at the relevant time.

91 The public bodies submitted that there had been arguments both for and against somebody holding that ‘dual role’. In the case of a mutual insurance company, there could have been no conflict between shareholders and policyholders and so there had been less potential for a conflict of interest in the Society’s case.

92 The Insurance Companies Act 1982 had not expressly prohibited the dual role and so the complaint that the prudential regulators ‘allowed’ this was, in the view of the public bodies, misplaced. It was said that those regulators could have objected to the appointment of a Chief Executive on the ground that he or she was not a ‘fit and proper’ person. This, however, had been taken to mean grounds such as dishonest conduct. The public bodies said that the person concerned had been amply qualified to be the Society’s Chief Executive.

93 In addition, the public bodies contended that there had existed specific circumstances in the case of Equitable, in that there had been no-one to take over from the incumbent as Appointed Actuary when he became Chief Executive.

94 The public bodies submitted that the prudential regulators had expressed concern but had had to accept that they could not impose a condition that the incumbent should end his dual role after 12 months; nor, it was said, could those regulators bring the dual role to an end. The prudential regulators and GAD had continued to express concern (from 1992 to 1996), but the incumbent’s response had been that he would give up one of the roles if a conflict arose, that it was still a temporary measure, and that there was no suitable replacement.

95 In addition, the public bodies contended that it was not clear what advantage to the complainants there would have been had the dual role been avoided, or what changed in Equitable’s thinking or actions when the dual role ended in 1997.

Complaint E – that the prudential regulators and GAD had failed to keep pace with developments in the pensions and life insurance industry and to assess and adapt their methods to reflect those developments.

96 The public bodies’ response to this head of complaint was that it was wrong to suggest that the regime remained static or that the prudential regulators had not taken steps to adapt to developments in the industry. There had been a series of initiatives from 1974 onwards.

97 Those initiatives had included successive legislative changes from 1974-2001 affecting the valuation of assets and liabilities, the applicable Regulations and the regulatory returns; moves to require the Appointed Actuary to specify certain facts in the returns; site visits from 1991; and the addition of the requirement for sound and prudent management in 1994.

98 Those initiatives had also included a Service Level Agreement between GAD and the DTI in 1995, replaced by a further such agreement in 1998; annual reports on the industry prepared by GAD from 1995; GAD surveys of bonus distributions (1993) and in respect of guaranteed annuity rates (1998) and three working parties set up through the Joint Actuarial Working Party in the 1990s – on policyholders’ reasonable expectations, on the net premium method of valuation and on the impact of guaranteed annuity rates. Changes in mandatory guidance issued by the actuarial profession to Appointed Actuaries and additional guidance by GAD through ‘Dear Appointed Actuary’ letters had also been issued.

99 In these ways, the public bodies said, the regime had been kept up-to-date and the level of regulation increased, despite a then prevalent policy of deregulation.

100 With regard to regulatory solvency, the public bodies submitted that this had been the crucial yardstick by which the balance between policyholder protection and freedom to compete had been struck. The public bodies stated that the prudential regulators could not be criticised for applying and scrutinising regulatory returns by reference to the prescribed solvency criteria.

101 The public bodies contended that the complainants’ real grievance appeared to be that, as the industry had moved increasingly towards non-guaranteed terminal bonuses, the prudential regulators should have required Equitable to reserve for these. But, in the view of the public bodies, those regulators could not have done so.

102 The Third Life Directive had given Member States discretion over whether or not to require the setting aside of reserves for bonuses. The United Kingdom Government had decided not to require this. The alternative approach that had instead been agreed was that an implicit allowance for terminal bonus should be made through a deliberately prudent and cautious approach to the valuation of assets and liabilities, which would create implicit margins for future bonuses. That was achieved in particular by requiring conservative valuation assumptions (including not taking credit for future capital appreciation on equity investments) and using a net premium method of valuation.

103 The public bodies submitted that it was not open to the prudential regulators to impose reserving by the back door method of policyholders’ reasonable expectations. Had those regulators done so, it would have gone against the policy decision of the Government and would have been an attempt to use its powers of intervention impermissibly in preventing a company from disposing of its assets even though the test for regulatory solvency had been met.

104 The public bodies also said that it was not clear from where policyholders had derived a reasonable expectation that Equitable would set aside reserves for terminal bonuses, given the lack of a statutory requirement to do so and given the Society’s well-publicised policy of full distribution. The public bodies submitted that, had Equitable set aside reserves, it would arguably have gone against the reasonable expectations of with-profits policyholders that there would be full distribution.

Complaint F – that GAD had recommended Equitable as a pension plan or additional voluntary contribution scheme provider in its advice to the administrators of the Principal Civil Service Pension Scheme and to other public sector pension schemes. This had led to a lack of proper separation of its responsibilities and to a clear conflict of interest between GAD’s role in providing advice to government bodies in relation to public sector pensions and in assisting the prudential regulators of the Society. This conflict of interest had compromised the proper discharge of GAD’s regulatory functions.

105 The public bodies submitted that it was wrong to suggest that the facts demonstrated any lack of proper separation of GAD’s responsibilities or a conflict of interest in GAD’s roles. GAD had provided advice at the time that Equitable had been selected to provide additional voluntary contributions for the civil service scheme (in 1988) and then had carried out three paper reviews (in 1992, 1993 and 1995) of this provision but this role had then been outsourced.

106 The public bodies said that GAD’s role of giving advice had not conflicted with its role assisting the prudential regulators. The two functions had been kept separate by what they referred to as a ‘Chinese wall’ and there had been no exchange of confidential information. There had been no professionally improper conduct and, in their view, the complaint was without substance.

Complaint G – that, from the mid-1980s until 1997, the prudential regulators had failed to evaluate the potential effect of guaranteed annuity rates on the solvency of Equitable in a context where current annuity rates were falling steadily, in line with the Bank of England’s base rate, to below contracted guaranteed annuity rates.

107 The public bodies’ response to this head of complaint was that the applicable Regulations had required guaranteed annuity rates to be valued on prudent assumptions – depending on the extent they would be ‘in the money’ if mortality and interest rate assumptions were borne out and with regard to a prudent assumed take-up rate. Otherwise, guaranteed annuity rates represented only a contingent liability and were something the Appointed Actuary was expected to take into account when analysing the company’s overall financial condition.

108 The public bodies noted that guaranteed annuity rates had begun to exceed current annuity rates briefly in 1993 (and then continuously from 1995). Equitable had decided to award a lower terminal bonus to a policyholder who took benefits with a guaranteed annuity rate and on this basis took the view that there was no need to set up a reserve. However, the public bodies argued that it had been the responsibility of the Appointed Actuary to disclose the company’s liabilities and to justify how they had been reserved for; it was contended that the prudential regulators had relied on the Society’s Appointed Actuary to do this and had been entitled so to do.

109 The public bodies noted that the Society’s returns had not disclosed its exposure to guaranteed annuity rates or the approach it had adopted of awarding differential terminal bonuses in anything approaching a satisfactory way. The public bodies contended that the prudential regulators could not have been expected to identify the problem from the information provided or (given the time and resources available and nature of the regulatory regime) to have sought the information needed. Contrary to the Society’s claim that it had disclosed its differential terminal bonus policy since 1993, the public bodies noted that Lord Penrose had found that the Society’s returns had failed to identify the growing obligations, with his report referring to obscure, opaque and uncommunicative information.

110 In relation to the November 1993 meeting, the public bodies stated that there had been no clear disclosure of Equitable’s policy or their exposure to guaranteed annuity rates. The note of that meeting had referred to the Society remarking that the allocation of a final bonus could be conditional on the waiving of the guarantee. But, it was said, the Appointed Actuary had said that in the context of the resilience reserve – i.e. that the guaranteed annuity rates may bite in the reduced interest rate scenario but not in the base valuation. The public bodies submitted that the Appointed Actuary had not been saying that, while a base valuation reserve was needed, this was not being held due to the differential terminal bonus policy. That this was the position had only emerged in 1998.

111 In relation to the study of the extent of guaranteed annuity rates in the industry, the public bodies said that it had not been until the late 1990s that guaranteed annuity rates had become of significant value to policyholders. At GAD’s suggestion, a professional working party had been set up in January 1997. Its terms of reference had recognised that there was no accepted practice for reserving for the guarantees.

112 The working party’s report had been published in spring 1998. It had found considerable variations in reserving practice and did not provide definitive recommendations as to the right approach. GAD had been represented on the working party but could not provide the prudential regulators with confidential information provided by (or concerning) companies. So GAD had initiated its own survey in June 1998, to tie in with the submission of 1997 returns by the end of June 1998. The public bodies said that this had been an appropriate follow-up to the professional working party report and there was no reasonable basis to suggest this should have been done a decade earlier.

113 The public bodies said that the Society’s exposure to guaranteed annuity rates had become apparent with Equitable’s response to GAD’s survey, in July 1998. This had showed that Equitable had not reserved for guaranteed annuity rates, had significantly higher exposure than others, and had not separated that business from non-guaranteed annuity rate business. For other companies, guaranteed annuity rate business had been on a smaller scale, or had been kept separate from other business, or the company had had an estate or was reserving on a proper basis.

114 The public bodies contended that the prudential regulators and GAD had reacted swiftly and firmly to information provided to them in July 1998. In November 1998, GAD had sent the Treasury a report identifying Equitable as particularly vulnerable. The prudential regulators had taken steps (which had begun in September 1998) to ensure that the Society made proper provision for those liabilities. Equitable had maintained their position that it would be excessively prudent for them to reserve on the basis that there would be a 100% take-up rate. The Society had threatened judicial review, sought the assistance of the then Economic Secretary to the Treasury, and continued the debate until the House of Lords’ judgment in July 2000.

115 The public bodies submitted that the Society’s difficulties after the decision of the House of Lords in Hyman had arisen due to the cost of honouring the guaranteed annuity rates on the non-guaranteed part of maturity values. That cost, it was said, had been determined by the prevailing investment conditions and not by the reduced interest rate scenario in the resilience test. The cost was separate from the cost of honouring guaranteed annuity rates on the guaranteed part of maturity values, which had already been reserved for at the insistence of the prudential regulators (subject to the renegotiation of the reinsurance treaty).

116 The public bodies contended that those events demonstrated no fault on the part of the prudential regulators or GAD, who had acted promptly and firmly: it was one thing to say, with the benefit of hindsight, that Equitable should have been quizzed about its approach at an earlier stage. The public bodies said, however, that the Society’s returns for 1993 to 1996 had not disclosed that Equitable were not reserving for the liabilities associated with guaranteed annuity rates, or that the extent of the relevant policies was significant; nor had those returns disclosed the reserving method, the rate of guarantee, or the volume of business.

117 The public bodies submitted that it was not the case that the Society’s failure to reserve had played a direct part in Equitable’s closure to new business and the subsequent cuts in policy values. It was said that Equitable had been required to reserve for guaranteed annuity rates and the outcome of the litigation had not changed their gross reserving requirements. After the House of Lords’ judgment, Equitable had sought a buyer to fund the guaranteed annuity rate costs. For various reasons, not all related to the financial state of Equitable, the sale had failed and policy values had had to be cut. The public bodies argued that there was no clear, let alone direct, link between the cut in policy values and the guaranteed annuity rate issue.

118 The public bodies contended that this had been a complex chain of events and that it was not clear what role, if any, the Society’s delayed introduction of full reserving had played. It was said that earlier additional reserves would most likely have been at the expense of showing a weaker statutory solvency position or of slimming down margins elsewhere in the valuation basis, so it was not clear that additional reserving would have forced Equitable to change their bonus policy.

119 The public bodies stated that the July 2001 cuts had been largely due to negative rates of investment returns earned by Equitable in 2000 and 2001, against a background of falls in equity markets and their policy of no estate, which meant that, in adverse investment conditions, policy values might have had to be cut.

Complaint H – that, from about 1990 onwards, the prudential regulators and GAD had failed to give sufficient consideration to the fact that some of the measures used to bolster Equitable’s solvency position were predicated on the emergence of a future surplus. As a consequence, the prudential regulators and GAD had not properly assessed the overall impact and adequacy of those measures.

120 The public bodies stated that the measures used to bolster Equitable’s solvency margin criticised in this head of complaint were assumed to relate to the use of future profits implicit items (those complaints which related to the subordinated loan and reinsurance are dealt with under Complaint J below).

121 The public bodies contended that United Kingdom and European legislation had allowed value to be placed on projected future surplus for demonstrating cover for the regulatory required solvency margin. For an insurance company to be permitted to include a future profits implicit item, an Order under section 68 of the Insurance Companies Act 1982 had been required. The value of the item was limited by law.

122 The United Kingdom’s approach, as reflected in guidance issued by the prudential regulators in 1984, had been more cautious, it was said, than the European regime – in requiring the amount applied for to be less than the present value of profits expected to arise on in-force business. The Appointed Actuary had been required to certify this. Guidance had made clear that the Appointed Actuary’s assessment had to be based on cautious assumptions.

123 The public bodies submitted that the role of the prudential regulators, acting with the advice and assistance of GAD, had been to determine whether a section 68 Order could be justified under relevant Regulations and guidance. It was said that the prudential regulators had been entitled to place weight on the certificate from the Appointed Actuary. If the calculations provided were justifiable, a refusal to grant the Order would have been highly unusual. The 1984 guidance had allowed, but had not required, the prudential regulators to request details of the assumptions used in the Appointed Actuary’s certificate.

124 The public bodies contended that it would not have been proportionate for this to have been done unless there had been evidence from the returns (particularly the ‘matching rectangle’ in Form 57 of the returns) to suggest that the application might not have been adequately supported. This, it was said, had never been the case with Equitable. In addition, even where a section 68 Order was granted, what credit should be taken for it in the returns had been a matter for the professional judgement of the Appointed Actuary.

125 The public bodies submitted that there was no evidence that the prudential regulators had ever wrongly granted a section 68 Order. The public bodies noted that Lord Penrose in his report had accepted that the Order made in September 2000 (and by implication each earlier Order) had been properly granted and in accordance with the Regulations.

126 The public bodies argued that the allegation that the prudential regulators had failed to assess the impact of these Orders was also not justified. Equitable had applied for and used less (generally substantially less) than they had been entitled to use. The Society had not been the first company to use such an item; the increase in its use from 1995 to 2000 had also not been out of line with the increase in the aggregate amount for the industry.

Complaint I – that, from 1990 onwards, the prudential regulators had allowed Equitable to publish financial results and projections that were misleading in that they had not reflected the Society’s true position.

127 The public bodies’ position in relation to this head of complaint was that the accuracy of the material in Equitable’s literature had not been a matter for the prudential regulators. The way Equitable had reported growth reflected their policy of a guaranteed reversionary bonus and non-guaranteed terminal bonus. It had not been for those regulators to prescribe the approach to be followed, provided that the Society complied with its statutory obligations.

128 The public bodies contended that the calculations contained in the Penrose Report, which suggested that the Society’s assets had been consistently less than policy values, had not been seen by the prudential regulators at the time and it was not clear how those or similar calculations by complainants ensured consistency of assets and liabilities.

129 The public bodies submitted that the comparison of policy values and asset shares was a complex actuarial exercise where different professional opinions were possible, depending on the methodology and assumptions employed. Thus, in their view, there was little scope for a finding of maladministration unless the specific professional opinion relied on was demonstrably unreasonable or was contrary to the then prevailing regulatory regime.

130 The public bodies maintained that no instances had been given of Equitable being allowed to disclose results or projections that were contrary to the Regulations. The only relevance for the prudential regulators of the literature supplied to customers was in relation to policyholders’ reasonable expectations, which are covered below in the response to complaints N and O below.

Complaint J – that, during the period under investigation, the prudential regulators and GAD had failed to act when Equitable had adopted what Lord Penrose described as practices of ‘dubious actuarial merit’.

131 The public bodies noted that the seven practices identified in this head of complaint included five of the six practices discussed by Lord Penrose in chapter 19 of his report. He had expressed concern, in paragraph 166 of that chapter, about the prudential regulators’ response to these practices, but had acknowledged that most of Equitable’s steps had been within the limits allowed for in the Regulations and in guidance. The public bodies said that such practices had been a matter for the professional judgement of the Appointed Actuary, acting within the limits allowed by the Regulations. The public bodies accepted, however, that not all of Equitable’s practices had been permissible but said that, when this had come to the prudential regulators’ attention, those regulators had taken appropriate action.

132 The full initial response of the public bodies to these allegations is set out within Part 4 of this report. That response rejected the basis of all the specific allegations made under this head of complaint.

Complaint K – that… the prudential regulators and GAD had ignored or failed to act on information that might have led to formal or informal regulatory action against Equitable, thus also failing to alert new investors to the risks of investing. Those occasions included when the Society’s Board papers were sent to GAD by the Appointed Actuary on 11 June 1991, and when information was provided to GAD on 10 September 1992 which showed that, for the years 1989 to 1991, the aggregate policy values had very significantly exceeded the value of the underlying assets.

133 The public bodies said that they did not accept that the Board papers provided to GAD in 1991 had contained critical information or had revealed extreme steps. Those bodies said that the adjustment made to the Society’s valuation basis had been well within the limits permissible under the applicable Regulations; the GAD actuary had seen no problem and neither had GAD in its correspondence with Equitable in November 1991. In addition, in their view the GAD actuary’s actions in not passing the papers to the DTI had been entirely professional and understandable. The public bodies submitted that any criticism of the actuary’s actions could only be made with hindsight.

134 The public bodies said that they also did not accept that the information provided to GAD on 10 September 1992 should have led to formal regulatory action. Those bodies said that GAD had raised the issue at a meeting on 15 September 1992 and had passed the letter to the prudential regulators. Equitable had acknowledged on 17 September 1992 that the implications for bonuses had to be considered carefully. There had been no need for specific comment on the figures, which in any event had showed that the excess of policy values over assets was falling.

135 The public bodies noted that GAD’s scrutiny of the 1991 returns had raised concerns about the weakening of the valuation base. The prudential regulators had, in November 1992, acknowledged that this painted a worrying picture. Those regulators had asked GAD to seek a fuller analysis.

136 In response, in March 1993, GAD had said that Equitable could survive a short term fall in the markets. GAD asked Equitable for an indication of the end 1992 position and, when Equitable had indicated that that position had much improved, those concerns ‘ebbed away’. Within the scrutiny of the 1992 returns, GAD had commented on this improvement and had anticipated a further improvement in the 1993 returns, which in turn happened.

137 The public bodies argued that it was not necessarily unacceptable for policy values to exceed the value of assets. Equitable’s view had been that the normal range was plus or minus 10% but that there could be circumstances when the relationship was outside this range.

138 There had been no reason, it was said, for the prudential regulators to doubt the Society’s view, particularly when the lack of an estate had made smoothing at times of very unfavourable market conditions more difficult. The Society’s lack of an estate had been well known and the public bodies said that it was difficult to argue that the Society’s approach had been inconsistent with policyholders’ reasonable expectations.

139 The public bodies also maintained that it had not been a matter for the prudential regulators to alert potential policyholders to the risks of purchasing policies from a particular company.

Complaint L – that, over a period of many years, the prudential regulators and GAD had permitted Equitable to operate an unsound business model, of which those regulators and GAD had been aware.

140 The public bodies stated that this complaint was founded on a false premise. In their view, it had not been for the prudential regulators to judge the soundness of a company’s business model.

141 To have done so, it was said, would have substantially interfered in the normal course of competition in the market, would have exceeded those regulators’ legal powers, and would have run contrary to the policy of ‘freedom with publicity’.

142 The public bodies accepted that the Society’s business model had meant that it was inherently weaker in balance sheet solvency terms than companies with shareholders or an estate. The Society’s model had had commercial risks. But, the public bodies submitted, that model had been no secret and the risks ought to have been appreciated by policyholders and their advisers when they were taking investment decisions.

143 The public bodies categorically rejected the suggestion that the prudential regulators should have sought to prevent or dissuade Equitable from following their chosen model. It was said that, provided the applicable Regulations had been followed, those regulators had had no power to intervene.

Complaint M – that the prudential regulators had failed to ensure any satisfactory correlation between the total of declared policy values and the Society’s admissible assets in a context where Equitable, uniquely in the industry, had declared total policy values that had included terminal bonuses and had, without exception, always paid all claims (both contractual and non-contractual) in accordance with those declarations.

144 The public bodies stated that this complaint added little to the other complaints. It was said that, in essence, Equitable had met their statutory solvency requirements, the Regulations did not require reserving for terminal bonus, realistic solvency had been a matter for the Board and the Appointed Actuary, Equitable’s business model had been legitimate, and there was nothing to suggest that the prudential regulators had failed, at any time, to ensure that Equitable met the obligations imposed on them by the regulatory regime.

145 In addition, while it was accepted that policyholders’ reasonable expectations had been a relevant issue, this was an area in which the role of the Appointed Actuary had been even more important than in other areas. In the view of the public bodies, it was not, and could not sensibly have been, a part of the role of the prudential regulators to monitor and make their own independent assessment of what, at any given time, were the reasonable expectations of the various classes of policyholders of the many life insurance companies.

Complaints N and O – the protection of policyholders’ reasonable expectations.

146 The public bodies submitted that the concept of policyholders’ reasonable expectations had been introduced in 1973 partly to ensure the interests of policyholders were protected as against those of shareholders. The public bodies contended that this concept had not been seen as a means of scrutinising the expectations of different cohorts of policyholders within a mutual company.

147 It was said that the powers of intervention granted to the prudential regulators were only to be exercised where it was obvious that the reasonable expectations of policyholders were not going to be met. Those powers were not to be used to ensure value for money. The Government of the day had also decided that policyholders’ reasonable expectations would be safeguarded solely by reference to the regulatory returns and that to take a different regulatory approach would have trespassed on management decisions. This, it was said, was a policy decision that the Government had been entitled to take.

148 The public bodies argued that the Insurance Companies Act 1982 had made clear that the powers of intervention on the grounds of the protection of policyholders’ reasonable expectations were extremely limited.

149 It was asserted that section 37(6) of the 1982 Act made clear that this was merely a residual power and that section 45(2) only permitted the prudential regulators to restrict the disposal of assets for the purposes of policyholders’ reasonable expectations when regulatory solvency had been breached or when a company had been closed to new business. It was also said that the applicable Regulations had placed the primary responsibility for monitoring policyholders’ reasonable expectations on the Appointed Actuary.

Complaint P – preparation for, and follow-up to, the House of Lords’ judgment

150 The public bodies argued that my first investigation had already fully considered all the issues in this head of complaint and that that investigation had ‘rightly concluded’ that there had been no fault by the prudential regulators. That remained the case in the view of the public bodies. The subsequent inclusion within my jurisdiction of GAD made no difference to those findings. GAD had advised the FSA, who had advised the Treasury. In the view of the public bodies, this complaint was not about the advice given by GAD but about the decisions which had been taken by the FSA and the Treasury.

Complaints Q and R – events in the period following the closure to new business

151 The public bodies contended that these complaints related to post closure events, which were not the focus of this investigation. In relation to the 2000 bonus declaration, it was said that there had been no such bonus. However, if the complaint referred to the addition of a notional interim bonus, that had not been something that Equitable had been required to report to the prudential regulators. But those regulators did keep a close watch over what Equitable were doing during this time and had taken the view that the Society was acting reasonably.

152 The public bodies submitted that, by the summer of 2001, it had been clear that the Society’s practices were no longer sustainable. Equitable had decided that the expectations of policyholders needed to be addressed and that a financial adjustment was needed for those leaving. That, it was said, had been the background to the policy cuts.

153 The public bodies contended that, provided such a decision had been reasonable, it had been for Equitable to decide the approach to these cuts, not a matter for the prudential regulators. Those regulators had considered the issues and had discussed them with Equitable at the relevant times. The prudential regulators had at all times sought to keep policyholders informed of the situation.

Injustice

154 Having addressed the allegations that maladministration had occurred, the public bodies then addressed the injustice claimed by complainants. For all the reasons set out in their full initial response to the complaints (which is set out within Part 4 of this report and is only summarised in this Chapter), the public bodies whose actions were the subject of complaint told me that they believed:

• that it was wrong to say, as complainants did, that the July 2001 policy value cuts had been in any material respect a consequence of ‘sustained over-allocation and sustained over-distribution on claims’, as Lord Penrose had concluded;
• that, on the contrary, analysis undertaken by the Society had demonstrated that more than 14% of the 16% cut in policy values made in July 2001 had been in fact attributable to:

(i) adverse investment conditions prevailing between 1 January 2000 and mid-July 2001;

(ii) adjustments made to the valuation of the Society’s liabilities (on a realistic basis) by the new Appointed Actuary; and

(iii) a decision (taken by the new Board on the advice of the new Appointed Actuary) to create, as at 31 July 2001, an excess in the with-profits fund of available assets over aggregate with-profit policy values of £600 million as a prudential measure given the uncertain outlook for the future;

• that, even to the very modest extent to which the 16% cut in policy values did relate to events before the end of 1999, it was not correct to say that those policyholders as at 31 July 2001 who had also been policyholders throughout the period covered by the analysis contained within the Penrose Report were any worse off;
• that the Society’s policy value cuts had not been out of line with those imposed by other life insurance companies at about the same time. Complainants could not demonstrate with any degree of certainty that sums invested elsewhere than with Equitable would have fared any better; and
• that, accordingly, there was no basis for the alleged injustice.

Conclusion

155 Having received a response from the public bodies whose actions were the subject of complaint to the allegations of maladministration made by complainants and to the claims of injustice that those complainants said resulted from such maladministration, and not being satisfied that those responses had resolved the complaints or had provided an explanation of the relevant facts that cleared up the issues, I decided to continue my investigation.

156 The next Chapter sets out the basis for my determination of the complaints contained within the terms of reference for that investigation.