Phase 5: 1994 – 1999

Introduction to Phase 5 – the DTI’s view of the concept of ‘sound and prudent management’ and ‘freedom with disclosure’

1994 – a year of change  

554 1994 saw considerable reform of the UK legislation relating to insurance, triggered by the need to give effect to the Third NonLife Directive³⁸⁴ and the Third Life Directive³⁸⁵ in domestic legislation.

555 This entailed significant amendments to the primary legislation (in particular, the ICA 1982), and the subordinate legislation (including that relating to the valuation of assets and determination of liabilities of long-term insurance businesses (through the replacement of ICR 1981) and in relation to accounting requirements and statutory returns (although the ICAS Regulations 1983 were not replaced until 1996)).

556 Implementation of the changes arising from the Directives provided the opportunity to consolidate amendments which had been made to the subordinate legislation over the years and to make other adjustments for domestic reasons.

557 A paper written by officials in the DTI for the Minister towards the end of 1994, after the changes to the UK legislation had been enacted, entitled ‘Insurance Supervisory Powers and Practice’, described the regime as it then stood.

The three main ‘supervisory weapons’

558 The paper explained the DTI’s regulatory objectives as being to supervise the insurance industry effectively so that policyholders were protected against the risks that companies would not meet liabilities or fulfil policyholders’ reasonable expectations. The DTI’s three ‘main weapons’ in achieving these objectives were described as being:

1.   
2. Authorisation: controlling the entry of new companies into the market, ensuring so far as possible that they were adequately capitalised and had a sound business plan.
3. Financial supervision: requiring insurance companies to submit detailed, comprehensive annual returns in addition to (and containing considerably more detail than) the shareholder accounts required under companies legislation. In particular, the solvency margin which insurance companies were required to maintain was intended to provide a safety margin so that they could suffer a degree of loss and still be able to meet their commitments in full. The asset valuation rules were designed to ensure that companies held a sensible spread of assets and valued them conservatively. Examination of the returns entailed consideration of such matters as assets, liabilities, reinsurance protection, profitability, quality of management and future trends, and was supplemented by visits to companies in order to ensure that ‘supervision is forward rather than backward looking’.
4. Sound and prudent management: it was noted that the implementation of the Third Insurance Directives in the UK in July 1994 had supplemented the preexisting powers of supervisors to take action in respect of unfit controllers, directors and managers, with the wider concept of ‘sound and prudent management’ which companies were required to maintain (see paragraphs 570 et seq). It was said that this new concept enabled the DTI to take a view as to whether the management of the company as a whole had the right balance of skills and experience (and not just to assess the fitness of the separately notified key individuals). It was said that this enabled the DTI to take action in a wider set of circumstances where it believed that a company was not acting in a prudent way and enabled the DTI to use all its existing powers of intervention in the event of failure by a company to comply with specified criteria of sound and prudent management.

559 The addition of the concept of ‘sound and prudent management’ to the legislation was described as having considerably strengthened the supervisors’ powers. The paper explained:

‘we are now able to intervene more easily where we have concerns that a company is acting in an imprudent manner, ie it is failing to comply with the criteria of sound and prudent management. In the past, there have been occasions where supervisors have regarded intervention as desirable but have either had no specific power to do so, or considered that the power was not clearly enough defined to allow it to be used³⁸⁶. These augmented powers are not intended to increase the overall level of supervision of soundly run insurance companies. They are designed to enable us to intervene in cases where previous legislation proved to be inadequate. It remains the case that the main grounds for intervention are the protection of policyholders or breach of an obligation under the legislation.’

560 The paper went on to describe a case in which the new powers had by then already been used in a ‘robust’ way. In the case described (which concerned nonlife business), the ‘sound and prudent management’ ground of intervention had been used to withdraw the company’s authorisation to write new business, notwithstanding that the company had shown a reasonable standard of solvency in its December 1993 return.

561 In view of considerable uncertainties about the adequacy of the company’s reserves to meet a particular potential liability (which had been highlighted in a report from an independent actuary), the DTI considered that the uncertainties about the company’s solvency were too great to permit it to continue to write business.

562 It was noted, in relation to the new ‘sound and prudent management’ ground that there were ‘difficult judgements to be made as to when these powers should be invoked and to what extent’, but that in the majority of cases, the DTI was able to rely on its ‘informal powers of persuasion’ to ensure that companies took appropriate action before serious problems arose, with the threat of formal sanctions in the background.

Freedom with publicity or freedom with disclosure

563 As regards the underlying philosophy of insurance regulation in the UK, the paper prepared for the Minister in late 1994 described the UK regulatory system as being founded on the principle of ‘freedom with disclosure’, in a freely competitive market place’. Insurance companies were said to have ‘considerable freedom to follow their commercial judgement within a broadly defined and nonintrusive regulatory framework’.

564 However, insurance companies were required to place on the public record a considerable amount of detail about the business they had accepted and their solvency position. It was noted that not only policyholders, but competitors, brokers, market analysts and journalists had access to the information in statutory returns, resulting in a growth in comparative analyses of data and a market in insurance information ‘producing a more informed market in insurance products and their financial security’.

565 It was considered that the commercial freedom enjoyed by insurance companies in the UK was one of the strengths of the domestic insurance industry which would help UK companies to compete in the European Single Market. It was stated that in a competitive market it was unrealistic to expect that all failures could be prevented, but that the risk of companies going out of business was ‘an acceptable price for an innovative and price competitive market, operating in the interests of its customers’. The aim of the regulator was to get as much early warning as possible about developing problems ‘and take appropriately robust action to prevent or minimise damage to policyholders’.

Amendments to the ICA 1982 – the Insurance Companies (Third Insurance Directives) Regulations 1994

Introduction and overview

566 The Insurance Companies (Third Insurance Directives) Regulations 1994³⁸⁷ (the ICTID Regulations 1994) gave effect to the Third Life Directive in terms of revisions to the ICA 1982. They were made by the Secretary of State as designated minister under section 2(2) of the ECA 1972.

567 One of the principal effects of the ICTID Regulations 1994 was to introduce into the UK legislation the principle of home state control, or the ‘single passport’ for insurance undertakings across the European Community. The Regulations also included provisions reflecting the further harmonisation of the rules regarding authorisation and regulation of insurance undertakings.

568 The ICTID Regulations 1994 came into force on 1 July 1994 and extended to Northern Ireland.

569 Part II of the Regulations contained amendments to the ICA 1982 and comprised six chapters dealing with:

1. Restrictions on carrying on insurance business (amending Part I of the ICA 1982);
2. Regulation of insurance companies (amending Part II of the ICA 1982);
3. Conduct of business regulation (amending Part III of the ICA 1982);
4. Recognition in accordance with insurance directives (replacing the whole of Part IIIA of the ICA 1982³⁸⁸);
5. Special classes of insurers (amending Part IV of the ICA 1982);
6. Supplementary provisions (amending Schedule 3A to the ICA 1982³⁸⁹).

570 The major changes to Parts I and II of the ICA 1982 introduced by the ICTID Regulations 1994 included:

• revisions to the structure and substance of those Parts of the Act to take account of the concept of home state control of insurance companies and to make distinct provision for companies with head offices in various parts of the EC or outside the EC;
• the introduction of the concept of the need for insurance companies to have ‘sound and prudent management’ based on specified criteria (in a new Schedule 2A);
• revision to the incorporate the concept of    ‘sound and prudent management’ in thespecified grounds for refusal of authorisation,withdrawal of authorisation, or intervention bythe Secretary of State and other changes tothe provisions on authorisation andintervention arising from the Third LifeDirective;
• a new power for the Secretary of State tosuspend authorisation of an insurance companyto carry out new business ‘forthwith’ in casesof urgency (section 12A);
• new obligations for insurance companies tosecure the adequacy of their assets in terms oftheir safety, yield and marketability and toensure the adequacy of the premiums payableto meet commitments under long term
• extending the circumstances in which theSecretary of State’s powers might be used insuch a way as to restrict the free disposal ofassets by a company to include those wherethe company had failed to maintain the marginof solvency under section 32 or to secure theadequacy of its assets under the new section35A (sections 37(3)(d) and 45(2)(d));
• new intervention powers for the Secretary ofState:
  • to seek an injunction to restrain a companyfrom disposing of or otherwise dealing withits assets (section 40A);
  • to appoint a competent person to conducta general investigation into whether thespecified criteria of sound and prudentmanagement were being fulfilled by acompany or would be fulfilled with anintended new controller of the company(section 43A);
  • to require the company to provide a reportfrom an actuary, accountant or otherprofessional person regarding specifiedmatters (section 44(2B);
• revisions to the residual power of interventionunder section 45 to give the Secretary of Statethe additional power to require a company totake action to ensure fulfilment of the newsound and prudent management criteria (wherethis objective could not be appropriatelyachieved through reliance on other specifiedpowers) and to make changes in relation torestrictions on the free disposal of assets;
• recasting the provisions on transfers andwinding up of insurance businesses to takeaccount of the position of companiesoperating in other countries; and
• a new prohibition on a controller of a UKinsurance company acquiring a ‘qualifyingholding’ in that company or its parent unlesswritten notice had been served on theSecretary of State and no objection had beenraised.

Sound and prudent management ground to refuseauthorisation and criteria

571 A new limitation was imposed on the power of theSecretary of State to issue authorisation to acompany on grounds of failure to fulfil specifiedcriteria of ‘sound and prudent management’³⁹⁰. Anew section 5(1A) was inserted in the ICA 1982 byRegulation 5 of the ICTID Regulations 1994:

The Secretary of State shall not issueauthorisation under section 3 above to anapplicant which is a UK or a non-EC companyif it appears to him that the criteria of soundand prudent management are not or will notbe fulfilled with respect to the applicant

572 ‘UK company’ and ‘nonEC company’ were defined in a new section 5(4) of the ICA 1982, inserted by Regulation 5(2), covering insurance companies issued with authorisation in the UK under the ICA 1982, other than those conducting only reinsurance or certain other limited forms of insurance business.

573 The term ‘criteria of sound and prudent management’ was also defined in the new section 5(4) to mean the criteria set out in the new Schedule 2A to the ICA 1982 which was inserted by Regulation 5(3).

574 The criteria specified in that schedule related to the integrity and skill of those directing, managing or controlling the company, their sufficiency in number and the manner in which business was to be conducted. The criteria included:

• that the business of the insurance company was carried on with integrity, due care and the professional skills appropriate to the nature of its activities;
• that each director, controller, manager or main agent of the company was a fit and proper person to hold that position;
• that the company was directed and managed by a sufficient number of persons who were fit and proper persons to hold their positions;
• that the company conducted its business in a sound and prudent manner; and
• that the company was not to be regarded as conducting its business in a sound and prudent manner: 
  • unless the company maintained adequate accounting and other records of its business and adequate systems of control of its business and records (which arrangements were not to be considered adequate unless they enabled the business of the company to be prudently managed; and in determining whether any systems of control were adequate, the Secretary of State was to have regard to the functions and responsibilities for those systems which were held by the directors, controllers, managers or main agents of the company);
  • if the company failed to conduct its business with due regard to the interests of policyholders and potential policyholders;
  • if the company failed to satisfy an obligation under the ICA 1982 or (in the case of a UK company) an obligation to which it was subject by virtue of the law of another EEA State³⁹¹ in which it conducted insurance business; or
  • if the company failed to supervise the activities of a subsidiary undertaking with due care and diligence and without detriment to the company’s business.

Additional grounds for withdrawal of authorisation in respect of new business and new power to suspend authorisation in urgent cases

575 Two new grounds for the withdrawal of authorisation in respect of new business were added to section 11(2) of the ICA 1982³⁹² by Regulation 10. The Secretary of State was empowered to withdraw authorisation in respect of new business if:

1. the company was a UK company and it appeared to him that it had failed to satisfy an obligation to which it was subject by virtue of the law of another EEA State which gave effect to the insurance Directives or was otherwise applicable to insurance activities in that State;
2. the company was a UK company or a nonEC company and it appeared to him that any of the criteria of sound and prudent management was not or might not be fulfilled by the company (or had not or might not have been fulfilled in the past).

576 Further, Regulation 11 inserted a new section 12A into the ICA 1982, giving the Secretary of State power to direct that the authorisation of a UK company or nonEC company to carry out new business generally or of a specified description be suspended ‘forthwith’ if it appeared to him that one of the grounds in section 11(2) (as extended) for the withdrawal of authorisation in respect of new business existed and that the authorisation should be suspended ‘as a matter of urgency’.

577 The company was entitled to make representations in writing to the Secretary of State within one month (and orally to an officer of the DTI if it so wished) which the Secretary of State was required to consider before deciding whether to confirm the direction. The direction would lapse two months after it was given unless it had been confirmed by the Secretary of State within that period.

New classes of insurance long term business, single authorisation by home state and amendment of rule on composite insurance businesses

578 Chapter I also added two new classes of long term business³⁹³ to the list in Schedule 1 to the ICA 1982 (Regulation 3).

579 Regulation 4 inserted a new definition of an ‘EC company’ which was to be excluded from the authorisation requirements under section 2 of the ICA 1982 provided that conditions set out in a new Schedule 2F had been complied with³⁹⁴, giving effect to the principle of a ‘single passport’.

580 The limitation on the authorisation of a combination of long term and general business under section 6 of the ICA 1982 was slightly relaxed to permit authorisation of a combination of long term business and any class within the ‘accident and health’ group of general business (Regulation 6).

Part II of the ICA 1982 on regulation of insurance business – EC companies

581 Again to give effect to the principle of home state control, EC companies were removed from the ambit of most of the provisions of Part II of the ICA 1982 on regulation of insurance business (regulation 13)³⁹⁵ .

Adequacy of assets and premiums

582 New sections 35A and 35B were inserted in the ICA 1982 regarding the adequacy of assets and premiums (Regulations 17 and 18).

583 Under the new section 35A(1), a UK company was required to secure that its liabilities under contracts of insurance were ‘covered by assets of appropriate safety, yield and marketability having regard to the classes of business carried on’ and without prejudice to the generality of this requirement, to secure that ‘its investments are appropriately diversified and adequately spread and that excessive reliance is not placed on investments of any particular category or description’.

584 Separate obligations were imposed in relation to linked long term contracts, which included a requirement for the company to secure that liabilities in respect of linked benefits were covered by assets of a description prescribed by regulations made under section 78³⁹⁶ .

585 The new section 35B required an insurance company to satisfy itself, before entering into a long term insurance contract, that the aggregate premiums under the contract and the income to be derived from them and any other resources of the company available for the purpose (without jeopardising its solvency in the long term) would be ‘sufficient, on reasonable actuarial assumptions, to meet all commitments arising under or in connection with the contract’.

Revised and additional grounds for intervention under section 37 of the ICA 1982

586 Several substantive and consequential amendments were made to section 37 of the ICA 1982 regarding the grounds on which the powers of the Secretary of State to intervene under the subsequent provisions of Part II of the Act could be exercised (Regulation 19).

587 The grounds for intervention under section 37(2)³⁹⁷ (which applied to the Secretary of State’s intervention powers under section 38 and 4145) were supplemented by a new ground in relation to ‘sound and prudent management’:

1. that the company is a UK or nonEC company and it appears to [the Secretary of State] that any of the criteria of sound and prudent management is not or has not been or may not be or may not have been fulfilled with respect to the company.

The ‘criteria of sound and prudent management’ were set out in Schedule 2A to the ICA 1982 and are summarised in paragraph 574 above.

588 As noted above, section 37(3) restricted the Secretary of State’s powers to intervene by way of imposing requirements for the maintenance of assets in the UK and the custody of assets by a trustee under sections 39 and 40, other than on exceptional specified grounds (in order to give effect to the earlier limitations in the Directives on restrictions on the free disposal of assets by insurance companies³⁹⁸). Section 37(3) was amended by Regulation 19:

1. to take into account a new intervention power which had the effect of restricting the free disposal of assets under section 40A (see paragraph 595);
2. to include a new exceptional ground for intervention under section 37(3)(a) to encompass the Secretary of State’s power to give a direction to suspend a company’s authorisation in urgent cases under the new section 12A³⁹⁹
3. to include further exceptional grounds for intervention under a new section 37(3)(d), namely where it appeared to the Secretary of State that the company had failed to comply with the obligation to maintain the margin of solvency under section 32⁴⁰⁰ or the obligation to secure the adequacy of the company’s assets to cover its liabilities under the new section 35A⁴⁰¹.

589 A new section 37(4A) was inserted which specified that the Secretary of State’s powers to intervene under the new section 43A (on general investigations by competent persons)⁴⁰² or under section 44 (to obtain information or production of documents) were exercisable to obtain information to enable him to perform his functions under the ICA 1982 (apparently to make it clear that these sections could be relied on even where none of the more general grounds for intervention under section 37(2) existed).

590 Consequential amendments were made to section 37(5) in relation to the more extensive powers of the Secretary of State to intervene under specified sections of Part II of the ICA 1982 in respect of companies which had been authorised or had been subject to a change of control within the preceding five years.

591 The provisions were extended to apply in cases where the Secretary of State had been notified of a person’s intention to acquire a ‘notifiable holding’ (under the new requirements of section 61A, referred to below) within the preceding five years.

592 Section 37(6), which restricted the Secretary of State’s powers to intervene under the residual power of section 45 in relation to PRE to circumstances where the objectives could not be appropriately achieved by reliance on other invention powers, was not affected by any of the above changes.

Maintenance of assets of a specified value in a specified location

593 The provisions of section 39 of the ICA 1982 empowering the Secretary of State to impose a requirement for the maintenance of assets in the UK were replaced to take account of the effects of the Third Life Directive. UK companies could be required to maintain assets of a value equal to the whole or a specified proportion of the amount of their EC liabilities in the European Community (rather than an amount related to their domestic liabilities being maintained in the UK) (Regulation 21).

Prohibition on disposal of assets

594 The Secretary of State was given powers under a new section 40A to apply to the court to obtain, on specified grounds, an injunction to prohibit a UK company from disposing of, or otherwise dealing with, its assets to the value of the liabilities of its business in the EC (Regulation 22).

595 The specified grounds on which the court might grant an injunction were those in section 37(3) (namely, the exceptional circumstances in which the Secretary of State could intervene to restrict the free disposal of assets by a company under sections 39, 40 or 40A such as withdrawal or urgent suspension of authorisation, failure to satisfy the obligations in respect of the minimum margin or to maintain the margin of solvency, or calculation of liabilities in the company’s accounts otherwise than in accordance with the valuation regulations).

596 If an order was made, the court was empowered to make subsequent orders to provide for incidental, consequential and supplementary matters as necessary to enable the Secretary of State to perform his functions under the ICA 1982.

General investigation by a competent person or persons

597 Regulation 23 inserted a new section 43A in the ICA 1982 empowering the Secretary of State to appoint one or more competent persons to make an investigation into, and to report to him on whether, the criteria of sound and prudent management⁴⁰³ were being fulfilled by a UK (or nonEC) company, or whether they would be fulfilled if a person who had notified the Secretary of State of his or her intention to do so, became a controller of such a company.

598 Obligations were imposed on directors, managers, controllers, agents, actuaries, auditors and solicitors of a company under investigation to produce documents, attend before and otherwise assist the person conducting the investigation. The person conducting the investigation was given power to enter premises occupied by the company provided prior written notice was given (unless he or she had reason to believe that documents would be removed, tampered with or destroyed if such notice was given).

Powers to obtain information and reports by an actuary, accountant or other professional

599 The powers of the Secretary of State under section 44 of the ICA 1982 to require the provision of information and production of documents by a company were extended by Regulation 24.

600 A new section 44(2B) empowered the Secretary of State to require a UK (or nonEC) company to furnish him, at a specified time, with a report by a specified person, being an actuary or an accountant or other person with relevant professional skills, on any matter about which the Secretary of State had required or could require the company to provide information under section 44(1).

601 A power of entry to premises occupied by a UK or nonEC insurance company was also given to any person authorised by the Secretary of State for the purpose of obtaining information or documents (new section 44(4A)).

Residual power to impose requirements for the protection of policyholders

602 The residual power under section 45(1)⁴⁰⁴ was recast by Regulation 25(1) to enable the Secretary of State to intervene not only to protect policyholders or potential policyholders against the risk that the company might be unable to meet its liabilities or to fulfil their reasonable expectations, but also:

... in the case of a UK or nonEC company, for the purpose of ensuring that the criteria of sound and prudent management are fulfilled with respect to the company.

603 Amendments were also made to section 45(2) in relation to the exceptional circumstances in which the power under section 45(1) might be used in such a way as to restrict a company’s freedom to dispose of it assets, equivalent to those which had been made to section 37(3).

604 The new exceptional grounds were those where a direction had been given under the new power to suspend authorisation in cases of urgency under section 12A; those where the company had failed to satisfy the margin of solvency requirement under section 32; or where it had failed to secure the adequacy of assets to cover its liabilities under section 35A (Regulation 25(2)).

Restrictions on disclosure and privilege from disclosure

605 Section 47A⁴⁰⁵ of the ICA 1982 was replaced and a new Schedule 2B to the Act was inserted, imposing restrictions on disclosure of information relating to the business affairs of any person which had been obtained by the Secretary of State for the purpose of the discharge of his functions under the 1982 Act without the consent of the person from whom the information was obtained, and if different, from the person to whom the information related (Regulation 26).

606 Exceptions applied if the information had been made available to the public from other sources, or if the information was in summary form or was so framed that information relating to any particular person could not be ascertained. Further exemptions related to disclosures made to enable or assist the Secretary of State to discharge his functions under the 1982 Act or rules or regulations made under it and disclosures made to certain other government departments, bodies or officials in connection with specified statutory functions. Criminal sanctions were imposed for disclosures made in contravention of these requirements.

607 Section 47B, under which a document was exempt from disclosure to the Secretary of State under section 44(2)(4) of the ICA 1982 in cases where production of the document by the person concerned could be refused in High Court proceedings on grounds of legal professional privilege, was extended to apply where the document was sought under the new section 43A (general investigation by a competent person) (Regulation 27).

Transfers of insurance business

608 In relation to an application to the court made on or after 1 July 1994 to sanction the transfer of an insurance business, sections 49 to 52 of the ICA 1982 were replaced with a new section 49 and Schedule 2C to the ICA 1982 (Regulation 28). Part I of the new schedule provided for transfers of long term business (and Part II dealt with transfers of general business).

609 The provisions of Schedule 2C were more elaborate than those they replaced and provided for the possibility that the transferor or the transferee company might be an undertaking with a head office outside the UK and that the transferor might have concluded contracts of insurance in other countries.

610 Section 52A of the ICA 1982 as originally introduced into the ICA 1982⁴⁰⁶ concerned cases where general business was proposed to be transferred to a UK insurance company from a company established in another member state, empowering the Secretary of State to certify, if he was satisfied that it was the case, that the UK insurance company possessed the necessary margin of solvency after taking the proposed transfer into account.

611 Regulation 29 substituted a new section 52A which related to both general and long term business and empowered the Secretary of State to issue such a certificate when a transfer to a UK company or to a nonEC company supervised by the Secretary of State was contemplated. The court was prohibited from sanctioning a transfer unless the Secretary of State (or the supervisory authority of the state in which the transferee was situated) had certified that the transferee company possessed the necessary margin of solvency after taking account of the proposed transfer (paragraph 3(1)(b) of Schedule 2C).

Winding up

612 The grounds on which the Secretary of State could petition the court to wind up an insurance company were slightly revised by Regulation 31. In 1990 section 54 of the ICA 1982 had been amended to include an additional ground for winding up in relation to companies conducting general business⁴⁰⁷ in circumstances where the company had failed to comply with an obligation to which it was subject by virtue of the law of another member state giving effect to the general insurance Directives. These provisions were extended to make them applicable to noncompliance with the law of another EEA State⁴⁰⁸ which gave effect to general or long term insurance Directives or which was otherwise applicable to the insurance activities of the company in that State.

Changes of director, controller or manager

613 Sections 60 to 64 of the ICA 1982 made provision for the Secretary of State to object to the appointment by an insurance company of a managing director or chief executive, or to a person becoming a controller of a company⁴⁰⁹ and contained requirements for the Secretary of State to be notified by the company of changes in the directors, controllers, managers and main agents and of such other matters as might be prescribed. (Notice of prescribed matters was also required to be given to the insurance company by controllers, shareholder controllers, directors and managers.)

614 Those provisions were revised by Regulations 3235 of the ICTID Regulations 1994 and a new Schedule 2D was inserted in the 1982 Act which made further provision for the situation where a new managing director, chief executive or controller of an insurance company was proposed, or where a controller proposed to acquire a ‘notifiable holding’.

615 Section 60(3) was amended by regulation 32 so as to include an additional ground on which the Secretary of State might serve notice of objection to a person whom the company proposed to appoint as managing director or chief executive:

... where the insurance company is a UK or nonEC company, that it appears to him that, if that person were appointed, the criteria of sound and prudent management would not or might not continue to be fulfilled in respect of the company.

The layout of section 60(3) was revised (by the creation of new subsection (3A)), but the substance of the remaining provisions of section 60 was preserved.

616 Equivalent revisions were made to section 61 regarding objection by the Secretary of State to a person proposing to become a controller (otherwise than by appointment as a managing director or chief executive), enabling the Secretary of State to serve notice of objection on ‘sound and prudent management’ grounds (Regulation 33).

617 Regulation 34 created a new section 61A which enabled the Secretary of State to serve notice of objection if a controller of a company intended to acquire a ‘notifiable holding’ in the company. A notifiable holding was defined⁴¹⁰ as being voting rights or shares which, if acquired by the person, would result in that person becoming a 10 per cent shareholder controller, a 20 per cent shareholder controller, a 33 per cent shareholder controller, a 50 per cent shareholder controller or a majority shareholder controller⁴¹¹ .

618 The controller was prohibited from acquiring the holding if the Secretary of State notified his objection within three months. Such an objection could be raised on the grounds that it appeared that the controller was not a ‘fit and proper person’ or it appeared that the criteria of ‘sound and prudent management’ might not be fulfilled. The provisions of section 61(2)(4) applied, requiring preliminary notice to be given by the Secretary of State that he was considering giving notice of objection and inviting the person concerned to make written and oral representations.

619 Section 62(1) was replaced with a new section which required those who became or ceased to be 10, 20, 33 or 50 per cent shareholder controllers or majority shareholder controllers⁴¹² to give notice to the company within seven days of having done so (in addition to such notice being required of those who became or ceased to be controllers⁴¹³ as under the original provisions) (Regulation 36). The obligation of the company to notify the Secretary of State within 14 days of such changes coming to the company’s knowledge (and of other matters of which notice was required to be given to it) was preserved.

Offences under Part II

620 Consequential amendments were made to section 71 of the ICA 1982 on offences under Part II to take account of the new requirements.

Other changes made by the ICTID Regulations 1994

621 Chapter III of Part II of the ICTID Regulations 1994 made changes to Part III of the ICA 1982 on conduct of business regulation, including changes in respect of information and statutory notices to be provided to policyholders and potential policyholders (inserting or amending sections 72A, 72B, 74 and 75).

622 Chapter IV of Part II replaced the whole of Part IIIA of the ICA 1982⁴¹⁴ and inserted two new Schedules (2F and 2G) concerning recognition in the UK of insurance companies which had their head office in one of the other states of the European Economic Area and the recognition of UK companies in those states.

623 Changes were also made to the provisions on special classes of insurers in Part IV of the ICA 1982 and to Schedule 3A⁴¹⁵ regarding the law applicable to insurance contracts concluded in various states.

624 Part III of the ICTID Regulations 1994 made amendments to the FS Act 1986, for example in relation to the application of the rules for selfregulating organisations as they applied to EC companies, to provide powers of intervention in respect of such companies and to extend the powers of the SIB to obtain information from ‘authorised persons’ and certain specified ‘recognised bodies’ under that Act.

Further amendments in 1994 and eventual repeal of the ICTID Regulations 1994

625 Further amendments were made to the ICA 1982 and to the ICTID Regulations 1994 by the Insurance Companies (Amendment) Regulations 1994⁴¹⁶ which came into force on 30 December 1994. The further revisions were mainly minor or technical and are not of relevance here.

626 The ICA 1982 was amended in 1995 by the Insurance Companies (Reserves) Act 1995, which inserted a new section 34A. This section required insurance companies which carried on general business of prescribed descriptions to maintain an ‘equalisation reserve’ in relation to that business. Tax relief was provided in relation to the reserve, under section 166 of the Finance Act 1996.

627 The ICTID Regulations 1994 were repealed along with the ICA 1982 with effect from 1 December 2001 by the Financial Services and Markets Act 2000 (Consequential Amendments and Repeals) Order 2001⁴¹⁷.

The Insurance Companies Regulations 1994

628 The Insurance Companies Regulations 1994⁴¹⁸ (ICR 1994) came into force on 1 July 1994 at the same time as the ICTID Regulations 1994. ICR 1994 was made under the ECA 1972 and various provisions of the ICA 1982. They consolidated ICR 1981 with the amendments which had been made to it over the years⁴¹⁹ and parts of other subordinate legislation⁴²⁰ and included amendments to implement the Third Life Directive.

629 As originally enacted ICR 1994 consisted of twelve parts⁴²¹ and seventeen Schedules. Those of most relevance to the prudential regulation⁴²² of life insurance business were:

•  Part I: commencement and definitions;
• Part II: authorisation, with the information to    be submitted in connection with    authorisation of long term business setout in Schedule 1;
•  
• Part IV: margins of solvency, with the minimum guarantee fund set out in Schedule 5;
• Part V: currency matching and localisation;
• Part VI: change of control, with Schedule 6specifying the particulars to be given by an insurance company in relation to proposed managing directors, chief executives and other ‘controllers’ when giving notice under section 60(1) or 61(1) of the ICA 1982;
• Part VII conduct of business, including not only matters relating to insurance advertisements and information given by intermediaries, but also provisions concerning the prescribed assets and indices to which benefits under linked long term contracts could be linked, with the list of permitted links set out in Schedule 10;
• Part VIII: valuation of assets, with the value of the assets of ‘dependants’ (subsidiary undertakings of an insurance company) set out in Schedule 11 and assets which could be taken into account only to a specified extent set out in Schedule 12; and
• Part IX: determination of liabilities.

630 The substantive changes introduced by ICR 1994 were comparatively minimal, since many of the basic requirements of the earlier EEC Directives on such matters as the margin of solvency and the guarantee fund had been embodied in ICR 1981, and a number of the harmonisation measures in the Third Life Directive were already broadly reflected in some form in the UK provisions.

631 However, changes were made to Regulation 64⁴²³ on the determination of liabilities, including an express requirement that the actuarial principles used in valuing long term liabilities should have due regard to PRE.

632 The following outlines the provisions of ICR 1994 which concerned the margin of solvency and guarantee fund, matching and localisation, valuation of assets and determination of liabilities for UK life companies (other than pure reinsurers).

Margin of solvency and guarantee fund – Part IV and Schedule 5

633 Part IV largely reproduced Part II of ICR 1981, with some additions. In simplified terms, the margin of solvency for non-linked life assurance and annuities (classes I, II and IX) under Regulation 18 was the sum of:

1. 4% of the mathematical reserves reduced by not more than 15% for liabilities which were reinsured; and
2. 0.3%⁴²⁴ of the capital at risk reduced by not more than 50% for reinsured liabilities.

634 For linked long term assurance, permanent health insurance, capital redemption, managed funds and collective insurance (classes III, IV, VI, VII and VIII), the calculation was as in (a) in the preceding paragraph, but the required percentage was reduced to 1% for contracts in classes III, VII and VIII if the company bore no investment risk.

635 For companies in those three classes the required margin of solvency was zero if the company bore no investment risk and the term of the contract (expired and unexpired) was no more than five years, or if management expenses were not subject to a fixed upper limit for a period of more than five years (Regulations 19 and 20).

636 Where a company carried on more than one class of long-term business such that more than one margin of solvency calculation applied, those margins were to be aggregated in order to arrive at the company’s required margin of solvency (Regulation 17(4)).

637 In general, the ‘guarantee fund’ (or minimum margin for the purpose of section 33 of the ICA 1982), was one third of the margin of solvency, subject to a minimum (in the case of a mutual) of 600,000 ECU (the ‘minimum guarantee fund’) (Regulation 22 and Schedule 5).

638 In the case of long term business, the minimum guarantee fund or at least half of the guarantee fund (whichever was larger) was required to be covered by explicit items⁴²⁵ such as share capital and reserves that were not attributed to any general business and the excess of the assets representing the fund over the liabilities (in so far as this excess did not form part of the mathematical reserves⁴²⁶ assessed in relation to assets at market value).

639 Regulation 23 made specific provision for determining the extent to which the value of a company’s assets exceeded its liabilities in connection with the required calculations of the margin of solvency, the guarantee fund and the minimum guarantee fund, in addition to all other applicable regulations⁴²⁷ .

640 The extent to which implicit items could be taken into consideration in the margin of solvency calculations continued to be dependent upon an order being made by the Secretary of State under section 68 of the ICA 1982 (Regulation 23(5)). Implicit items consisted of:

1. an allowance for future profits of up to 50% of the product of the estimated annual profit and a factor representing the average outstanding term of the policies subject to a maximum of ten years (Regulation 24);
2. an allowance, where zillmerising was appropriate but had not been used or had been used only partially, of not more than 3.5% of the relevant capital at risk or at a rate equal to the loading for acquisition costs included in the premium, subject to a reduction for any Zillmer adjustment which had already be made in the valuation (Regulation 25);
3. hidden reserves⁴²⁸ resulting from an underestimation of assets and overestimation of liabilities (other than the mathematical reserves) which were not of an exceptional nature (Regulation 26).

Matching and localisation – Part V

641 The currency matching and localisation rules in Part V required that where an insurance company’s liabilities in a particular currency exceeded 5% of its total liabilities, at least 80% of those liabilities were to be covered in the same currency. If the liabilities were in sterling, the assets could be held in any member state; if they were to cover liabilities in any other currency, the assets were to be held in the EC or in the country of the currency concerned (Regulations 27 and 31).

642 Index linked liabilities, business conducted by a UK company outside the EC and pure reinsurance business were excluded from the matching and localisation provisions (Regulations 28 and 32(1)(b) and (c)).

Valuation of assets – Part VIII and Schedules 11 and 12

643 Part VIII of ICR 1994 was made under the power of the Secretary of State to make valuation regulations under section 90 of the ICA 1982 and consolidated the law previously in force in relation to assets under Part V of ICR 1981⁴²⁹ with amendments. Regulations on the valuation of assets had first been made in 1974⁴³⁰ and had become progressively more complex over the years.

644 The interpretation regulation in Part VIII included a number of new or revised definitions⁴³¹ and ran to some eight pages; however, the general approach of the regulations remained as being to specify the manner in which assets were to be valued and to impose limitations on the extent to which certain assets could be taken into consideration when determining the solvency of a company. The basic aims remained as being to ensure that there was no undue concentration of risk in particular kinds of asset or overvaluation of assets which could endanger solvency.

645 Part VIII applied to the valuation of assets for the purposes of the following provisions of the ICA 1982: sections 29(7) (declaration of dividends), 31 (restrictions on transactions with connected persons), 32 (margin of solvency), 34 (companies supervised in other member states), 35 (form and situation of assets), 38 (requirements about investments), 39 (maintenance of assets in the UK) and 45 (residual powers to impose requirements to protect policyholders) and in relation to investigations under sections 18 and 42 of the 1982 Act.

646 Part VIII did not apply to the determination of the value of linked assets in relation to contracts providing for the payment of property linked benefits to the extent that the assets were held to comply with the requirements of section 35A of the ICA 1982 (regarding the adequacy of assets), to match liabilities in respect of such benefits⁴³² .

647 Part VIII applied to both long term business and general business. In broad terms, the approach to valuation of assets (set out in Regulations 4656) was to require that assets be valued as at a prescribed amount (for example, at their market value) or as not being greater than a specified amount, in the latter case, subject to an overriding requirement that this should be no more than the amount which, in all the circumstances of the case, was likely to be realisable (Regulation 45(4), which was extended in the following year, see paragraph 684)⁴³³ .

648 Regulation 48 on the valuation of debts and other rights was substantially revised from its predecessor provision⁴³⁴. Debts in respect of premiums which were due but had been outstanding for more than three months were to be disregarded⁴³⁵. The value attributed to land was to be no greater than the open market sale value assessed within the preceding three years by a qualified valuer (Regulation 49). The value of computer equipment was to be written off over four years and of other office machinery over two years (Regulation 50). Regulation 55 made provision for the valuation of rights under derivative contracts (for which no specific provision had been made in ICR 1981)⁴³⁶ .

649 The rules on the extent to which assets could be taken into account (known as the ‘admissibility rules’⁴³⁷) were substantially revised (Regulation 57 and Schedule 12). The admissibility rules limited the extent to which most assets could be taken into account, based on the company’s ‘aggregate exposure to such assets’. If the aggregate exposure exceeded the ‘maximum admissible value’ for assets of the particular description, the excess value was to be left out of account.

650 The ‘maximum admissible value’ of various assets for a company carrying on long term business was included in Part I of Schedule 12. The limits were assessed by reference to the ‘long term business amount’ (initially defined as being, broadly, the sum of the company’s long term liabilities and one sixth of its margin of solvency (or 800,000 ECU if greater), less specified deductions for such items as liabilities in respect of property linked benefits). Part I of Schedule 12 prescribed percentages of the long term business amount in relation to various descriptions of assets; assets of a value which exceed this percentage were to be disregarded in assessing the value of the company’s assets for solvency purposes. For example, unsecured debts due from any one unincorporated body of a value greater than 1% of the long term business amount were to be left out of account.

651 The aim of the admissibility rules was to reduce the amount which could be taken into account for solvency purposes where there was considered to be too great a concentration of holding of a particular type of asset or holding with a particular party.

652 The admissibility rules were most strict in relation to assets considered to present the greatest risks. Certain assets were excluded from the admissibility rules, such as approved securities, debts due under reinsurance contracts and debts in respect of premiums.

653 As noted in paragraph 684, Regulation 57 of and Schedule 12 to ICR 1994 were replaced in 1995 and a revised definition of the ‘long term business amount’ was included in the new Schedule 12 (which was then reamended in 1996). Under the amended definition, the long term business amount was defined as being the amount of the company’s long term insurance liabilities (net of reinsurance ceded and excluding property-linked liabilities), together with the (entire) amount of the margin of solvency (less any implicit items) and the amount of any depositback in connection with reinsurance in respect of long term business.

654 In the main, separate provision was made in relation to assets which supported linked long term business. As noted, assets required to match liabilities in respect of property linked benefits were excluded from Part VIII of ICR 1994. The benefits under such contracts entered into on or after 1 July 1994 were to be determined wholly by reference to the value, or fluctuations in the value, of the property listed in Part I of Schedule 10 (Regulation 43(1)).

655 Although assets held to cover index linked benefits were subject to the asset valuation rules in Part VIII, most descriptions of assets used to cover the liabilities under such contracts were initially excluded from the admissibility rules under Regulation 57 (by Regulation 57(14)). Regulation 57 was then substituted in 1995 and the assets used to cover the liabilities under contracts providing for indexlinked benefits were made subject to the counterparty exposure limits under the asset admissibility rules. Index linked benefits were to be determined by reference to fluctuations in an index which met the description in Part II of Schedule 10 (Regulation 43(2)).

Determination of liabilities regulations – Part IX

656 In common with Part VIII, Part IX was made under the Secretary of State’s power to make valuation regulations under section 90 of the ICA 1982. It reenacted, with amendments, the provisions of Part VI of ICR 1981 which had first introduced regulations in relation to the determination of liabilities⁴³⁸ .

657 Part IX applied in respect of the determination of liabilities for the purposes of the same provisions of the ICA 1982 as those for which Part VIII on valuation of assets applied (see paragraph 645), and for the purpose of section 37(3) (exceptional grounds for intervention in relation to sections 39, 40 and 40A, which included the submission by the company to the Secretary of State of an account or statement which specified an amount of any liabilities which appeared to the Secretary of State to have been determined otherwise than in accordance with valuation regulations).

658 Part IX applied to the determination of property-linked liabilities (unlike Part VIII, from which valuation of assets held to match such liabilities was excluded (see paragraph 646)).

659 It has been noted that, although the effect of the liability regulations was to restrict the actuary’s freedom to choose a valuation basis, the actuary still retained a very considerable degree of flexibility of choice in comparison to that available to actuaries in many other countries of the European Union⁴³⁹ .

660 Regulation 60 reenacted the basic requirements in relation to the determination of liabilities for long term and general insurance business previously contained in Regulation 52 of ICR 1981, with a new exception in relation to cumulative preference shares (which were dealt with in Regulation 23(3) of the 1994 Regulations).

661 Although, as noted in paragraph 195 there were no financial reporting standards specifically for insurance business, Regulation 60 stated that:

1. Subject to this Part of these Regulations, the amount of liabilities of an insurance company in respect of its long term and general business shall be determined in accordance with generally accepted accounting concepts, bases and policies or other generally accepted methods appropriate for insurance companies.
2. In determining under paragraph (1) above the amount of the liabilities of an insurance company, all contingent and prospective liabilities shall be taken into account but save as provided in regulation 23(3) of these Regulations not liabilities in respect of share capital.

662 ‘Long term liabilities’ were defined as under regulation 50 of ICR 1981 to mean ‘liabilities of an insurance company arising under or in connection with contracts for long term business’, but with the addition of a reference to the expression including liabilities arising from ‘deposit back arrangements’⁴⁴⁰ (Regulation 58).

663 A new requirement was imposed on companies under regulation 61 in relation to liabilities under derivative contracts (and contracts with equivalent effect), to make sufficient provision on prudent assumptions for the effect of possible adverse changes in the value of the assets to which the contract related⁴⁴¹.

664 As noted above, Regulation 64 (derived from regulation 54 of ICR 1981), which contained general requirements for the determination of the amount of the long term liabilities, included for the first time a reference to the ‘reasonable expectations of policyholders’ in relation to the actuarial principles to be used.

665 Regulation 64 was intended to impose overriding obligations in relation to the determination of the amount of a company’s liabilities. It required, without prejudice to its generality, compliance with the more detailed provisions of Regulations 65 to 75 in determining the amount of the long term liabilities. Regulation 64 provided:

1.     
2. The determination of the amount of long term liabilities (other than liabilities which have fallen due for payment before the valuation date) shall be made on actuarial principles which have due regard to the reasonable expectations of policy holders and shall make proper provision for all liabilities on prudent assumptions and shall include appropriate margins for adverse deviation of the relevant factors. (Emphasis added.)
3. The determination shall take account of all prospective liabilities as determined by the policy conditions for each existing contract, taking credit for premiums payable after the valuation date.
4. Without prejudice to the generality of paragraph (1) above, the amount of the long term liabilities shall be determined in compliance with each of regulations 65 to 75 below and shall take into account, inter alia, the following factors:
   1. all guaranteed benefits, including guaranteed surrender values;
   2. vested, declared or allotted bonuses to which policy holders are already either collectively or individually entitled;
   3. all options available to the policy holder under the terms of the contract;
   4. expenses, including commissions.

666 It is to be noted that paragraph (1) of Regulation 64 required provisions to include appropriate margins for adverse deviation of relevant factors⁴⁴² . Paragraphs (2) and (3) were also new and mirrored the provisions of the first principle for the determination of technical provisions under the Life Directives⁴⁴³, which required a prudent prospective actuarial valuation which included the specified items listed in paragraph (3) of Regulation 64.

667 Regulation 54 of ICR 1981 (from which Regulation 64 of ICR 1994 was derived) had specified that the amount of the long term liabilities should ‘in the aggregate not in any case be less than the amount calculated in accordance with regulations 55 to 64 below’ (see paragraph 266). The reference to ‘in the aggregate’ in respect of the determination of the amount of the long term liabilities was not replicated in Regulation 64 of ICR 1994, which did not, in general, envisage the use of alternative valuation methods to those prescribed in the Regulations⁴⁴⁴.

668 However, Regulation 67 of ICR 1994, which made specific provision for the valuation of future premiums, provided that if any alternative valuation method to those described in Regulation 67 had been used to value future premiums, it should be demonstrated that the alternative method resulted in reserves which were no less, in aggregate, than those which would result from the application of the methods specified in Regulation 67 (see paragraph 679 regarding Regulation 67(4)).

669 It is difficult to assess the practical impact of the inclusion of a reference to ‘the reasonable expectations of policyholders’⁴⁴⁵ in the regulation which set out the fundamental requirements for the determination of long term liabilities. Its predecessor provision (Regulation 54 of ICR 1981) which had not included this term had been considered to provide a means of strengthening reserves where necessary in relation to the interests of with-profits policyholders if the net premium valuation basis did not result in sufficient provision for future bonuses⁴⁴⁶ .

670 The professional guidance issued to appointed actuaries by the F&IA had made reference to the need for actuaries to consider policyholders’ reasonable expectations in some way from the time GN1 was first issued in 1975 and by 1992, that guidance referred to the need for the actuary to have regard to policyholders’ reasonable expectations when assessing long term liabilities⁴⁴⁷ .

671 The inclusion of the expression in the legislation in 1994 appears to have been intended to give the concept greater significance. Although doubts continued to be expressed about the ambit of the phrase, it appears to have been accepted that it was intended to encompass something more than contractual liabilities, and was of particular significance for policyholders’ expectations in relation to discretionary items, such as reversionary and terminal bonus.

672 A note of a meeting between DTI and GAD officials regarding the drafting of ICR 1994 in or around April 1994⁴⁴⁸ indicates that it had been proposed that the words ‘which have due regard to the reasonable expectations of policyholders and to the value placed on assets’ should be included to amplify the reference to ‘actuarial principles’, in order to make it clear that proper allowance should be made in the valuation for future bonuses.

673 The final words of this proposed additional drafting (quoted in bold text) did not appear in ICR 1994, as it had been considered that those words would ‘steer the actuary towards requiring a reserve for terminal bonus’⁴⁴⁹. It was considered that the remaining requirement (to have regard to the reasonable expectations of policyholders in the actuarial principles used) would be ‘sufficient to supervise this area adequately, and it will allow the use of the investment reserve for accrued terminal bonus’.

674 The Penrose Report⁴⁵⁰ indicates that even ICR 1994 did not require recognition of liabilities by reference to policyholders’ reasonable expectations, but simply that liabilities which were recognised should be quantified for the purpose of the statutory returns taking into account, inter alia, policyholders’ reasonable expectations (noting that Skerman’s⁴⁵¹ original approach to policyholders’ reasonable expectations was to cater for them through the use of a net premium basis for valuation and not by treating them as liabilities).

675 Whether or not policyholders’ reasonable expectations were to be treated as ‘liabilities’ under ICR 1994, if the additional reference to them was to serve any function, it is to be assumed that it was intended that policyholders’ reasonable expectations should be a factor which could affect the amount or composition of the technical provisions which a company was required to make.

676 Describing the changes then shortly to be introduced by ICR 1994 at a meeting of the Institute of Actuaries in April 1994, a GAD actuary explained that there would no longer be any reference to specific reserves for future bonuses; instead the actuary would have to have regard to PRE. ‘There was, however, no intention of requiring a general strengthening of reserves in this area.’⁴⁵²

677. Regulation 65 on methods of calculation of long term liabilities was entirely new and was made to implement obligations under the Third Life Directive. It required the amount of the long term liabilities to be determined separately for each contract by a prospective calculation, permitting a retrospective calculation only if a prospective calculation could not be applied to the particular type of contract or benefit or where a retrospective calculation would produce an amount at least as great as a prudent prospective calculation⁴⁵³ .

678 That Regulation also required that the method of calculation of the amount of the liabilities and the assumptions used should not be subject to discontinuities from year to year arising from the arbitrary changes. It required that liabilities for with-profits contracts should have regard to the level of premiums under the contracts, to the assets held in respect of those liabilities, and to the custom and practice of the company in the manner and timing of the distribution of profits or the granting of discretionary additions.

679 Regulation 67 dealt with the valuation of future premiums. The first three paragraphs of the regulation repeated the provisions of Regulation 57 of ICR 1981⁴⁵⁴ which entailed a net premium method of calculation in most cases. A new paragraph (4) was added which provided:

An alternative valuation method to that described in paragraphs (1)(3) above may be used where it can be demonstrated that the alternative method results in reserves no less, in aggregate, than would result from the use of the method described in those paragraphs.

680 Regulation 69 which dealt with the rates of interest to be used in calculating the present value of future payments by or to an insurance company was revised from its predecessor provision (Regulation 59 of ICR 1981), in light of the provisions of the Third Life Directive which set out limits and requirements for the rules to be made by member states in relation to the prudent choice of an interest rate⁴⁵⁵ in determining the amount of the technical provisions.

681 Regulation 72 regarding options replaced Regulation 62 of ICR 1981⁴⁵⁶. The wording of paragraph (1) was revised to require that provision should be made ‘on prudent assumptions’ to cover any increase in the liabilities caused by policyholders exercising options under their contracts⁴⁵⁷. Paragraph (2), regarding the calculation of the required provision for options under which the policyholder could secure a guaranteed cash payment within twelve months after the valuation date, reenacted the provisions of Regulation 62(2) of ICR 1981 without amendment.

682 Regulation 75 which replaced Regulation 55 of ICR 1981⁴⁵⁸ regarding the impact on the determination of liabilities of the nature and term of the assets representing the long term fund, contained revised and expanded provisions. The changes were intended to clarify the need to ensure the adequacy of the assets to meet obligations under long term contracts as they arose and the liabilities as determined in accordance with regulations 65-74.

Amendments to ICR 1994

683 ICR 1994 was amended later in 1994⁴⁵⁹ and in 1995⁴⁶⁰. Revisions made in 1995 included a substituted Regulation 45(4) (which extended to all valuations under Part VIII the overriding rule that assets should not be valued at an amount greater than that at which they were expected to be realised), a new regulation 47A (relating to certain sale and repurchase transactions), the replacement of certain of the asset valuation regulations (Regulations 5153 and 5557), the replacement of Schedule 12 (which was substantially amended and contained a revised definition of the ‘long term business amount’, which was reamended in the following year), and minor revisions to the determination of liability regulations (Regulations 58, 60, 61, 62, 64 and 69).

684 ICR 1994 was amended by six other statutory instruments⁴⁶¹ before they were revoked with effect from 1 December 2001 by article 460 of the Financial Services and Markets Act 2000 (Consequential Amendment and Repeals) Order 2001⁴⁶². The amendments made in 2000 by the Insurance Companies (Amendment) Regulations 2000⁴⁶³ are referred to below (paragraphs 969 et seq).

The Insurance Companies (Accounts and Statements) (Amendment) Regulations 1993 and 1994

1993 amendment regulations to the ICAS Regulations 1983 (appointed actuary certificate of compliance with professional guidance)

685 The Insurance Companies (Accounts and Statements) (Amendment) Regulations 1993⁴⁶⁴ revised the certificate which the appointed actuary was required to give under Schedule 6 to the ICAS Regulations 1983 in connection with the statutory returns, as had been proposed in the consultation paper issued by the DTI in 1990 regarding the need to strengthen the role of the appointed actuary system⁴⁶⁵ .

686 With effect from 1 January 1994, the actuary’s certificate was required to include a statement (provided it was the case) that the two guidance notes issued by the F&IA: GN1 and GN8 dated July 1992, had been complied with. Thus, the professional guidance to actuaries was given some acknowledgment within the statutory regime (but without making it a statutory requirement to comply with it).

1994 amendment regulations to the ICAS Regulations

687 The third main set of regulations enacted to give effect to the Third Life Directive (and the Third NonLife Directive) in the UK was the Insurance Companies (Accounts and Statements) (Amendment) Regulations 1994⁴⁶⁶ (the ICASA Regulations 1994). Their primary purpose was to implement the Directives to the extent that they affected the form and content of the annual returns required to be submitted by insurance companies under the ICA 1982 as prescribed in the 1983 Regulations. They also contained amendments consequent upon the consolidation of ICR 1981 by ICR 1994.

688 The ICASA Regulations 1994 were made by the Secretary of State as designated Minister under section 2(2) of the ECA 1972 and under various provisions of the ICA 1982. They came into force on 1 July 1994, the same date as the other two main sets of regulations made in 1994.

689 Changes were made by the ICASA Regulations 1994 to a number of provisions of the ICAS Regulations 1983, including the prescribed forms, to take account of the European Economic Area Act 1993⁴⁶⁷ and to exclude ‘EC companies’⁴⁶⁸ from the obligation to submit annual returns to the Secretary of State, save in exceptional circumstances (regulation 2).

690 The ICASA Regulations 1994 required that additional information be given in the returns in relation to derivative contracts, subordinated loan capital⁴⁶⁹ and cumulative preference shares, with a new prescribed form to provide an analysis of derivative contracts, a new statement of additional information on such contracts and amendments to other prescribed forms (Regulations 9 and 15 inserting a new Regulation 22B and Form 13A in the ICAS Regulations 1983).

691 Regulation 17 of the ICASA Regulations 1994 imposed a new requirement for the abstract of the valuation report prepared by the appointed actuary (under Schedule 4 to the ICAS Regulations 1983) to describe the investment guidelines of the long term fund, including the use of derivative contracts and the method by which allowance had been made for derivative contracts in determining the long term liabilities.

692 Additional information was required to be provided in relation to ‘shareholder controllers’⁴⁷⁰. The company was required to provide, in respect of each person who was a shareholder controller at the end of the financial year, a statement of the percentage of shares that person held and the percentage of the voting power that he or she was entitled to exercise (under a new Regulation 22C inserted in the ICAS Regulations 1983 by Regulation 10 of the ICASA Regulations 1994).

693 Regulation 18 of the ICASA Regulations 1994 required an additional statement to be included in the certificate to be given by the directors of the company under Schedule 6 to the ICAS Regulations 1983, in the form of a list of any published guidance⁴⁷¹ with which the company’s internal systems of control complied or in accordance with which the return had been prepared (new paragraph 6A of Schedule 6 to the 1983 Regulations).

694 The requirements for the certificate to be given by the appointed actuary were also revised to require an additional statement (if it was the case) of his or her opinion that the premiums for contracts entered into during the financial year were sufficient to enable the company to meet its commitments in respect of those contracts and, in particular, to establish adequate mathematical reserves (new paragraph 9(a)(v) of Schedule 6 to the 1983 Regulations).

695 The requirements for qualifications of auditors under Regulation 30 of the ICAS Regulations 1983 were amended to specify that the auditor of an insurance company’s accounts for the purpose of section 21 of the ICA 1982⁴⁷² should be a person eligible for appointment as the company’s auditor under section 25 of the Companies Act 1989, other than a person to whom section 34(1) of the Act applied⁴⁷³ (Regulation 14). The requirements relating to qualifications of appointed actuaries in Regulation 28 of the ICAS Regulations 1983 were not amended.

696 The ICAS Regulations 1983 were revoked together with the ICASA Regulations 1994 and other amending regulations in respect of any financial year ending on or after 23 December 1996 by the Insurance Companies (Accounts and Statements) Regulations 1996⁴⁷⁴ referred to below.

The Auditors (Insurance Companies Act 1982) Regulations 1994

697 Section 21A of the ICA 1982 (inserted in that Act by the FS Act 1986⁴⁷⁵) was designed to enable auditors of insurance companies to communicate to the Secretary of State any matters which came to their attention which were relevant to the Secretary of State’s functions under the 1982 Act.

698 Section 21A(2) and (3) empowered the Secretary of State to make regulations to specify circumstances in which an auditor would be under a duty to communicate a matter to the Secretary of State, if it appeared to him that any auditor or class of auditor was not subject to satisfactory rules made or guidance issued by a professional body in this respect. The matters to be communicated could include matters relating to persons other than the insurance company.

699 The Auditors (Insurance Companies Act 1982) Regulations 1994⁴⁷⁶ were made for the purpose of section 21A(2) and (3), to specify the circumstances in which an auditor of an insurance company was under an obligation to communicate a matter to the Secretary of State.

700 In effect, such an obligation arose where the auditor became aware of matters which gave him or her reasonable cause to believe that they were or might be of material significance for determining whether any of the Secretary of State’s powers of intervention under sections 38 to 45 of the ICA 1982 should be exercised.

701 With effect from 16 July 1996, the Auditors (Insurance Companies Act 1982) Regulations 1994 were amended⁴⁷⁷, inter alia, to place the auditor under obligations to communicate information to the Secretary of State in additional circumstances. These additional circumstances were those in which the auditor had reasonable cause to believe that:

1. the authorisation of the company concerned⁴⁷⁸ could be withdrawn under section 11 of the ICA 1982, other than on grounds of sound and prudent management under section 11(2)(ab);
2. there had been, or might be or might have been, a failure to fulfil any of the criteria of sound and prudent management and that the failure was likely to be of material significance⁴⁷⁹;
3. there had been, or might be or might have been, a contravention of any provision of the ICA 1982 and that contravention was likely to be of material significance; or
4. the company’s continuous functioning might be affected;

or where the circumstances were such as to preclude the auditor from stating in his or her report that the company’s annual accounts had been properly prepared in accordance with the Companies Act 1985 or section 17 of that Act.

Guidance for Appointed Actuaries 1994 revisions to GN1 and GN8

702 As noted above⁴⁸⁰, from 1 January 1994 the certificate to be given by the actuary as part of the statutory returns was required to include a statement of compliance with the guidance notes GN1 and GN8, giving the professional guidance a degree of statutory recognition.

GN1

703 A revised version of GN1 (version 4.0) was issued in December 1994, following the various changes to the ICA 1982 and the subordinate legislation which had been introduced in July of that year. On this occasion PRE did not feature in the revisions, which related to such matters as:

1. the new requirement for an actuary to possess a practising certificate⁴⁸¹ in order to act as an appointed actuary (paragraph 2.1);
2. a requirement for the appointed actuary to certify, inter alia, that GN1 and GN8 had been complied with (and stating the effective dates of the Guidance Notes); if sufficient information on issues relating to the financial position of the company had not been made available to ensure compliance with GN1 and GN8 the actuary was required to qualify the certificate (paragraphs 4.1 and 4.3);
3. to advise that any appointed actuary who became doubtful as to the proper course to adopt in relation to a potentially significant problem should seek help and advice through the Professional Guidance Committee⁴⁸² (replacing the previous reference to the Honorary Secretaries of the Institutes) (paragraph 1.2);
4. the new requirement for the certificate to be given by the appointed actuary to include a statement of the adequacy of the premium rate ‘on reasonable actuarial assumptions, to meet all commitments under or in connection with the contract’ as required by section 35B of the ICA 1982⁴⁸³, noting that the certificate was retrospective (relating to contracts written during the financial year) and that reserves would have been set up to allow for any anticipated losses such that this requirement should not in itself make any demands on the actuary (paragraph 5.2);
5. to specify a basis for assessing the minimum provision to be made for future expenses of continuing the existing business (paragraph 6.4);
6. requirements for the appointed actuary to be aware of the possible effects of derivative instruments used by the company when choosing the valuation basis (paragraph 6.6) and to advise the company that appropriate guidelines should be given to investment managers regarding the use of derivative contracts (paragraph 6.11);
7. a requirement that the appointed actuary should be satisfied that the margins in any published valuation of the liabilities, including those required by statute, were adequate having regard to the actuary’s own assessment of the risks inherent in the conduct of the company’s business (paragraph 6.13); and
8. in respect of the actuary’s written report to the DTI, the appointed actuary was required to use best endeavours to ensure that the financial results were presented in a way which demonstrated the true underlying position of the company and that the results were not distorted by any undisclosed valuation methods or assumptions (paragraph 8.1).

704 The F&IA began to issue practising certificates at the end of 1992. The criteria for the issue of practising certificates were intended to address both the experience and knowledge and the ‘good character’ of the actuary, and incorporated the statutory criteria⁴⁸⁴. According to the proposals outlined before their introduction⁴⁸⁵ the criteria for issue of practising certificates were to require an appointed actuary:

1. to be a fellow of the Faculty or the Institute of Actuaries;
2. to be at least thirty years of age;
3. to have undertaken appropriate Continuing Professional Education (CPE);
4. to have appropriate practical experience;
5. to have undertaken a professionalism course if recently qualified;
6. to have had no adverse tribunal⁴⁸⁶ finding; and
7. to be ‘Form B satisfactory’⁴⁸⁷, i.e. ‘fit and proper’ (later described as an ‘appropriate person’, similar to the ‘fit and proper’ requirement for insurance company directors).

It was intended that appointed actuaries would receive a certificate automatically on application, which was to include an undertaking by the actuary to notify relevant changes in circumstances, for example if the person’s CPE record was not up to date or if there had been changes affecting their ‘fit and proper’ status.

705 The DTI commented informally on the proposals for the practising certificate system established by the F&IA⁴⁸⁸.

706 By 1994, GN1 had become a significantly longer document than when first introduced in 1975 and imposed even greater obligations on the appointed actuary in relation to the regulation of the company’s business. Nonetheless it continued to contain substantial elements of the original guidance, drafted in broad and general terms. It also continued to envisage that the appointed actuary might hold more than one role within a company, such as that of a director.

GN8

707 The version of GN8 issued in 1994 (version 4.0) was considerably updated and expanded in the light of ICR 1994.

708 The advice on Regulation 64 of ICR 1994 (corresponding to that on Regulation 54 of ICR 1981) was extended in view of the new drafting in Regulation 64 which specified that the actuarial principles used to determine the amount of the long-term liabilities must have due regard to policyholders’ reasonable expectations and include appropriate margins for adverse deviation of the relevant factors.

709 Actuaries were advised that it was permissible to group categories of contract (e.g. those with similar kinds of benefit, including options and guarantees which were considered to be sufficiently homogeneous) in deriving a valuation basis (paragraph 2.1); two separate paragraphs then dealt with policyholders’ reasonable expectations and resilience testing.

710 In relation to policyholders’ reasonable expectations, paragraph 2.3 stated:

When carrying out the valuation in compliance with Regulations 65 to 75⁴⁸⁹, this should be interpreted as requiring the valuation basis to be sufficiently strong to enable an appropriate level of reversionary bonus to emerge (and similar bonuses which are added periodically over the term of the contract) but not as requiring implicit or explicit provision for any element of terminal bonus or any final payment of additional bonus. The actuary would, however, be expected to make other investigations in order to be satisfied that the life fund is able to support a proper level of future terminal bonus having regard to the bonus smoothing policy followed by the company. (Emphasis added.)

711 In relation to the need to provide appropriate margins for adverse deviations of the relevant factors under Regulation 64, paragraph 2.4 of version 4.0 of GN8 repeated earlier guidance on Regulation 54 of ICR 1981, that the appointed actuary should consider the resilience of the valuation to changes in circumstances with special reference to more extreme changes to which the office might be vulnerable – but did not give specific examples of changes to be considered.

712 The requirement under Regulation 64(1) to ‘include appropriate margins for adverse deviation of the relevant factors’ gave effect to part of the provisions of article 18 of the Third Life Directive (amending article 17 of the First Life Directive) and applied to all the assumptions used in the valuation. Regulation 64(1) created an additional requirement to that under Regulation 75 of ICR 1994 (to take account of possible future changes in the value of assets) which gave rise to resilience testing and resilience reserves and which had been a UK requirement which had been part of the original UK determination of liabilities regulations (Regulation 55 of ICR 1981).

713 Much of the guidance on individual regulations was expanded or revised. In relation to Regulation 75⁴⁹⁰, paragraph 3.6.3 stated that the company’s reserves (including any additional reserves required under Regulation 75) should be sufficient to absorb the effect of changes in interest rates and asset values on a suitably prudent basis without prejudicing the company’s ability to hold reserves which satisfied Regulations 6474 in the changed conditions.

714 When assessing any additional reserves required by Regulation 75, any derivative contracts were to be revalued taking those changes into account. In relation to with-profits business, paragraph 3.6.4 specified that actuaries were to ensure that ‘the liability in the changed investment conditions adequately covers policyholders’ (revised) reasonable expectations and (more generally) that the valuation basis satisfies regulation 64 (excluding the reference to regulation 75)’.

Prudential Guidance Notes and ‘Dear Director’ letters from the DTI

Prudential Note 1994/1 – Hybrid Capital: Admissibility for Solvency

715 From 1994 onwards the DTI began to issue a series of guidance notes to insurance companies on topics of interest or concern, described as ‘Prudential Notes’ or ‘Prudential Guidance Notes’ (PGNs). The first, numbered 1994/1, dealt with ‘hybrid capital’, the subordinated loans which had been the subject of changes introduced by article 25 of the Third Life Directive, allowing the value of such loans to count towards the cover for the margin of solvency, subject to certain limits⁴⁹¹ .

716 In the UK, no ‘blanket’ permission was included in the legislation to allow companies to use subordinated loans for these purposes. Instead, a company had to make an application to the Secretary of State for an order under section 68 of the ICA 1982 to permit this on a case by case basis.

717 Prudential Note 1994/1 explained the meaning of ‘hybrid capital’ as being essentially loan capital, but with a number of conditions which removed some of the lender’s usual rights, allowing the loan to be treated like the proceeds of a share issue for regulatory purposes. The note stated that the Department’s main concern was to ensure that companies had sufficient risk capital to meet unexpected pressures on business and that it would view applications to count loan capital as part of the solvency margin in that light.

718 Prudential Note 1994/1 described four categories of capital which would satisfy the requirements of the First Life Directive: three specified types of subordinated loan capital and in the case of a mutual, a ‘subordinated members’ account’⁴⁹² .

719 The note explained the detailed requirements for hybrid capital, including the required limitations on the usual lender’s rights and the extent of the subordination and imposed additional requirements to those in the Directive. In order to protect the interests of with-profit policyholders in the long term fund, the loan was not to constitute a liability attributable to that fund.

720 Furthermore, the lender’s rights were to be subordinated to all other creditors in the event of winding up. The note repeated the limits on the use of subordinated loans in meeting the solvency margin as set out in the Third Life Directive (up to 50% of the required margin of solvency with no more than 25% in aggregate being covered by fixed term instruments).

721 Prudential Note 1994/1 explained that under insurance companies legislation, the value of hybrid capital instruments could not count for the purpose of providing the required margin of solvency because the instruments gave rise to liabilities which would offset the value of the funds raised. However, section 68 of the ICA 1982 gave the Secretary of State⁴⁹³ discretion to modify or disapply specified provisions of the Act and regulations made under it.

722 It was envisaged that a section 68 order made in those circumstances would vary the terms of Regulations 23 and 60(2) of ICR 1994, so that the liability to repay the loan would be excluded from the margin of solvency calculations (up to the appropriate proportion of the margin of solvency).

723 Insurers ‘wishing to take advantage of the opportunity offered’ were invited to apply to the DTI for a section 68 order⁴⁹⁴. The procedure and timescale for such applications were explained in the note.

‘Dear Director’ letters

724 From 1 December 1994, the DTI began to issue a series of letters to the chief executives of insurance companies known as ‘Dear Director’ or ‘DD’ letters. The first, referenced DD1994/1, drew the company’s attention to two new series of PGNs on ‘Systems of Control’ (in relation to the new ‘sound and prudent management’ obligations under the ICA 1982 as amended) and ‘Preparation of Returns’.

725 These two series of guidance notes were intended to be treated as ‘published guidance’ for the purpose of the requirement that the directors should include in their certificates as part of the statutory returns, a list of, inter alia, the published guidance with which the company’s systems of control complied or in accordance with which the return had been prepared⁴⁹⁵ .

726 Companies were advised that it was not compulsory to comply with the guidance, but that it was compulsory to have adequate systems of control in place (and to comply with, for example, the valuation regulations). Appendices to the letter described the background to the two types of guidance and listed guidance on those and other topics which the DTI had issued or intended to issue.

727 The first DD letter enclosed a copy of PGN 1994/6 on systems of control over investments, counterparty exposure and the use of derivatives and asked companies to provide a ‘state of play’ report summarising the extent to which the company’s systems already complied with PGN 1994/6 and any remedial action being undertaken if they did not.

728 The next such letter, DD1994/2 (16 December 1994), circulated PGN 1994/7 on asset valuation. Subsequent DD letters dealt with such matters as guidance on valuation of reinsurance recoveries (DD1994/3), clarification of the accounting treatment which should apply to financial reinsurance arrangements in preparing the statutory returns to the DTI (DD1995/1) and the contents of directors’ certificates in relation to years starting on or after 1 January 1995 (DD1995/2), which annexed an updated list of the published guidance considered to be relevant for this purpose.

729 The last of those letters explained that what the DTI was looking for from the directors’ certificates in so far as they applied to the ‘preparation of returns guidance’ was an assurance that a responsible individual or team had read the guidance and had understood its implications and that the company had a reasonable system for valuing assets and assessing derivatives which was consistent with the guidance.

Departmental consideration of PRE and Ministerial statement in 1995

730 From around 1989 onwards a number of individual cases came to the attention of the DTI and GAD in which the meaning of PRE was considered to be of particular importance. Seven such cases had been outlined in the first F&IA joint working party report of April 1990 and individual cases of concern continued to emerge, commonly relating to the balance between the interests of policyholders and those of shareholders in relation to the division of profits.

731 Counsel’s opinion had been obtained by the DTI (and by the insurance companies concerned) on a number of occasions⁴⁹⁶. A draft DTI document dated 11 April 1995 summarised the main principles to emerge from the advice the DTI had obtained from counsel. This included advice to the effect that:

1. policyholders may have a ‘reasonable expectation’ for the purposes of the ICA 1982 notwithstanding that it went beyond enforceable legal rights;
2. the subjective expectations of a particular policyholder or even the generality of policyholders were not relevant (and the ‘expectations’ in question included those of potential policyholders, who by definition could have no state of mind about the affairs of the company); the word ‘reasonable’ imported an objective test relating to a hypothetical reasonable policyholder;
3. the hypothetical policyholder could have an expectation of the manner in which the business of the company would be conducted notwithstanding that the generality of policyholders were wholly ignorant of the relevant facts. If this were not so, the Secretary of State would be unable to exercise his intervention powers if the information which led him to act was not available to the generality of policyholders and a company would be less amenable to regulation the more secretively it behaved. The Secretary of State’s powers to intervene depended upon the information which was available to him at the time and not necessarily that which was available to policyholders;
4. action by a company would certainly be contrary to the reasonable expectations of policyholders if their policies had been marketed to them on a basis which was inconsistent with that action;
5. PRE related to more than the amount of any declared bonuses; a hypothetical policyholder could reasonably expect that the balance between policyholders and shareholders or between different classes of policyholders would not be, in any substantial respect, altered in a manner adverse to them (or to any class of them). ‘Adverse’ referred to the balance between groups and not to the anticipated return before and after the relevant action by the company. Policyholders might therefore be adversely affected even if they would be better off after the relevant action, if the facts showed that they would have been better off by a larger margin had the balance of competing interests been left undisturbed; and
6. factors relevant to the determination of PRE in any particular case depended upon: 
   1. past practice of the company;
   2. written or oral statements made by the company at the point of sale, in marketing literature, policy documentation, with-profit guides etc; and
   3. industry practice as understood through media commentary.

(Advice had also been given on ‘orphan estates’⁴⁹⁷ suggesting a division between policyholders and shareholders in a 90:10 proportion as a starting point based on industry practice.)

732 In view of the increasing number of cases in which PRE was emerging as an issue, from at least 1994 onwards, correspondence took place within the DTI and between the DTI and GAD about the need to establish some principles relating to PRE against which to judge the different cases. The possibility of a public statement or even further legislation was suggested.

733 Eventually a public statement on PRE was made, in the form of an answer to a Parliamentary Question given by the then Minister for Consumer Affairs on 24 February 1995⁴⁹⁸, following the announcement by a major insurance company of its proposal to restructure its long-term funds in a manner which was considered to be consistent with the response given by the Minister.

734 The statement was directed at the position of with-profit proprietary offices which had accumulated a surplus in their long term funds and the issue of the division of that surplus between policyholders and shareholders, advocating division in the proportion 90:10, unless there was clear evidence to support a different allocation. The principles were outlined in very general terms:

The Department considers that policyholders’ reasonable expectations in respect of attribution of surplus are influenced by a range of factors, notably:

1. the fair treatment of policyholders visávis shareholders;
2. any statements of the company as to its bonus philosophy and the entitlement of policyholders to share in profits, for example, in its articles of association or in company literature;
3. the history and past practice of the company;
4. general practice within the life insurance industry.

It was said that the Department would assess any similar proposals from other life offices having regard to the facts and the principles set out in the statement.

735 It appears that little or no detailed guidance was issued at this time in relation to the question of the interpretation of PRE for policies containing guarantees or options, although there had been statutory requirements under the Regulations to make proper provision for them for many years. Nor was there any published guidance from the DTI, GAD or the profession on how reserves should be made for them⁴⁹⁹.

736 The working party set up by the Life Board of the F&IA in 1997 to consider reserving for annuity guarantees, the letter sent to managing directors of insurance companies by the Treasury in December 1998⁵⁰⁰ in relation to PRE and guaranteed annuity option costs, the DAA letters sent to actuaries by GAD on reserving for guarantees and the position statement on annuity guarantees issued by the Life Board in March 1999 are all referred to in paragraphs 854 et seq.

Internal audit of insurance supervision and IT strategy in 1994

737 During 1994 the Internal Audit Directorate of the DTI undertook an audit of insurance supervision and IT strategy. An ‘end of audit meeting’ was held on 14 June 1994 (prior to the preparation of the audit report) and was attended by audit staff and senior officials in the DTI.

738 The report of that meeting is prefaced with the comment that although it concentrated on weaknesses, the internal auditors had identified several areas of strength, including management of change (for example in relation to the Third Life Directive), the programme of visits to companies⁵⁰¹, the professional expertise provided by GAD and the system for the initial analysis of returns. Those strengths were also to be referred to in the audit report.

739 The report of the June 1994 meeting shows that audit findings⁵⁰² had been made in respect of such areas as:

1. increasing the degree of specialist expertise at Higher Executive Officer (HEO) level in the DTI’s Insurance Division;
2. ensuring that information obtained from and about companies was readily available, possibly using the computer system Insurance Division Information System (IDIS) to store key items of data;
3. updating lists of advisers and completing the Policy Guidance Notes⁵⁰³ manual;
4. various improvements to the systems for dealing with annual returns and setting deadlines for companies to respond to queries regarding their returns;
5. in cases where companies were failing to notify changes or were late in doing so or in submitting their returns⁵⁰⁴, standard letters should be issued to companies warning that formal action would be taken;
6. using formal action against companies rather than informal action in some instances;
7. in relation to the supervision of long term business, although the responsibility rested with the DTI, in practice any required action arising from annual and quarterly returns was determined by GAD; the DTI agreement⁵⁰⁵ should be reviewed regularly (possibly annually) to ensure that the DTI was receiving the right information and advice from GAD at the right time, with a view to ensuring that the DTI was discharging its responsibilities in relation to the supervision of companies conducting long-term business in an effective manner; it was suggested that there might be a case for GAD actuaries concerned with this work to be ‘housed’ within the DTI or employing external actuaries if GAD was unable to provide a service of ‘acceptable timeliness’⁵⁰⁶;
8. there appeared to be a lack of active monitoring by the DTI of the agreement between the DTI and GAD⁵⁰⁷;
9. responsibilities between the DTI and GAD relating to the supervision of long-term business did not appear to be as clearcut as they should be; this appeared to be because the agreement between the DTI and GAD was not being enforced;
10. there was some evidence that the responses GAD received to queries raised with companies on their annual returns were not copied to the DTI508;
11. the system for quarterly returns for long-term business was almost wholly reliant on examination by GAD, but there was no system for regular reports by GAD on the progress of the examinations⁵⁰⁹;
12. a qualitative and not just a quantitative analysis of the visits programme to companies was needed; and
13. in relation to the IDIS system, a large part of the supervision process seemed to fall outside the scope of IDIS; the system faced obsolescence (as neither the hardware nor the software were likely to be supported in the future); the system lacked a ‘plain English’ description of its capabilities; the data quality was poor and in some cases the output was not directly relevant; and performance monitoring, testing and training were needed or required improvement.

740 The findings of the internal audit and the proposed recommendations were discussed with officials in the DTI over the following months.

741 A memorandum from the Director of the Insurance Division to DTI Internal Audit of 30 September 1994 indicates that the DTI’s Insurance Division was ‘content to accept most of the recommendations and the underlying analysis’, although there were a few areas in which changes to the recommendations were suggested by the Insurance Division. The final internal audit report was issued in November 1994.

742 In response to the audit report the DTI prepared an ‘action document’⁵¹⁰ showing how each of the recommendations which had been accepted was being implemented or had been implemented. It appears from that document that the final recommendations included points concerning:

1. he need for renegotiation of the agreement between the DTI and GAD (see the following section regarding the 1995 service level agreement which addressed a number points raised during the internal audit);
2. regular (at least annual) review of the agreement with GAD should be undertaken;
3. the allocation of priority ratings for companies should be reviewed to ensure the most effective use of supervisory resources;
4. the implementation of a ‘bring forward’ system for letters to companies which required a reply; the DTI was also to operate such a system for major requests for information from companies made by GAD and the DTI was to remind GAD if further details were not supplied within a reasonable time;
5. initial assessment of annual returns for companies conducting long-term business should be completed within six weeks;
6. targets should be set for the annual review of the DTI training strategy;
7. a qualitative review of the programme of visits to companies should be undertaken and the frequency of visits to companies should be varied to reflect their anticipated value to the supervisory process; and
8. improvements should be made in relation to management information, sources of advice and information, record keeping and in relation to the IDIS system.

743 An DTI memorandum of 22 May 1995 indicates that by the time it was written, all the recommendations in the final audit report had been implemented.

1995 Service Level Agreement between the DTI and GAD

744 As noted above, the service level agreement (SLA) entered into between the DTI and GAD in 1984 indicated that the agreement was to be reviewed in 1986, but it does not appear that any further agreement was concluded at that time.

745 A new agreement, on broadly similar lines to the 1984 SLA, was entered into between the DTI and GAD in March 1995. The 1995 SLA related to the supervision of insurance companies conducting long term business and the supervision of the long term business of composite companies.

746 The language used in the 1995 SLA was more ‘colloquial’ than that in the earlier agreement and in general, less concise. Four references to ‘policyholders’ reasonable expectations’ were made in the 1995 agreement.

747 As before, the focus was on scrutiny of the statutory returns and the need for the DTI to form a view on insurance companies’ present and future solvency. The main outcome of the process continued to be the provision of scrutiny reports on individual companies by GAD to the DTI, to enable the DTI to form a view on the company’s solvency, compliance with the statutory requirements and, on this occasion, to identify any failure by a company to meet PRE. However, the need for advice and services from GAD in relation to wider aspects of the prudential regime, particularly in relation to issues of solvency, was also provided for.

Main principles

748 The respective roles of the parties were recorded with some care. The section of the agreement on ‘Main Principles’ stated that the primary role of the DTI as set out in its ‘mission statement’ was to:

... regulate the insurance industry effectively (within its duties and powers set out in the Act) so that policyholders can have confidence in the ability of the UK insurers to meet their liabilities and fulfil policyholders’ reasonable expectations.

749 One of GAD’s primary functions was to advise the DTI on the fulfilment of those aims. As in the first SLA, it was made clear that the DTI retained sole responsibility for all executive decisions. The distinction in the parties’ roles was given emphasis by a statement that GAD recognised that its function was advisory and that it had no responsibility for the exercise of the Secretary of State’s powers under the Act.

750 The SLA recorded the importance of a close working relationship between the DTI and GAD in which ‘both sides’ would keep each other fully informed, with the DTI copying all relevant correspondence⁵¹¹ with companies to GAD. GAD was to be notified of all changes of control of companies and changes of appointed actuaries.

751 GAD was to accompany the DTI on all visits to companies and was to attend all meetings between the DTI and companies unless ‘special circumstances’ arose. GAD was allowed to hold meetings with companies on actuarial issues at GAD, but was to notify the DTI of the meetings and offer the Division the opportunity to attend.

Detailed activities

752 The detailed activities required of GAD under the 1995 SLA were set out in three separate sections. Section A of the 1995 SLA concerned the examination or scrutiny of annual returns (described with slightly less precision than in the earlier agreement). Section B dealt with authorisation of new companies and section C with ‘other supervisory matters’.

753 The description of the detailed activities was prefaced with a statement that it did not provide an exhaustive description of the services to be provided by GAD to the DTI (in this context reference was made to the DTI rather than to its Insurance Division): ‘In particular, as section B and C⁵¹² make clear, GAD will stand ready to comment and advise where appropriate on all issues when asked to do so by the DTI⁵¹³.’

Section A – examination or scrutiny of annual returns

754 Section A refers to five levels of priority to be used in the scrutiny process (as opposed to the four levels described in the 1984 SLA), but the meaning of each priority level was not explained within the document. In practice, GAD supplemented the SLA by issuing internal criteria for setting the priority ratings as part of their internal guidance. This is dealt with in more detail in chapter 5 of Part 1 of the report.

755 The document proceeded on the basis that most company year ends were on 31 December, but if the year end of a company differed, ‘the same principles’ were to apply. A general timetable of events was then set out.

Scrutiny programme

756 By September of each year the parties were to agree a programme for the order in which returns were to be examined by GAD. If it was known that a visit to the company was to take place during the year, GAD was to make every effort to carry out the scrutiny and report to the DTI before the visit. The parties were to agree any topical issues affecting the life assurance industry in the forthcoming year which needed to be addressed in the scrutiny.

Initial action (prior to September)

757 The DTI was to be responsible for ensuring that GAD received copies of the statutory returns and the shareholders’ accounts and for chasing late returns (which were normally due to be deposited within six months of the close of the period to which they related – it was aimed to provide GAD with appropriate copies within four working days of receipt). The DTI was to inform GAD of the visits to be carried out in the next year and of any extensions of time given to companies for the submission of their returns.

758 The role of GAD during the initial process was to deal with the following matters and provide the DTI with a ‘clear overview of the scrutiny programme’ by mid September:

1. report to the DTI⁵¹⁴ immediately if the initial scrutiny of a company raised any serious concern, of which the following ‘main examples’ were given: 
   1. a company had failed to meet its solvency margin or was in financial difficulties;
   2. the company had failed to provide the necessary directors’, actuary’s and auditor’s certificates or any of the certificates had been significantly qualified;
   3. significant data errors or omissions existed;
   4. section 30 of the ICA 1982 (allocation of surplus to with-profit policyholders) appeared to have been breached;
   5. it appeared that a company was not complying with its ‘Notice of Requirements’⁵¹⁵ or an undertaking it had given to the DTI; and
   6. there appeared to be any other clear breaches of the Act or Regulations.
2. send a report to the DTI by the end of August covering all initial scrutinies, consisting of: 
   1. a priority rating for each company based on GAD’s view of its financial strength;
   2. an indication of the solvency cover for the company; and
   3. a target date for full scrutiny of the company’s return.

759 The DTI and GAD were to use their best endeavours to agree, by mid September, the scrutiny programme including both timetabling and allocation of priority ratings. GAD was not required to wait for the scrutiny programme to be agreed before starting detailed scrutiny of what it perceived to be the most urgent cases (which would generally be ‘priority 1’ cases).

The detailed scrutiny process

760 The required outcome of the detailed scrutiny process was to provide the DTI with a means, in the form of a report, of identifying companies which:

1. were not complying with statutory requirements;
2. were failing to meet the statutory requirements, or were in danger of doing so in the near future; and
3. appeared ‘not to be meeting policyholders’ reasonable expectations’.

761 The scrutiny report was required to contain a basis for action in relation to individual companies where any of the fundamental requirements listed above were not being met, or if trends in the returns pointed to problems arising in the near future. It was also to contain a basis for ‘informed longer term discussion’ with individual companies on problems which might arise in the future if ‘current trends in key performance indicators continue[d]’.

These key performance indicators were said to include:

1. cover for the solvency margin and trends in free asset ratios⁵¹⁶;
2. actuarial issues, for example a change in the strength of the valuation basis or issues about matching;
3. the volume and mix of new business being written;
4. trends in expense ratios;
5. trends in lapse rates;
6. assets: ‘worrying exposures’, investment strategy and impact on bonus strategy; and
7. significant developments during the year.

762 The scrutiny report was to follow a prescribed format, referred to as being set out in an annex to the SLA (unless a different format had been agreed between GAD and DTI in an individual case).

763 The broad aim was to provide detailed reports for all companies:

1.       
2. with priority ratings 1 to 3: by the end of March of the following year, with priority 1 and 2 cases being given priority within that period;
3. with priority 4 rating: by the end of May⁵¹⁷; and
4. with priority 5 rating: the cases would not be given full scrutiny in the year in question, but were to receive a fuller initial scrutiny.

764 It was envisaged that this programme, including the ratings and timetable, might need to be amended to allow ‘some fine tuning’ for example, due to the level of the stock market at the balance sheet date. The DTI and GAD were to agree revised target dates where it was necessary to make amendments to the programme.

Action arising from detailed scrutiny and monitoring of progress

765 GAD was required:

1. (normally) to be responsible for taking up points arising from the detailed scrutiny of the returns with the company or its actuary; however, GAD was always to consider whether it was more appropriate for the DTI to do so and to recommend accordingly;
2. to chase for responses from companies within six weeks and to respond to points arising from replies from companies within two weeks;
3. to make appropriate recommendations to the DTI if GAD considered that the Secretary of State might need to exercise his powers; it was stressed that GAD was not to initiate any such action or commit the DTI to any particular decision or course of action; and
4. to circulate a report to the DTI at the end of each month on the progress of the scrutiny programme.

Sections B and C – other areas in which services from GAD were required

766 Sections B and C of the 1995 SLA outlined additional areas in which GAD’s assistance or advice was or might be required.

767 Section B dealt with services and advice to be provided by GAD in relation to the authorisation of new life offices, explaining that the purpose of the authorisation procedure was to form a view on whether the company would remain solvent until its fourth year of operation and that it would be managed and controlled by fit and proper persons.

768 GAD’s main role was to evaluate the financial projections and to provide its opinion to the DTI as to whether the solvency requirements would be met. GAD’s services were to include commenting on successive drafts of the applications and attending meetings with the companies which intended to make, or had made, an application for authorisation.

769 Section C dealt with ‘other supervisory matters’, covering the need for advice on all areas with an impact on the solvency of a life office aside from the scrutiny of returns and the authorisation process, noting that it was ‘not possible in a document of this nature to anticipate all of the instances in [the] future where GAD’s advice will be sought’. All documents received from the life office were to be copied to GAD⁵¹⁸. The SLA stated that the DTI:

... will request advice from the GAD when there are issues which might affect, for example, the financial security of a life office, policyholders’ reasonable expectations, or where the issues raised are actuarial or professional. However, GAD are always free to comment on any document if it believes that there are issues that should be brought to I Division’s attention. These other areas of responsibility include: ...

770 The document went on to identify six particular areas and referred to required response times and similar ‘level of service’ requirements in relation to each. These specific areas included transfers of portfolios; requests by companies for concessions under section 68 of the ICA 1982⁵¹⁹; quarterly returns; company visits; and miscellaneous correspondence including requests for interpretation of legislation.

771 GAD was to provide such other services as might be agreed from time to time including ‘input to policy development as appropriate’ and representation at meetings, for example, of the F&IA or in relation to the EU.

Fees

772 The level of fees to be paid by the DTI to GAD was to be the subject of a separate agreement to be negotiated annually.

773 The 1995 SLA was superseded by the agreement between the Treasury and GAD in 1998 referred to below (paragraphs 909 et seq).

The Insurance Companies (Accounts and Statements) Regulations 1996 (and the Deregulation (Insurance Companies Act 1982) Order 1996)

Introduction

774 In December 1996⁵²⁰, the Insurance Companies (Accounts and Statements) Regulations 1996⁵²¹ (the ICAS Regulations 1996) revoked and replaced the ICAS Regulations 1983 and the various regulations which had amended them. They were made by the Secretary of State in the exercise of various powers conferred on him by the ICA 1982.

775 Notwithstanding the emphasis placed on PRE in various parts of the legislation and in the guidance issued to appointed actuaries by the F&IA, up until 1996 there was no requirement for insurance companies to provide any specific information in their statutory returns about the manner in which the company had taken PRE into account.

776 Such a requirement was included in the changes introduced by the ICAS Regulations. Those changes also included a requirement for the abstract of the appointed actuary’s valuation report to include a new statement in a prescribed form (Form 57) described as a ‘matching rectangle’⁵²², as further described in paragraphs 797 et seq.

777 This form was to be provided in relation to each fund or group of funds, showing how assets had been notionally allocated to corresponding long term liabilities (subject to specified exceptions), dealing with with-profit and nonprofit policies separately and with separate forms prepared for each interest rate used in the valuation.

778 General changes from the ICAS Regulations 1983 made by the ICAS Regulations 1996 included the following:

1. reorganisation and updating of the prescribed forms for the statutory returns to take account of then current commercial practice;
2. transfer of several of the long term business forms which had appeared in Schedule 3 to the ICAS Regulations 1983 to Schedule 4 to the ICAS Regulations 1996, making those forms the responsibility of the appointed actuary and no longer subject to audit;
3. a reduction of reporting in certain areas through the introduction of increased de minimis thresholds; and
4. the omission of a prescribed form for a quinquennial statement of long term business as required by section 18(3) of the ICA 1982 in anticipation of an order being made under the Deregulation and Contracting Out Act 1994 (the DCOA 1994), abolishing the requirement for such a statement.

The Deregulation (Insurance Companies Act 1982) Order 1996

779 Under section 1 of the DCOA 1994, Ministers of the Crown were given power to remove or reduce burdens on businesses and individuals (but without removing any necessary protection), by amending or repealing an enactment contained in an Act passed before or in the same session as the 1994 Act.

780 The Deregulation (Insurance Companies Act 1982) Order 1996⁵²³ was made by the Secretary of State under those powers, following consultation with representative organisations and others as required by section 3 of the DCOA 1994. The Order came into force concurrently with the ICAS Regulations 1996 on 23 December 1996 and provided for:

1. the repeal of section 18(3) of the ICA 1982 (which required companies to which Part II of that Act applied which carried on long term business to prepare a statement of that business every five years);
2. the repeal of section 42(1)(c) of the ICA 1982 (which empowered the Secretary of State to require a company to prepare a statement of its long term business);
3. the repeal of section 22(2) of the ICA 1982 (which required insurance companies to deposit with the Secretary of State details of persons who had acted as intermediaries (under section 74) and who were connected with the company); and
4. the amendment of sections 22(1), 42 and 82 of the ICA 1982 so that the insurance company could choose whether to deposit five printed copies of every account, balance sheet, abstract, statement and other document which comprised the annual returns and the abstract of any special actuarial investigation report (as originally required) or only one printed copy of each of the required documents, together with a copy of each document in a form approved by the Secretary of State.

Requirements for annual returns of long term insurance companies under the ICAS Regulations 1996

781 The general objectives of the ICAS Regulations 1996 were later described⁵²⁴ as being:

1. to demonstrate that the solvency margin requirements had been met and that the directors, appointed actuary and auditor had certified compliance with various requirements;
2. to provide the regulator with backing data with which to form its own assessment of the value given to the company’s assets and liabilities and the potential for fluctuations;
3. to standardise the treatment of reporting certain information to facilitate interpretation of the situation of individual companies and to enable comparisons to be made between companies;
4. to establish a body of data which could provide ‘screening tests’ or an early warning system for problem areas or problems within particular companies; and
5. to satisfy the concept of ‘freedom with publicity’.

782 The annual returns required under the ICAS Regulations 1996 were in six parts corresponding to the Schedules in the Regulations (two of which related to general business). Those relevant to long term business comprised:

Schedule 1: Balance sheet and profit and loss account (Forms 9 to 17);

Schedule 3: Long term business: revenue account and additional information (Forms 40 to 45);

Schedule 4: Abstract of the valuation report prepared by the appointed actuary (Forms 46 to 61);

Schedule 6: Certificates by the directors and appointed actuary and report of the auditors.

Basis of values and amounts stated

783 The value or amount given for any asset or liability shown in the documents required to be prepared under the ICAS Regulations 1996 was to be that determined in accordance with Parts VIII and IX of ICR 1994⁵²⁵ unless otherwise provided (Regulation 4). Every account, balance sheet, note, statement, report and certificate that a company was required to prepare under section 17(1)(3) of the IC Act 1982 (annual accounts and balance sheets) was to be prepared in the manner prescribed in the ICAS Regulations 1996 and to ‘fairly state the information provided on the basis required in these Regulations’ (Regulation 5 of the ICAS Regulations 1996).

Balance sheet, profit and loss account and revenue account

784 Regulations 6 and 7 required that the balance sheet and profit and loss account should comply with the requirements of Schedule 1 and identified the required prescribed forms for the various classes of business. The revenue account of a company carrying on long term business was required to be in Form 40 in Schedule 3, with additional information provided in Forms 41 to 45 in that Schedule (Regulations 8 and 17).

Abstract of actuary’s valuation report (including PRE information and matching rectangles)

785 The abstract of the actuary’s report of the annual actuarial investigation under section 18 of the ICA 1982 was to comply with the requirements of Schedule 4 and contain the information specified in that Schedule, together with such of Forms 46 to 49 and 51 to 58 as might be appropriate (Regulation 25). Schedule 4 and the forms prescribed in that Schedule required that extensive information be provided about an insurance company’s long term business.

786 Schedule 4 required that information be given on issues set out in 23 numbered paragraphs of the Schedule, with the answers numbered accordingly in the abstract.

787 In relation to each category of contract which comprised accumulating with-profits contracts, paragraph 4(1)(a) required that the abstract contain a full description of the benefits, including various specified factors, such as the circumstances in which, and the method by which, any charge might be deducted from the benefits on payment of a claim and a full description of any ‘material options’. Paragraphs 4(1)(b) and (c) required that details be provided of material options contained in other kinds of non-linked contracts.

788 Paragraph 6 related to the general principles and method adopted in the valuation, and required specific reference to matters which included:

1. the method by which account had been taken of derivative contracts in the determination of the long term liabilities;
2. the method by which due regard had been given to the reasonable expectations of policyholders as required by Regulation 64 of ICR 1994 and by which account had been taken in the custom and practice of the company in the manner and timing of the distribution of profits or the grant of discretionary additions over the duration of each policy, as required by Regulation 65(6) of ICR 1994;
3. where the net premium method had been used⁵²⁶, whether and to what extent it had been modified, the purposes for which any such modification had been made and whether any modifications on account of zillmerising conformed to Regulation 68 of ICR 1994;
4. whether any negative reserves had arisen and the steps taken to ensure that no contract of insurance was treated as an asset as required by Regulation 73 of ICR 1994;
5. whether any specific reserve had been made for future bonuses and if so at what rate or rates; and
6. the basis of the reserve made for any guarantees and options.

789 Paragraph 7 of Schedule 4 required information to be given on the rates of interest and tables of mortality and morbidity which had been assumed in the valuation for each category of contract. Subparagraph 7(6) required that a description be provided of the scenarios of future changes in the value of assets which had been tested in order to take account of the nature and terms of the assets held in determining the amount of the long term liabilities in accordance with Regulation 75 of ICR 1994.

790 Subparagraph 7(7) required information to be given on any reserves which had been made pursuant to Regulations 75(a) (ability of the company to meet its obligations under long term contracts as they arose) and 75(b) (adequacy of the assets to meet the liabilities determined in accordance with Regulations 6574 of ICR 1994). Subparagraph 7(8) required further information to be given in relation to the test for the purpose of 75(b) which produced the most onerous requirement (whether or not a reserve was required).

791 Paragraph 10 required information on the assumed levels of inflation of expenses and the bases used in the valuation to allow for such future inflation.

792 Where any rights of policyholders to participate in profits related to particular parts of the long term business fund, a revenue account in the format of Form 40 was required for each such part and information was to be given on the methods applied in apportioning the investment income, increase or decrease in the value of assets brought into account and expenses and taxation (unless the information was provided elsewhere).

793 Paragraph 14(1) required information to be provided about the principles on which the distribution of profits among policyholders and shareholders was based (as described in the constitution of the company, board resolutions, issued policies, advertisements, documents required to be issued by a regulatory body authorised under the FS Act 1986 and other relevant documents).

794 Paragraph 14(2) required a broad statement of the company’s aims in relation to the distribution of profits among policyholders, including the company’s aims in relation to:

1. policies which matured or were surrendered and claims arising on death;
2. the appropriate and equitable treatment of groups of participating policyholders;
3. smoothing⁵²⁷;

and the methods used to ensure that those aims were achieved. (Where different principles or bonus policies applied to different categories of with-profit policies issued by the company, the required information was to be given in respect of each category.)

795 Paragraphs 15 and 16 required information to be provided in respect of bonuses allocated to each category of contract and the practice of the company in relation to any bonus payments to be made in the period up to the next actuarial investigation, including the basis of calculation and the form in which the bonus was payable.

796 Paragraphs 1720 dealt with Forms 46 and 46A (summary of changes in long-term and industrial business); Forms 47 and 47A (analysis of business in force); Forms 48 and 49 (separate statements of assets covering long term liabilities (other than linked liabilities) in respect of each fund or group of funds for which separate assets were appropriated); and Forms 5154 (which required separate valuation summaries to be completed in respect of each fund (and category of contract) for which a surplus was to be determined, analysed in various ways).

797 Paragraph 21 required statements in the form set out in Form 57 (the ‘matching rectangle’) for each fund or group of funds for which separate assets were appropriated in respect of long term liabilities, except unit liabilities in respect of property linked benefits, investment liabilities in respect of index linked benefits and any reserve in respect of tax on unrealised capital gains. Form 57 was included in Schedule 4 with instructions for its completion.

798 The matching rectangle in Form 57 was required to show a notional allocation of assets to corresponding liabilities, with separate forms to be complete for with-profit and nonprofit contracts in each of the categories; (i) life assurance and annuity business; (ii) pension business; (iii) permanent health business and (iv) other business.

799 The matching rectangles were intended to enable the DTI to check the interest rates which were being used in the valuation and a separate form was to be used for each rate of interest used. The forms were to cover 90% of the remaining liabilities after excluding the specified items concerning linked policies and any tax reserve. In its originally prescribed format, the final line of the matching rectangle was required to show the values attributed to the assets in the ‘worst case’ resilience test referred to in paragraph 7(8) of Schedule 4 (see paragraph 808 regarding the changes made in 1997).

800 The prescribed format for the matching rectangle in Form 57 (and the instructions for its completion) were replaced for financial years ending on or after 31 December 1997 by the Insurance Companies (Accounts and Statements) (Amendment) Regulations 1997⁵²⁸ which made other amendments as noted in paragraphs 807 et seq. Appendix C contains copies of Form 57 as originally prescribed and as substituted in 1997.

801 Form 57 (both the 1996 and 1997 versions) was intended to demonstrate that:

1. the valuation rates of interest were supported by the investment returns earned on the assets notionally allocated to each group of contracts (on the basis that the value of such assets equalled the mathematical reserves, including any resilience reserve, for that group of contracts) and thus satisfied Regulation 69 of ICR 1994; and
2. in the most extreme resilience test scenario, the changed value of the notionally allocated assets (but possibly reallocated among different groups of contract) still covered the changed mathematical reserves (excluding any resilience reserves) calculated using valuation rates of interest that were supportable in that scenario and which complied with the relevant regulations.

Information on derivative contracts

802 Regulation 23 required additional information to be provided on derivative contracts in the form of a statement annexed to the balance sheet, profit and loss account and revenue account.

Signing of documents

803 All the documents relating to the business of the company were to be signed by at least two directors and by the chief executive⁵²⁹. The abstract of the appointed actuary’s report under section 18 of the ICA 1982 was to be signed, additionally, by the appointed actuary who had made the investigation on which the abstract was based (Regulation 27). It is understood that, in practice, these provisions have generally been interpreted as requiring that only the appointed actuary should sign the actuary’s report.

Certificates of directors and actuary and opinion of company auditor

804 As under the ICAS Regulations 1983, all insurance companies were required to annex to their accounts a certificate from the directors and an opinion of the company auditor; in the case of companies carrying on long term business, they were also to annex a certificate from the appointed actuary (Regulations 28 and 29). These documents were required to contain statements prescribed in Schedule 6 to the ICAS Regulations 1996.

805 Part I of Schedule 6 dealt with the directors’ certificate which was to be signed by the same directors as those who had signed the account documents⁵³⁰ and include statements about specified matters⁵³¹. If any of the required statements could not truthfully be made by the directors they were to be omitted. Part II of the Schedule dealt with the certificate to be given by the appointed actuary⁵³², to which the actuary was to add any qualification, amplification or explanation as he or she considered necessary. Part III dealt with the auditors’ report, which was to state his or her opinion on specified matters⁵³³ (which did not include the prescribed forms which comprised the abstract of the actuary’s valuation report under Schedule 4) and which was to be qualified, amplified or explained if the information or explanations the auditor had received did not allow the auditor to express one of the required opinions. If the auditor referred in the report to any uncertainty, he or she was to state whether that uncertainty was material to determining whether the company had available assets in excess of the required minimum margin.

Qualifications of appointed actuary and company auditor

806 The requirements concerning the qualifications of the appointed actuary, the information to be supplied about the appointed actuary and the qualifications of the auditor were substantively unchanged from those in the ICAS Regulations 1983 as amended (Regulations 30, 31 and 32).

Amendment and lapse of the ICAS Regulations 1996

807 The ICAS Regulations 1996 were amended by the Insurance Companies (Accounts and Statements) (Amendment) Regulations 1997⁵³⁴, which applied to documents submitted to the Secretary of State in respect of any financial year ending on or after 31 December 1997.

808 The 1997 Regulations made a number of detailed amendments which affected the disclosure requirements for both the accounts documents and the abstract of the actuary’s valuation report and slightly reduced the scope of the audit report. New prescribed forms were introduced and a number were replaced including Form 57, the ‘matching rectangle’, notionally attributing assets to liabilities, as it was widely felt that the originally prescribed form had proved unsatisfactory.

809 For financial years ending on or after 31 December 1997 the layout of Form 57 was revised, although similar information was required to be shown. In the revised form, the last four columns were intended to demonstrate, under the ‘worst case’ scenario, how asset values changed and were reallocated between groups of contract and how the associated supportable valuation rates of interest altered.

810 The last line of the form disclosed the mathematical reserves for the contracts before and after the scenario change, with the difference being the release of the resilience reserve and the effect of changing the valuation rate of interest used in the resilience scenario⁵³⁵ .

811 Separate forms continued to be required for each rate of interest used in the valuation (and as before, one form could include all contracts valued at the same rate provided they came within specified categories, such as the ‘sterling liabilities of life assurance and annuity business’).

812 The ICAS Regulations 1996 were further amended by the Insurance Companies (Amendment) Regulations 2000⁵³⁶ as referred to below. They lapsed on 1 December 2001 with the repeal of the ICA 1982 by the Financial Services and Markets Act 2000 (Consequential Amendments and Repeals) Order 2001⁵³⁷ .

Guidance for Appointed Actuaries: GN1, GN2 (dynamic solvency testing) and GN8 in 1996 and GN7 (the reporting actuary) in 1997

GN1

813 An updated version of GN1 was issued in September 1996 (5.0)⁵³⁸. The main changes related to the three areas of guidance outlined in the following paragraphs (which entailed still further references to PRE).

814 The extent of the appointed actuary’s responsibility (section 3 of GN1): earlier versions of the guidance had stated that the two aspects of an appointed actuary’s appointment, namely his or her appointment and remuneration by the company and his or her duties to the DTI, would ‘seldom ... conflict in a material way’. Version 5.0 acknowledged that ‘[these] responsibilities may be in conflict from time to time but it would be seldom that any such conflict could not be resolved by discussions internal to the company’.

815 Paragraph 3.2 of GN1 was expanded and slightly revised. This paragraph dealt with the actuary’s responsibilities in circumstances where there was a material risk that the long term fund would be insufficient to cover the company’s liabilities or that the company would fail to meet obligations under the ICA 1982 in relation to long-term business.

816 According to the covering letter issued with the revised guidance, the aim of the amendments was to clarify the circumstances and sequence of events to be followed before the appointed actuary informed the DTI. The revised paragraph set out three possible reasons for such a risk arising:

1. because of a particular course of action being, or proposed to be, followed by the company;
2. because of a failure by the company to take appropriate action in response to a change in circumstances; or
3. because a particular situation had arisen, perhaps outside the control of the company.

Earlier guidance was then repeated, that in such circumstances the appointed actuary should inform the company accordingly; if the company failed to take action to remedy the position and did not advise the DTI of the situation, then the appointed actuary was under a duty to do so after so informing the company (notwithstanding the contents of the F&IA’s Memorandum on Professional Conduct)⁵³⁹ .

817 A new paragraph 3.4 was added in relation to the statutory requirements for insurance companies to fulfil the criteria of sound and prudent management⁵⁴⁰. It was stated that these criteria included the need for insurance business to be conducted with due regard to the interests of policyholders and potential policyholders and that in formulating his or her advice to the company, the appointed actuary was required to take account of those interests.

818 Premium rates and conditions (section 5): two new paragraphs were added. The first (paragraph 5.7) related to contracts which specified that particular terms were to be determined by the appointed actuary or by the company on the advice of the appointed actuary. In determining such terms or when advising the company, the appointed actuary was required to have regard to policyholders’ reasonable expectations and to ‘existing legislation’ including, where relevant, that covering unfair contract terms.

819 The second addition to section 5 was a new paragraph concerning unit linked business (paragraph 5.8), which noted that unit pricing, fund charges and deductions in respect of taxation were all key elements of policyholders’ reasonable expectations; all discretionary elements affecting these matters should be applied consistently with policyholders’ reasonable expectations and equitably to any policyholders who were directly or indirectly affected.

820 Internal matters (section 9): paragraph 9.3 of the guidance was expanded. This paragraph concerned the relationship between a director who was an actuary (which I refer to as a ‘directoractuary’) and the company’s appointed actuary.

821 The additional guidance made clear that the presence of a directoractuary on the board of the company did not lessen the responsibilities of the appointed actuary in any way or make it any less necessary for the appointed actuary to have direct access to the board.

822 The guidance envisaged that directoractuaries might give actuarial advice to the board formally or informally. However, if a directoractuary did so in a way which could encroach on the role of the appointed actuary, the directoractuary was required to ensure that the appointed actuary was informed of that advice and given the opportunity to present properly reasoned comments to the board.

823 A further version of GN1 was issued on 1 December 1998 (version 5.1). A few minor deletions were made, the most significant of which was the deletion of the advice to appointed actuaries to seek help and advice through the Secretary of the Professional Affairs Board if doubtful about the proper course to follow when facing a potentially significant problem. References to the DTI and to the Secretary of State were replaced with references to the ‘Supervisory Authority’.

824 GN1 now stated that policyholders’ reasonable expectations were ‘clearly influenced by policy literature and other publicly available information such as own charge illustrations’. Version 5.1 of GN1 was replaced by version 6.0 on 1 December 2001.

GN2 – Dynamic Solvency Testing and Financial Condition Reports

825 In March 1996 a new series of Guidance Notes for appointed actuaries was issued, ‘GN2: Financial Condition Reports’, the first version of which came into effect on 25 March 1996.

826 The status of this guidance was ‘recommended’ rather than mandatory⁵⁴¹. The aim of GN2 was to suggest a possible format for a Financial Condition Report and to outline how ‘Dynamic Solvency Testing’ (DST) would ‘normally be used’ to derive the background information underlying such a report.

827 DST was described in GN2 as the ‘principal technique’ which enabled appointed actuaries to assess the ability of an office to withstand changes in the external economic environment and in the particular experience of the office. 

828 DST involves projecting the company’s revenue account and balance sheet forward and then changing each of the important assumptions in turn, to establish the company’s sensitivity to changes in a particular assumption or in a combination of assumptions in the future, having allowed for plausible action by management⁵⁴². DST is intended to provide a means by which the management of an insurance company can plan for various scenarios which might emerge in the future.

829 The production of GN2 followed on from the work of a further joint actuarial working party of the F&IA on DST which had reported in November 1993 at the Blackpool Life Insurance Convention⁵⁴³ . The work undertaken by the Working Party was discussed at a Current Issues in Life Assurance seminar in April 1994⁵⁴⁴, at which there appears to have been debate about whether the production of a financial condition report should be mandatory and whether the report should automatically be made available to the supervisory authorities (and, if so, whether it would be possible to maintain its confidentiality). Nonetheless, some of those present saw DST as ‘fundamental to the role of the life office actuary’. There was discussion about whether deterministic⁵⁴⁵ or stochastic modelling⁵⁴⁶ should be used and a request was made for detailed guidance on the form that a financial condition report should take⁵⁴⁷ .

830 Correspondence between the DTI and GAD in June and July 1994⁵⁴⁸ in relation to the findings of the Working Party on DST suggests that there was considerable interest in DST. GAD suggested that information of the kind contained in a financial condition report would be of ‘enormous value to the regulator’.

831 However, it was considered that the value of such a report would be diminished if it were to become a statutory requirement to deposit the report with the regulator, as companies would be concerned that the regulator might react prematurely to the information contained in it and would therefore produce a ‘sanitised version’ of what was originally intended to be a ‘management tool’. GAD noted that:

DST is essentially a management tool rather than a method of assessing liabilities and therefore seems to have little direct relevance to the solvency margin review. ... DST is more useful as part of a package of requirements for judging the adequacy of a company’s capital and reserves to meet its solvency requirements in the future over different scenarios i.e. a form of mediumterm resilience test.

832 GN2 recommended that the financial condition report should be addressed to the board of the company or the appropriate group with responsibility for policy formation for the company concerned (paragraph 1.3). It was stressed that the report should be ‘expressed in a form which is accessible to its readers’ and that important information should not be concealed inadvertently, for example through undue length or complexity (paragraph 1.4).

833 GN2 recommended that the appointed actuary should address the actions open to the company to deal with particular circumstances and make recommendations where appropriate. GN2 envisaged the use of both deterministic and stochastic techniques to appraise the various risks or whatever techniques the actuary considered appropriate to the company’s business (paragraph 1.7).

834 Section 2 of the guidance provided an outline of the main points which were normally to be addressed in a Financial Condition Report, among which were the methods and assumptions which had been used and any changes in those methods and assumptions since the last similar report.

835 Section 3 provided guidance on DST and included examples of the areas in which testing of variations in assumptions should be undertaken, noting that there ‘would need to be specific reasons for not testing variations in the [...] assumptions’ about future investment conditions, levels of new business, expenses and persistency (paragraph 3.4.1).

836 Among the list of assumptions suggested as being of ‘considerable importance in some companies but not in others’ was the assumption about the exercise of options by policyholders (paragraph 3.4.2). A further list of factors (in paragraph 3.4.3) which the appointed actuary needed to be alert to as potentially affecting the company included such matters as:

(v) impending major claims or litigation that might affect the company;

(vii) unusual contracts or relationships which may have financial implications;

(viii) risks created by deficient product literature or policy documentation; and

(x) the effect in different scenarios of options and guarantees in the insurance liabilities.

For each scenario tested, provision was to be made for all elements of the statutory liability including an appropriate level of resilience reserve (paragraph 3.4.4).

837 The conclusion of GN2 stated that:

The very least that it is reasonable for a Board to expect of the advice from the Appointed Actuary is that the company does not unknowingly run foreseeable risks which could jeopardise its financial wellbeing.

838 The first version of GN2 on Financial Condition Reports remained in effect up to 30 December 2002 when it was replaced with version 1.1.

839 A paper produced for the F&IA in 2000⁵⁴⁹ suggested that GN2 had become best practice, with most appointed actuaries by then producing a report on the impact of different ‘likely potential scenarios’ on the financial condition of the company.

840 One of the recommendations made in the Corley Report⁵⁵⁰ was that the provision of an annual Financial Condition Report should be made mandatory through GN1, although GN2 should remain as recommended practice⁵⁵¹ .

GN8

841 GN8 was updated in September 1996 (version 5.0). Additional guidance was given on Regulation 70 of ICR 1994, which required the use of prudent rates of mortality and disability when determining the amount of the company’s long term liabilities.

842 The additional guidance referred to the need to take account of future improvements in mortality⁵⁵² where this would increase the required reserve. For assurance and sickness business, allowance was to be made for the incidence of mortality and morbidity arising from known diseases where the impact might not have been reflected fully in the mortality or morbidity experience current at that time (paragraph 3.4).

843 The guidance on Regulation 71 of ICR 1994, concerning the need to make prudent assumptions for expenses when calculating liabilities, was also expanded following discussions between the F&IA and the DTI and GAD. The additional subparagraphs

(3.5.4.1 and 3.5.4.2) explained the circumstances in which explicit provision would and would not be necessary in relation to the costs of new business and how the additional provision should be calculated where it was required.

844 Revised and additional guidance was given on Regulation 75 of ICR 1994, which required the actuary to take into account the nature and term of the assets in determining the amount of the long term liabilities.

845 The new guidance explained that Regulation 75(a) required the appointed actuary to consider mismatching provisions from the point of view of cash flows, whilst Regulation 75(b) required a test of the resilience of the overall reserves to satisfy Regulations 65 to 74 in changed investment conditions. The overall provision to be established was to be equal to the greater of these two amounts. Additional guidance was then given on how the two calculations, under paragraphs (a) and (b) of Regulation 75, were to be undertaken (paragraphs 3.6.1, 3.6.3 and 3.6.4).

846 Version 5.0 of GN8 was superseded in March 2001 by version 6.0 which is mentioned below.

Guidance in GN7 and the reporting actuary

847 The F&IA issued guidance concerning the Companies Act accounts of insurance companies and the role of actuaries and their relationship with auditors in Guidance Note 7 (GN7). The version of that guidance issued in 1997 (version 3.0) took account of the new Schedule 9A inserted in the Companies Act 1985 by the CAICA Regulations 1993⁵⁵³. The classification of the guidance in GN7 was ‘recommended practice’ rather than ‘mandatory’, or a ‘practice standard’, as in the case of GN1 and GN8.

848 The guidance noted that the technical provisions for long term insurance under Schedule 9A came within the scope of audit, unlike those in the regulatory returns where the auditor, in giving his or her opinion, was permitted to rely on the certificate issued by the appointed actuary⁵⁵⁴.

849 The stated aim of GN7 was to explain the professional duties of the various parties in relation to the financial statements under Schedule 9A. GN7 also referred to the relationship between the appointed actuary and the company’s auditors in respect of the preparation of the statutory returns under the ICA 1982.

850 GN7 referred to the actuary who made the computation of the long term business provision⁵⁵⁵ for the purpose of the Companies Act accounts as the ‘reporting actuary’.

851 The guidance included the following points in relation to the role of the reporting actuary (and the auditor):

1. the directors of an insurance company remained legally responsible for all statements made in the financial statements required under the Companies Act, although they were entitled to rely on the professional expertise of the reporting actuary to calculate the amounts which were required to be calculated by an actuary under Schedule 9A;
2. the making of computations under Schedule 9A required the exercise of professional judgment by the reporting actuary;
3. it was perfectly proper for the directors to give instructions to the reporting actuary regarding the broad approach to the calculation of the long term business provision, but the reporting actuary should be aware that readers of the financial statements would be placing reliance on the figure shown (and the actuary was reminded of his or her professional duties to third parties);
4. ‘in many instances’, the reporting actuary and the appointed actuary would be the same person (but this need not be the case);
5. the reporting actuary would need to be familiar with accounting principles and current audit practice since the computations were made under the framework of the Companies Act where a different methodology to that appropriate for the solvency test might be applicable;
6. the reporting actuary should ensure that the auditor was aware of the approach he or she proposed to adopt to the accounting principles in SSAP 2⁵⁵⁶ as there was particular uncertainty as to their application;
7. the reporting actuary could choose to base the calculation of the long term business provision on the equivalent mathematical reserves calculation made by the appointed actuary (but the reporting actuary would retain full responsibility for the calculation). Reference was then made to the need to modify⁵⁵⁷ the amounts calculated by the appointed actuary to comply with the Modified Statutory Guidance Note⁵⁵⁸;
8. the reporting actuary might reach different professional judgments to those of the appointed actuary, but should defer to the appointed actuary on matters regarding PRE;
9. where the reporting actuary relied on ‘other areas within the company’ to produce information on which to base his or her calculations, although that information would be subject to audit, it would be inappropriate for the reporting actuary to place too much reliance on the auditor for its accuracy and completeness as the auditor may have carried out work at a ‘different level of materiality’ to that required by the reporting actuary; (further, the auditor might well consider it inappropriate to extend the scope of the audit work to give comfort to the actuary, since the auditor might be required to express an independent view on the work of the reporting actuary);
10. although the statutory role of the reporting actuary was limited to the long term business provision, actuarial advice might be needed to calculate other elements of the balance sheet and profit and loss account;
11. an important part of the reporting actuary’s work was the preparation of a report to the directors on the approach to the computation of the long term business amount and the material assumptions used; the actuary’s report should not only address the amounts computed, but it should also make recommendations about disclosures;
12. actuaries involved in the preparation of published financial statements should be familiar with Audit Guideline 311⁵⁵⁹;
13. in order to form an opinion as required by the legislation, the auditor must assess, understand and where appropriate challenge the assumptions underlying the work of the reporting actuary; an actuary advising an auditor in supporting a reasonable challenge to the work of the reporting actuary would not be in breach of the Memorandum on Professional Conduct⁵⁶⁰.

852 In relation to the role of the appointed actuary (and the auditor) the guidance:

1. required the appointed actuary to be prepared to advise the directors on the evidence of compliance (or lack of compliance) with the Prudential Guidance Notes⁵⁶¹;
2. noted that there were certain areas in which the work of the appointed actuary and that of the auditor overlapped, most particularly in checking the accuracy of policy data and the valuation of assets; the guidance advised that it was inappropriate for the appointed actuary to place too much reliance on the work of the auditor unless the work had been undertaken in accordance with ‘a specifically scoped assignment’ outlined in a formal letter of engagement;
3. advised that the auditor might wish to discuss with the appointed actuary any financial condition report which the appointed actuary had prepared, in order to understand the appointed actuary’s view of the future development of the company’s finances and the risks to which the long term fund was exposed, but this did not imply that the financial condition report was subject to audit.

853 The version of GN7 referred to above was not revised until December 2004.

Working party on annuity guarantees and guidance on annuity guarantees, reserves and terminal bonus calculations 1997-1999

854 With falling rates of interest during the early part of the 1990s, the advantage to policyholders of taking benefits in guaranteed annuity form as opposed at the current annuity rate was apparent⁵⁶² .

855 However, it was not until the late 1990s that there were public signs that consideration was being given to the impact of annuity guarantees and the reserves which companies made for them, although GAR options had commonly been available in some form in connection with with-profit policies since at least the 1950s.

856 The following outlines some of the events and key correspondence regarding the issues surrounding GARs, the reserves made for them and the issue of differential bonus calculations.

The Annuity Guarantees Working Party report

857 In January 1997, the Life Board of the F&IA set up a working party to consider the issues surrounding GARs. The terms of reference of the Annuity Guarantees Working Party (AGWP) stated that:

Currently there is no accepted practice for reserving for these guarantees and there is no published research to guide Appointed Actuaries in setting reserves. The DTI have not published any guidance or regulations specific to annuity guarantees.

858 The AGWP was to:

1. determine the different kinds of GAR which had been issued and obtain an indication of the volume of business;
2. determine the current practice regarding reserving for guarantees;
3. research the cost of such guarantees under different scenarios of investment return and mortality;
4. consider PRE issues;
5. consider and recommend appropriate reserving bases for annuity guarantees, taking account of DTI general guidance and regulations; and
6. prepare a report summarising its conclusions.

859 The AGWP completed its report in November 1997. The introduction to the report noted that, collectively, insurance companies had over ú35 billion of liabilities to which GARs applied. It stated that, with relatively low interest rates and improving mortality, the guarantees were potentially very valuable, yet there had not been ‘any attempt to consider appropriate reserving standards in the light of the Insurance Company Regulations’.

860 The AGWP:

1. conducted a survey of life companies carrying on pensions business in order to ascertain the extent of the guarantees currently in force and the practices of companies in reserving for them;
2. analysed the implications of the guarantees in terms of the statutory requirements for reserving; and
3. considered two alternative approaches to measuring the value of the guarantees, using stochastic investment models or a market based approach using financial instruments to ‘hedge’ the guarantees.

861 Questionnaires had been issued to 85 insurance companies. Of the 66 companies which had responded, 41 had issued GARs. It was estimated that the 66 respondents represented at least 90% of the total market liabilities. Key findings from the survey included the following:

1. almost all the companies had ceased offering GARs on new policies, but in the majority of cases the guarantee continued to apply to the premiums being paid on existing policies which contained GARs;
2. 51% of the companies held no reserves for guarantees⁵⁶³, the remainder calculated the liability on the basis of the greater of the value of the cash option and the value of the guaranteed annuity on the valuation basis;
3. few companies made explicit allowance for the effect of future premiums to which the GAR applied;
4. a number of companies said that no allowance for the effect of GARs was made in the resilience test for the resilience reserve;
5. the majority of companies took no account of GARs in setting investment guidelines; and
6. the majority of companies made no allowance for GARs when establishing maturity values; a small number had made adjustments to asset shares or had made specific adjustments to terminal bonus rates⁵⁶⁴ .

862 The AGWP report noted in passing that the whole question of reserving for with-profits business (leaving aside the effect of GARs) was not a precise science and that alternatives to the net premium valuation method had been considered by other working parties, which raised issues which went ‘far beyond’ the scope of the AGWP paper⁵⁶⁵.

863 In relation to the action which should be taken in respect of reserving for GARs under with-profits contracts, the AGWP made no recommendations, but offered three ‘possible approaches for consideration’, none of which it considered to be entirely satisfactory. These comprised:

1. allowing for guarantees in the same way as unitlinked business, by setting aside additional reserves related to prudent estimates of the cost over and above existing, unadjusted, with-profit reserves;
2. recognising the cost of GARs as effectively increasing the guaranteed sum assured on some prudent basis and then recalculating the net premium reserves on this basis; or
3. the third option was: ‘reviewing whether and to what extent the guarantee will be covered by terminal bonus adjustments. Providing that terminal bonus adjustments will be used and are sufficient to cover guarantees in all circumstances, there is an argument for not reserving for such guarantees – no explicit provision is made for terminal bonuses and hence the provision for guarantees is simply part of this implicit provision subject to the existence of appropriate terminal bonus margins.’

864 The AGWP considered that the first option was the most prudent, recognising however that the adverse impact on published survey ratios for an office adopting this approach in isolation⁵⁶⁶ might make it unattractive.

865 The second approach was said to be somewhat arbitrary in its effect on the overall strength of the valuation basis, whilst the third approach could be viewed as unsound as it made no explicit provision for an explicit guarantee⁵⁶⁷ .

866 The AGWP survey had requested comments on PRE issues, but relatively few had been made. The AGWP noted that if maturity payments were in some way linked to asset shares (as appeared to be almost universal practice), an office’s approach to spreading the costs across generations of policyholders and across policy types was likely to be of most significance. (The survey had revealed that most offices had made no allowance for the cost of guarantees either through adjusting asset shares or terminal bonuses.) Some respondents had made the point that allowing for the cost of guarantees in ‘payouts’, particularly through adjustments to terminal bonus only as and when guarantees bite, would be contrary to the spirit of the guarantees and hence contrary to PRE.

867 The report noted that other offices practised or intended to consider exactly such an approach: appendix 2 to the AGWP report indicated that four of the 29 companies that responded said that they would consider adjusting terminal bonus rates to compensate for a guarantee which was biting.

868 The report recommended that life offices needed to consider some (apparently fundamental) issues in relation to GARs such as their likely cost and sensitivity to changes in future conditions and how the costs of meeting them should be provided for, whether by adjustments to asset shares, adjustments to terminal bonus or implicitly against the company’s estate⁵⁶⁸.

869 The report of the AGWP discussed the use of stochastic methods to assess the costs of guarantees, using variable interest rates. As an alternative, it was suggested that financial instruments such as ‘options to swap’, or ‘swaptions’, might be used to protect the fund against the impact of guarantees, by eliminating or setting an upper limit on the interest rate risk.

870 It was suggested that a ‘promising approach’ might be to purchase an option to swap floating rate interest payments for a fixed rate payment at a specified date for a specified period. It was said that there was a very large liquid market for trading such swaptions, particularly at the shorter dates, and illustrative prices were given.

871 The conclusions of the report stated that there was ‘limited evidence’ that insurance companies had started to address issues such as the opportunity to take account of guarantees in setting bonus rates and the impact this might have on PRE.

872 It was noted that many companies had not worked out their approach to reserving for guarantees and with low interest rates and improving mortality, they would need to do so in the near future. The AGWP had felt unable to recommend an approach to reserving as ‘the variation between products and the approaches of different companies to managing guarantees [were] so great’.

GAD questionnaire on annuity guarantees – June 1998

873 The AGWP report is dated November 1997. On 20 June 1998, GAD wrote to appointed actuaries with its own questionnaire, having expressed the view to the Treasury (to which prudential regulation functions had by then been transferred⁵⁶⁹) that the regulatory returns did not provide sufficient information about companies’ exposure to GARs.

Treasury letter on guaranteed annuity option costs and PRE (and terminal bonus) – 18 December 1998

874 Following on from the survey conducted by GAD, on 18 December 1998⁵⁷⁰ the Insurance Directorate at the Treasury wrote to all managing directors of insurance companies authorised to carry on long term business, noting that the results of that survey had indicated that exposure to guaranteed annuity options (GAOs) was relatively widespread in the industry and had the potential to have a significant financial impact on a number of companies.

875 The stated purpose of the letter was to give some guidance to companies on the Treasury’s interpretation of PRE in the context of GAOs⁵⁷¹ . The letter was said to contain the Treasury’s considered view, but to be ‘without prejudice to any decision of the courts which might affect it’.

876 According to the letter, as a starting point, the Treasury took the view that:

‘policyholders entitled to some form of annuity guarantee or option on guaranteed annuity terms could reasonably be expected to pay some premium, or charge, towards their option or guarantee.’

877 Having made clear the Treasury’s view that in relation to linked contracts any costs of meeting a guarantee which could not be covered by accumulated charges made to the policyholder would fall to be met by the insurer, the letter went on to suggest that in the case of participating⁵⁷² policies:

... any charge could be deemed to be met out of each premium received (or the investment return to be credited by way of bonus), and hence would impact on the assessment of bonuses, including in particular any terminal bonus that would normally be payable to the policyholders. Generally we consider that it would be appropriate for the level of the charge deemed to be payable by participating policyholders for their guarantee (or annuityoption) to reflect the perceived value of that guarantee (or option) over the duration of the contract. This could be achieved in some cases through some reduction in the terminal bonus that would be payable if there were no such guarantee (or option) attached to the policy. However the selected treatment by each office would need to depend on the wording of the contract involved and how it had been presented to policyholders.

Under the majority of participating policies which have been written it appears that any guarantee or annuity option is applicable to at least the guaranteed initial benefit under the policy and any attaching declared bonuses. As a consequence of this, we would expect that for most companies the present guaranteed cash benefits (including declared bonuses) would be converted, as a contractual minimum, to the annuity on the guaranteed terms. However as indicated above, it would appear possible, depending on the particular circumstances relating to the contract, that any terminal bonus added at maturity may be somewhat lower than for contracts without such options or guarantees, and that this terminal bonus could in some cases be applied at current annuity rates.

878 The letter went on to deal with the apportionment  of any ‘residual cost’ which fell to be met by the insurer in respect of GAOs (for both participating and non-participating contracts), specifying that they should be met from the long term fund and any shareholder funds.

879 Where the long term fund was to be used, in the first instance the cost would be met out of any estate; thereafter the insurer might wish to consider adjusting future bonus allocations for some or all participating policyholders (or making a transfer to the long term fund from any shareholders’ fund).

880 The letter then highlighted that the appropriateness of any such adjustments to bonus allocations for participating policyholders would need to be assessed by each office in the context of the reasonable expectations of all⁵⁷³ their policyholders, and that this assessment would be influenced by such matters as policy documents and representations made through marketing literature, bonus statements or elsewhere.

881 The letter appeared to suggest that ex post facto  charges might be made to GAR policyholders who exercised their options⁵⁷⁴. The guidance in the letter was suspended by the FSA⁵⁷⁵ on 27 July 2000, seven days after judgment was given by the House of Lords in Equitable Life Assurance Society v Hyman⁵⁷⁶.

Dear Appointed Actuary letter from the Government Actuary: DAA11, January 1999

882 On 11 January 1999⁵⁷⁷, the Government Actuary wrote to appointed actuaries, following up on the letter from the Treasury to managing directors of 18 December 1998, on the specific issue of reserving for GAOs (DAA11).

883 The letter stated that the Government Actuary considered that Regulation 64 of ICR 1994 required life offices to calculate their liabilities, and hence to reserve, on the basis of all the benefits offered under the contract and that long term liabilities should be determined on ‘actuarial principles’ and ‘make proper provision for all liabilities on prudent assumptions’. In addition to reserving for all guaranteed annuity benefits companies should, in his view, have been reserving fully in respect of any facility for policyholders to select an alternative form of benefits:

In general it would not in my view be prudent to assume that policyholders will choose a benefit form that is of significantly lower nominal value to them...

He then went on to suggest that some limited allowance ‘of a few percentage points of the reserve’ could be made in some cases for the possibility that some policyholders might prefer to take their benefit in some other form. This statement was clarified in a subsequent DAA letter of 22 December 1999 (DAA13, mentioned below). This clarification explained that the Government Actuary had been referring to a few percentage points of the reserve for the contract and not to a reserve for the guaranteed annuity rate.

884 Paragraph 7 of the Government Actuary’s letter stated:

Where the levels of terminal bonus are to be adjusted with the aim of bringing the value of the guaranteed annuity option closer to the value of the alternative benefits, there might at first sight appear to be some room for argument that it was not necessary to reserve on the assumption that almost all policyholders will take the guaranteed annuity benefit. However, it needs to be remembered that, although the benefits formally ‘guaranteed’ under the alternative form of benefit may be lower than those under the guaranteed annuity option, the company’s discretion in setting the value of the terminal bonus applied to the alternative form is limited as a result of the guaranteed annuity. It is likely that close to 100% of policyholders will exercise the annuity guarantee unless the company maintains terminal bonus at a level which ensures that the value to the policyholder of the alternative benefit is at least equal to the value of the guaranteed annuity. Accordingly, this constraint will need to be reflected in the valuation assumptions made about either the proportion of policyholders opting for the alternative benefit or the value of that alternative benefit. Consequently any reduction in the reserves held by the insurer by more than a few percentage points below the full value of the guaranteed annuity for this reason would require very careful justification by the actuary.

885 The paragraph quoted above appears to envisage that it might be permissible to make some form of adjustment to ensure parity been the two alternatives, consistent with the Treasury’s letter dated 18 December 1998 (see paragraphs 874 et seq), albeit that the subject of the Government Actuary’s advice was the valuation assumptions that should be adopted.

886 The letter went on to record that the Government Actuary did not consider it prudent to use past experience alone, of a 25% take up of benefits in the form of a tax free cash lump sum, as a basis for reducing the percentage of benefits assumed to be taken in guaranteed annuity form. It was likely that policyholders and their advisers would see the annuity guarantees as valuable and something to be used in full.

887 The Government Actuary went on to advise that companies should assess the extent to which a resilience reserve was required to cover their annuity guarantees. The need to hold substantial mathematical reserves to cover guaranteed annuity options was not a sound argument for reducing the stringency of the resilience test applied.

888 The Government Actuary drew attention to the requirements of paragraphs 4(1) and 5(1) of Schedule 4 to the ICAS Regulations 1996 which required that the abstract of the actuary’s valuation report include a description⁵⁷⁸ of the benefits under the contracts, including any ‘material options’ and indicated that he would expect such a description to provide an indication of the form of any annuity guarantee offered. In addition, he advised that actuaries should provide a description of the way in which reserves for any annuity guarantees and options had been determined (including an indication of the interest rate and mortality assumptions used), in order to comply with paragraph 6(1)(h) of Schedule 4.

889 The Government Actuary made clear that annual returns should include sufficient information to enable the FSA and GAD to make an assessment of the extent of the guarantees offered, the reserving basis adopted by the company and hence the scope for the annuity guarantees to have an impact on the financial position of the company.

890 The Government Actuary concluded the letter with a statement (as contained in the letter from the Treasury of 18 December 1998) that it contained his considered view and was ‘without prejudice to any decision of the courts which may affect it’.

F&IA position statement on annuity guarantees

891 In March 1999, in the light of considerable press comment about annuity guarantees, the F&IA issued a ‘position statement’ for use within the F&IA, to enable its Officers, Council members and senior members of staff to answer questions from members of the actuarial profession, members of the public and the press. The document stated that it did not contain formal guidance and nor should it be taken as a full expression of the profession’s views on the subject.

892 The statement expressed the ‘full support’ of the profession for the position set out in the letter from the Treasury of 18 December 1998 and the clarification and guidance given by the Government Actuary in his letter of 13 January 1999 (see footnote 577).

893 The statement noted that it had been suggested in the press that insurance companies had not reserved fully for annuity guarantees, and that the profession was ‘unaware of any specific examples of this’ but would be concerned to ensure that any such cases were as a result of reasonable professional differences of opinion. If not, they would be subject to the profession’s disciplinary procedures.

894 In relation to the question of whether companies had reserved adequately for the guarantees, it was stated that the appointed actuary of each insurer had a duty to ensure that sufficient reserves were held to meet that insurer’s obligations under its own approach; in doing so, the appointed actuary should have regard to the Government Actuary’s letter of January 1999, as well as the requirements of the Regulations and the profession’s guidance in GN1 and GN8.

895 The position statement offered alternative ways of dealing with GAOs. For an insurer with no constraints caused by policy conditions, marketing literature or other representations, the first alternative was to:

... ensure that the value of the cash benefits and the value of the pension benefits remain the same, by working out the amount of the guaranteed annuity but then reexpressing the cash option on the basis of the current annuity rates.

This was identified as producing no cost to the office unless terminal bonus rates fell to zero.

896 The next alternative was to allow the value of the guaranteed annuity and the cash option to move apart, leading to a significant cost to the office. The third option was an intermediate position between the two extremes, for example, by applying the guaranteed annuity rate to only a part of the benefits.

897 The paper urged insurers to explain their position so that each policyholder, particularly those close to retirement, would have a clear idea of how the guarantees might affect them.

Dear Appointed Actuary letter from the Government Actuary: DAA13, 22 December 1999

898 Having reviewed, initially, the returns submitted by insurance companies following his letter of 13 January 1999 (DAA11), the Government Actuary wrote again to appointed actuaries to provide further ‘clarification’ of the reserving standards which would normally be expected to be seen in future returns to the regulator, having noted that some aspects of his earlier advice had been interpreted in a variety of ways in the recent returns.

899 In a letter of 22 December 1999 (DAA13), the Government Actuary reiterated his earlier advice about the assumptions which could prudently be made about the take up rate of guaranteed annuity options, bearing in mind that the alternative offered a significantly lower nominal value to policyholders. He clarified his earlier reference to an allowance of ‘a few percentage points’ being made to reduce the liability for guaranteed annuities in respect of policyholders who chose to take alternative benefits.

900 In his view, an allowance in excess of 5% would not be considered to represent ‘a few percentage points’. Whilst there might be a stronger case for making an allowance for policyholders choosing to take a proportion of their benefits in the form of a tax free cash lump sum, in his view it would not be prudent to assume that more than 20% would take the maximum cash lump sum permitted.

901 The Government Actuary also indicated that he was reviewing the level of disclosure made by each company in their 1998 returns, regarding the assumptions made to determine the level of reserve for contracts containing a guaranteed annuity, saying: ‘For the avoidance of any doubt, we would expect to see full disclosure of the proportions of policyholders assumed to take any available guaranteed annuity, along with the underlying mortality and interest rate assumptions’, adding that GAD would expect to see prudent assumptions for future mortality improvements.

Proposals to reform prudential regulation and transfer of functions in relation to insurance to the Treasury

902 In a statement to the House of Commons on 20 May 1997, the then Chancellor of the Exchequer announced in broad terms the government’s proposals to reform the regulation of the financial services industry, to create a single statutory regulator with a single set of statutory powers.

903 The Chancellor noted that the distinctions between different types of financial institution: banks, securities firms and insurance companies, were becoming increasingly blurred and that many of them were regulated by a plethora of different supervisors. The supervision of banking and financial services was to be merged under an enhanced SIB, underpinned by statute. On 28 October 1997, the SIB changed its name to the Financial Services Authority.

904 These proposals eventually led to the enactment of the Bank of England Act 1998 and the FSMA 2000. The background to the latter is described in Phase 6.

905 As a preparatory step towards the implementation of the government’s proposals to create a single financial regulator, with effect from 5 January 1998 the functions of the Secretary of State in relation to various aspects of insurance regulation which had been administered by the DTI were transferred to the Treasury. This was achieved through the Transfer of Functions (Insurance) Order 1997⁵⁷⁹, an Order in Council made under the Ministers of the Crown Act 1975.

906 The functions transferred to the Treasury included those under the ICA 1982 and the PPA 1975, although certain functions under the 1982 Act were to be exercisable concurrently by the Secretary of State and the Treasury⁵⁸⁰. Functions under the FS Act 1986 which had been retained by the Secretary of State, or which were exercisable by the Secretary of State and the Treasury jointly as a result of changes made in 1992⁵⁸¹, were also transferred to the Treasury.

907 The transfer of functions order made consequential modifications to a number of enactments, including the ICA 1982, to replace references to the Secretary of State with references to the Treasury.

908 The Treasury assumed responsibility for the prudential regulation of insurance companies on 5 January 1998, pending the enactment and coming into force of the FSMA 2000. Staff in the Insurance Division of the DTI were seconded to the Treasury, Insurance Directorate until certain functions relating to prudential regulation were contracted out by the Treasury to the FSA with effect from 1 January 1999.

1998 Service Level Agreement between the Treasury and GAD

909 A service level agreement (SLA) was entered into between the Treasury and GAD, signed by the parties on 29 October and 6 November 1998.

910 Most of the terms of the new SLA replicated those of the agreement between the DTI and GAD signed in March 1995⁵⁸², with the references to the DTI and to its Insurance Division substituted with references to the Treasury and its Insurance Directorate respectively.

911 Section 22(1) of the ICA 1982 continued to require that company returns be deposited with the Treasury within six months after the close of the period to which they related – meaning, for the majority of companies with a financial year end in December, that they were to be submitted by the end of June in the following year.

912 However some changes were made in the new SLA. These included:

1. a new Annex A, which provided a description of the five priority ratings, indicators and target periods for scrutiny (a transcription of which appears in Appendix D to this document);
2. the timescales for production of detailed scrutiny reports for all companies with priority ratings 1 to 3 were reduced by three months; they were to be received by the Treasury (from GAD) by the end of December in the year in which the returns had been received by the Treasury, with priority 1 and 2 being given greatest priority within that period and completed by the end of October (for companies with December year ends);
3. the timescale for completion of detailed scrutiny reports for priority 4 cases was reduced by two months: they were to be received by the Treasury by the end of March of the following year;
4. GAD was to endeavour to complete ‘a scrutiny’ of the remaining priority 5 cases by the end of May (replacing a statement in the 1995 SLA that such cases would not receive a full scrutiny in the year in question, but would receive a fuller initial scrutiny);
5. the position regarding companies with year ends other than December was clarified. Detailed reports were to be provided within a comparable timescale according to the priority awarded to them (as indicated in Annex A);
6. in relation to action arising from the detailed scrutiny, a requirement was added for GAD actuaries to be available on request to discuss with supervisors any issues concerning individual companies arising out of their detailed scrutiny;
7. in section C, which dealt with ‘Other supervisory matters’, having repeated the requirement that GAD should be notified of changes of appointed actuaries, it was specified that GAD would liaise with the Treasury over any action that was needed where there was any concern about the reasons for the change in the appointed actuary. All new appointed actuaries, who had not previously held such a position, were to be interviewed by the Government Actuary and a note of the meeting was to be forwarded to the Treasury; and
8. a new item was added to the list of ‘other areas of responsibility’. GAD was to provide appropriate training for insurance supervisors on request.

913 It appears that the 1998 SLA between the Treasury and GAD continued to be relied on in relation to services provided by GAD to the FSA following the contracting out of functions referred to in the next two sections⁵⁸³ .

The Contracting Out (Functions in Relation to Insurance) Order 1998

914 From 1 January 1999, the FSA was to assume daytoday responsibility for most aspects of prudential regulation of insurance companies, prior to relevant functions being formally vested in it under the FSMA 2000 with effect from 1 December 2001. The means by which this was achieved was through the contracting out order referred to in this section, an authorisation issued by the Treasury to the FSA for the purpose of that order, and the SLA between the Treasury and the FSA outlined in the next section, which set out the terms and conditions upon which the functions were to be exercised by the FSA and the service standards to be achieved.

915 In November 1998 the Contracting Out (Functions in Relation to Insurance) Order 1998⁵⁸⁴ (the Contracting Out Order) was made by the Treasury under sections 69 and 77(2) of the DCOA 1994 to permit the statutory functions specified in that Order to be exercised by or on behalf of such person, or the employees of such person, as might be authorised by the Treasury.

916 The Contracting Out Order came into force on 18 November 1998. In effect, it enabled the Treasury to ‘contract out’ most of the functions which had been transferred to the Treasury by the Transfer of Functions (Insurance) Order 1997⁵⁸⁵. This included specified functions under the ICA 1982, the PPA 1975, the FS Act 1986, the Policyholders’ Protection Act 1997, ICR 1994 and other legislation.

917 Certain of the Treasury’s functions under the ICA 1982 were not included in the Contracting Out Order⁵⁸⁶, in particular the powers to make regulations and the power under section 68 to disapply or modify specified sections of Part II of the ICA 1982 and related subordinate legislation (which was of relevance to applications by companies for concessions in respect of implicit items and subordinated loans to provide cover for the margin of solvency).

918 The Contracting Out Order was enacted as a further interim step pending the enactment and coming into force of the FSMA 2000, a draft Bill for which had been published for consultation in July 1998.

December 1998 Service Level Agreement between the Treasury and the FSA

919 Before 18 December 1998, when the SLA between the Treasury and the FSA (the FSA SLA) was entered into, the FSA was discharging certain functions under the FS Act 1986 and the Banking Act 1987⁵⁸⁷ , whilst the Treasury was responsible for the discharge of functions under the ICA 1982 and other legislation relating to insurance business.

920 The purpose of the FSA SLA was to set the terms and conditions on which the FSA and its employees were to exercise functions under, inter alia, the ICA 1982 following authorisation being granted to the FSA by the Treasury in pursuance of the Contracting Out Order. It set the standards to be met by the FSA in exercising those functions and provided for monthly service charges to be paid by the Treasury to the FSA. The FSA SLA came into effect on 1 January 1999.

Functions contracted out to the FSA by the Treasury

921 The functions the FSA was to be authorised to exercise were listed in the schedule to the authorisation⁵⁸⁸ which the Treasury issued to the FSA pursuant to the Contracting Out Order (a draft of which was stated to be annexed to the FSA SLA). The functions which were contracted out to the FSA under the authorisation included those of the Treasury under the ICA 1982:

1. to grant authorisation to carry on insurance business and to suspend or withdraw authorisation (section 3);
2. to receive the regulatory returns of insurance companies (section 22);
3. to require a company in breach of its margin of solvency to submit a plan for the restoration of a sound financial position (section 32(4));
4. to require a company which failed to maintain its minimum margin of solvency (as defined in the legislation) to submit a short term financial scheme (section 33(1) and (2));
5. to impose requirements about investments (section 38);
6. require the maintenance of assets in the UK (section 39);
7. to impose requirements with respect to the custody and disposal of assets (section 40);
8. to limit the premium income (section 41);
9. to require a company to make an actuarial investigation into its financial condition (section 42);
10. to require a company to submit its annual returns early (section 43);
11. to obtain information and require the production of documents (under certain of the provisions of section 44); and
12. the residual power to impose requirements for the protection of PRE (section 45).

922 The authorisation was for a period of two years and was subject to the provisions of sections 69(5)(b) and (c) of the DCOA 1994 (which specify that such an authorisation may be revoked at any time by the Minister or officeholder⁵⁸⁹ by whom it was given and shall not prevent the Minister, the officeholder or any other person from exercising the function to which it relates). The FSA SLA stipulated that it was to be terminated with immediate effect if the authorisation was revoked (clause 6.2).

The Service Standard Specification – Schedule 1 to the FSA SLA

923 Schedule 1 to the FSA SLA contained a ‘Service Standard Specification’. This set out the aims and objectives which the FSA was to adopt in respect of services it was authorised to exercise on behalf of the Treasury and defined standards and performance measures which the FSA was to use its best endeavours to achieve.

924 The aims and objectives of the service standards reflected the proposals for the role of the FSA as a single financial services regulatory body contained in the draft Financial Services and Markets Bill published in July 1998. Those proposals included such matters as:

1. maintaining confidence in the UK financial system;
2. promoting public understanding of the financial system, including an awareness of the risks associated with various kinds of investment; and
3. securing an appropriate degree of protection for consumers, having regard to such matters as differing degrees of risk involved in different kinds of investments or other transactions, differing degrees of consumer experience and expertise and the general principle that ‘consumers should take responsibility for their own decisions’.

It was noted that these objectives might be amended during the passage of the legislation but they ‘serve[d] to inform the general approach the FSA proposes to take during the period prior to the new legislation coming into force⁵⁹⁰’. This was to include the FSA’s approach to carrying out the functions which it was to exercise on behalf of the Treasury for insurance supervision.

925 In relation to insurance, the FSA’s aim was required to be:

... effectively to regulate the insurance industry so that policyholders⁵⁹¹ can have confidence in the ability of UK insurers to meet their liabilities and fulfil policyholders’ reasonable expectations ...

The FSA was also to play a part in maintaining and improving international cooperation within the EC and more widely in relation to insurance regulation.

926 The FSA’s ‘key supporting objectives’ were to include:

1. to ensure that persons or companies who were not fit and proper or appropriately resourced or otherwise not able to satisfy the criteria for authorisation did not carry on business in the UK;
2. to carry out the regulation of insurance companies efficiently and effectively;
3. to meet the industry’s reasonable requests for prompt and clear responses to requests for information and advice;
4. to keep the cost and inconvenience of regulation for insurers as low as was commensurate with effective protection of the customer;
5. to cooperate with the Treasury in seeking to deliver efficient operation of the single market, including assistance in EU negotiations in relation to EC law.

927 A section of the FSA SLA headed ‘Insurance Supervision Work Programme’ identified key areas of work on which resources were to be deployed during 1999, covering three broad areas:

1. the conduct of ongoing regulatory and related work to specified standards;
2. initiatives to support the development of more effective and efficient regulatory procedures; and
3. preparations for the coming into force of the new regulatory regime.

928 The requirements for each of these three areas were then described in greater detail in relation to various subcategories of work, with performance measures outlined for many of them. In respect of the first of the broad areas of work, the subcategories comprised:

• ‘Authorisation, fit and proper checking, perimeter’;
• ‘Supervision’;
• ‘International’; and
• ‘Policy issues and case work’.

929 In respect of ‘Supervision’, the FSA’s general responsibilities were to include the prudential supervision of some 350 nonlife companies, 200 life companies and 40 composite insurance groups and:

Protecting policyholders against the risk of company failure and, more specifically, to protect them against the risk that UK authorised insurers might be unable to pay valid claims. In the case of life insurance companies this includes the risk that they will be unable to meet policyholders’ reasonable expectations. The Treasury and FSA agree that it is neither realistic nor necessarily desirable in a climate which seeks to encourage competition, innovation and consumer choice, to seek to achieve 100% success in avoiding company failure. The FSA will therefore pursue its supervisory objectives by aiming to minimise, but not eliminate, the risk of company failure by identifying early signs of trouble, and taking preventative action.

930 Key tasks for the ‘supervisory resource’ included monitoring the financial soundness of insurers to see that they were run in a sound and prudent manner by fit and proper people, based mainly on scrutiny of financial returns and other information (with the assistance of GAD, particularly in the case of life insurance companies) and site visits.

931 In relation to performance measures it was stated that the supervisory process was in an ‘ongoing state of development’. Changes had been made to the examination procedure in the preceding six months and further changes were to be expected in the context of the development of more effective and efficient regulatory procedures (described in a later section on policy issues).

932 In respect of the way in which the supervisory process was expected to be conducted for the 1998/99 supervisory year, performance measures were set out in Annex A of Schedule 1 to the FSA SLA. Those measures were to be kept under review and amended from time to time as agreed between the Treasury and the FSA. Annex A set out target timescales for various activities such as receipt and processing of returns, with five priority ratings (which do not appear to be defined) and shorter timescales for higher priority cases.

933 In respect of 75% of the cases, the annual examination process was to be completed within nine months of receipt, with 100% to be completed within 12 months. In respect of life companies, in 90% of the cases any necessary followup action was to be taken within two weeks of completion and review of the GAD scrutiny (with the remaining 10% to be dealt with within six weeks). ‘Timely and satisfactory outcomes’ to ongoing and future proposals for ‘life industry restructuring and inherited estates’ were to be secured in 100% of cases.

934 In respect of ‘General policy issues’, the FSA was to provide the Treasury (on request or on its own initiative) with timely advice on such matters as the development of government policy initiatives with a bearing on the insurance industry; the proposed content of draft speeches or statements prepared for the Treasury, other ministers or senior officials; Parliamentary business; matters relating to the implementation of the Policyholders Protection Act 1997; matters relating to insurance law; specified tasks of investigation and enforcement and ‘other relevant subjects, raised either by the Treasury or the FSA’.

935 It was recorded that whilst the FSA was to have daytoday responsibility for supervising insurance companies, certain of the powers required to carry out this function were to remain with the Treasury until the coming into force of the ‘proposed relevant provisions of the Financial Services and Markets Bill’.

936 As noted above, one of the provisions of the ICA 1982 which had been excluded from the Contracting Out Order and which the Treasury was therefore unable to authorise the FSA to exercise was section 68, the power to disapply or modify specified sections of Part II of the ICA 1982 and related subordinate legislation.

937 A section⁵⁹² of the Service Standard Specification dealt with the services the FSA was to provide in connection with section 68 orders. Those services included providing the Treasury Financial Services team and the Treasury Solicitor’s Department with:

1. a draft order;
2. advice giving background, recommendation and timing for the Order; and
3. a draft letter for the Treasury to send to the insurer to accompany the Order (containing specified information).

938 The Treasury was then to consider ‘the Order’, clarify any points with the FSA and/or the Treasury Solicitor’s Department and if satisfied, make the Order and dispatch it. The Treasury was to maintain a separate record of Orders and letters issued and advise the FSA at the end of each month of the correspondence which had taken place.

939 It was noted that there were other ‘supervisory Orders’ with a bearing on specific companies which would come within the responsibility of the FSA after the proposed new legislation was in force, but which until then could not be made by the FSA and would be ‘taken forward by the Treasury using the same principles of cooperation, consultation, and good administration which are to apply to s68 Orders.’

940 A section of the FSA SLA concerning ‘Proposed secondary legislation on insurance matters’ required the FSA to advise the Treasury on how legislation might keep pace with market developments, while remaining effective and without imposing an undue burden on the insurance industry.

941 The FSA was to provide the Treasury with statements of the policy to be achieved where subordinate legislation was required and was to support the preparation of new legislation needed to implement European Directives through secondary legislation.

942 As part of the initiatives to support the development of more effective and efficient regulatory procedures, during 1999 the FSA was to:

1. review and where necessary undertake an interim update of nonlife and life insurance supervisory procedures and internal guidance to ensure a consistent and properly documented approach;
2. prepare sectoral and market analyses to improve understanding of the context in which insurance companies operated;
3. undertake specific projects in response to market developments;
4. pursue the enhancement of a riskbased approach to insurance supervision against the FSA’s ‘broader canvas of financial regulation’ with a view to aligning the methodology and categorisation with other sectors of the financial industry (to the extent possible); a particular focus of this work was to be on the development of a risk rating system which could be implemented within two years of the proposed legislation coming into force; and
5. the implementation of a comprehensive training and development programme to develop the skills and competencies of insurance and friendly society supervisors and specialists.

Responsibility within the FSA for the provision of services in relation to the prudential regulation of insurance companies pursuant to the FSA SLA

943 Responsibility for the functions which the FSA had been authorised by the Treasury to exercise was delegated by the FSA to its Insurance Supervisory Committee⁵⁹³ .

944 That Committee was responsible for considering the exercise of any power or discretion under the ICA 1982 which the FSA had been authorised to exercise in relation to any insurer, and for making recommendations to the Treasury to exercise supervisory powers which the FSA had not been authorised to exercise, in particular those under section 68 of the ICA 1982. GAD attended meetings of the Committee for papers on which it had a particular contribution to make.

945 The staff who had been seconded from the DTI to the Treasury in January 1998 moved to the FSA and combined with the supervisory staff of the Friendly Societies Commission to form the Insurance and Friendly Societies Division of the FSA. The IFSD had daytoday responsibility for the supervision of insurance companies and continued to obtain actuarial advice from GAD.

Further guidance from GAD on resilience testing in 1998 and 1999

946 On 24 November 1998 the Government Actuary wrote to all appointed actuaries regarding the resilience test for life insurers (DAA10), to update the three scenarios for testing which had been set out in his letter of 30 September 1993⁵⁹⁴. He noted that increased volatility in equity markets had produced extreme daily fluctuations in the Financial Times Stock Exchange (FTSE) 100 Share Index and the FTSE All Share Index, such that the resilience tests which had been used since 1993 could produce ‘unreasonable results’.

947 This volatility was combined with a significant fall in the yields on gilts. The Government Actuary noted that a working party of the F&IA was considering possible revisions to the resilience test for the future, but their proposals were unlikely to come forward for several months. He therefore outlined a temporary amendment to the second of the September 1993 tests⁵⁹⁵, substituting it with a more complex test in the event that the FTSE 100 Index fell below 4,500. (The first and third tests set out in the September 1993 DAA letter were not amended.)

948 On 30 September 1999, the Government Actuary again wrote to appointed actuaries regarding the resilience tests (DAA12) to set out a further revision to test (2). In place of the formula described in the November 1998 letter, test (2) was to comprise a combination of:

1. a 10% fall in fixed interest yields; and
2. a fall in the value of equities of the greater of:
   1. 25%, subject to the fall being restricted to such as would not produce a price/earnings ratio on the FTSE Actuaries All Share Index lower than 75% of the inverse of the long term gilt yield before the assumed fall in paragraph (a); and
   2. 10%.

949 Shortly before the Insurance Companies (Amendment) Regulations 2000 came into force in May 2000, the Government Actuary wrote yet again to appointed actuaries to revise the resilience tests, in anticipation of changes to be made to ICR 1994 by the 2000 Regulations in relation to the assumed rate of interest on future investments, as noted below.

F&IA joint working parties on an alternative to the net premium valuation method of statutory reporting

1996 statutory valuation working party report

950 One of four joint working parties set up in 1993 by the F&IA through the operation of the JAWP to report on various aspects of statutory valuation considered the question of possible alternatives to the net premium method of valuation for reporting for regulatory purposes (the NPWP).

951 The NPWP consisted of members of the F&IA and GAD, with observers from the DTI. It was asked to look at alternative valuation methods used for supervisory purposes in other countries, make recommendations as to whether there should be a move to another method for supervisory purposes in the UK and if so, to recommend a method to be used and to consider the effects for reserves such as the resilience reserve.

952 The NPWP presented its report to the Faculty of Actuaries in January 1996 and to the Institute of Actuaries in February 1996⁵⁹⁶. In summary, it recommended that the net premium method of valuing liabilities should be replaced by a comprehensive gross premium system for all types of policies.

953 Perceived disadvantages of the net premium method were said to include:

1. that it was not appropriate for many modern types of business, e.g. single premium with-profits business and flexible annuities;
2. that the method was artificial, it made no explicit allowance for renewal expenses or future bonuses, in particular for terminal bonus, which represented a significant part of PRE;
3. the substantial use of equitytype investments did not sit easily with the net premium method;
4. the value of liabilities did not always act consistently with changes in investment conditions which presented a difficulty with then current resilience reserve calculations;
5. the method did not deal well with alterations to policies; and
6. it was sometimes necessary to use a gross premium or cash flow method to take account of particular circumstances (and mixing the use of the net premium method with those other methods was unsatisfactory).

954 In relation to PRE, the NPWP noted:

It may also be argued that the regulations do not deal sufficiently rigorously with PRE and, in particular, future bonuses. The new regulations do specify that due regard has to be paid to PRE, a requirement that has been in actuarial Guidance Note GN1 for some time. It is not expected that the inclusion of PRE in the regulations will change companies’ approach to the valuation of with-profits policies. Under conventional with-profits policies, the use of the net premium method makes an implicit reserve for reversionary bonuses by using a suitably low rate of interest. However, it is not clear how this implicit approach relates to the actual level of reversionary bonuses declared, nor does the method make any direct provision for terminal bonuses, which currently make up a large part of the proceeds of claims under with-profits policies.

955 The replacement method proposed in the 1996 report involved the calculation of a ‘statutory solvency reserve’, based on the requirements of the Third Life Directive, with an appropriate allowance for tax, and a ‘realistic policy liability’, which would be a realistic gross premium valuation liability incorporating some prudent margins.

956 As regards the proposed statutory solvency reserve, the NPWP considered that no specific provision for terminal bonus need be made. Under the realistic policy valuation, the valuation was to reflect PRE and:

... in particular, make adequate provision for the level of bonuses, including terminal bonuses that the office would expect to pay, following its current practices, consistent with the assumptions used in the valuation.

957 It was recommended that the realistic policy liability should be published, as a realistic valuation of the benefits which policyholders could reasonably expect in the future, calculated using realistic assumptions of future experience. It was proposed that reserves for both the statutory solvency reserve and the realistic policy liability should be published in the returns to the DTI and made available to the general public.

1998 statutory valuation working party report

958 A further working party was established (the SVWP) to build on the work of the NPWP and, in particular, to determine whether the idea for a statutory solvency reserve put forward in the 1996 report could be developed into a system of solvency valuation superior to the approach set out in the then current valuation of liability regulations.

959 The report of the SVWP presented to the F&IA in 1998⁵⁹⁷ indicated that the reaction of members of the F&IA to the proposals in the NPWP’s 1996 report to publish a realistic policy liability in the annual supervisory returns had been generally unfavourable, although the prospect of overhaul of the net premium method had received greater (but not universal) support.

960 The SVWP considered the approach to valuation which should be adopted in respect of various classes of business and made separate recommendations in relation to each. It noted that the overall strength of the reserves would be affected, to a very considerable extent, by the form and parameters for the resilience test (which, at the time of the report, were being considered by a separate working party).

961 For non-linked, nonprofit business, it was recommended that the net premium standard should be replaced by a gross premium or cash flow approach. In the case of ‘conventional with-profits business’, the SVWP recommended that the net premium standard for valuation should remain, however a requirement for a PRE surrender value should be made explicit (and regulations governing the treatment of altered policies should be liberalised).

962 For accumulating with-profits business the SVWP took the view (believed to be shared by the supervisory authority and GAD), that the variety of reserving bases for accumulating with-profit business then being used was unsatisfactory and could not be allowed to continue. The SVWP recommended that changes to ICR 1994 and/or GN8 were ‘certainly needed, and should be introduced at the earliest practicable opportunity’.

963 The report included, as Appendices E and F, possible changes to individual determination of liability regulations of ICR 1994 and to the guidance in GN8 which would accommodate the SVWP’s recommendations.

964 The changes suggested by the SVWP to Regulations 64, 67 and 72 of ICR 1994 in Appendix E were largely⁵⁹⁸ adopted and put into effect by the Insurance Companies (Amendment) Regulations 2000 referred to below and are not repeated here.

965 A separate recommendation made by the SVWP that the reinvestment rate of 6% in regulation 69(9)(a) should be reviewed in the light of economic trends was adopted when ICR 1994 was revised in 2000. Proposed changes to the ICAS Regulations 1996 to accommodate the results of gross premium valuations in the prescribed forms were also adopted and put into effect by the Insurance Companies (Amendment) Regulations 2000.

966 Similarly, the changes to GN8 suggested in Appendix F to the SVWP’s report were substantially embodied in the revised version of GN8 (6.0) which was issued in March 2001 and is mentioned below.

967 The 1998 SVWP report stated that in recent years there had been a growing recognition within the profession of the need to ‘interpret and safeguard’ PRE. It was said to be a common theme of various sections of the report that the mathematical reserves might not have kept pace with the development of the concept of PRE.

968 It was said to be in consequence of the considerable emphasis that the SVWP had given to PRE in its deliberations that it had recommended that the major part of the practical implementation of its proposals should be through amendments to GN8, rather than through amendments to ICR 1994. The SVWP considered such an approach to be advantageous, given the relative ease of amending GN8, as opposed to amending the Regulations.

Footnotes

³⁸⁴ 92/49/EEC.

³⁸⁵ 92/96/EEC.

³⁸⁶ Apparently an allusion to uncertainties over the ambit of the residual power to impose requirements to protect policyholders under section 45 of the ICA 1982.

³⁸⁷ SI 1994 No. 1696.

³⁸⁸ Which had been inserted in the ICA 1982 by SI 1990 No. 1333 (see paragraph 416) implementing the NonLife Directive 88/357/EEC and later amended by further statutory instruments.

³⁸⁹ Inserted in the ICA 1982 by SI 1990 No. 1333.

³⁹⁰ In the light of article 7 of the Third Life Directive.

³⁹¹ A state which was a contracting party to the Agreement on the European Economic Area signed at Oporto on 2 May 1992 as adjusted by the Protocol signed at Brussels on 17 March 1993, with special provision for Liechtenstein (Regulations 5(2) and 50(1)(g) of the ICTID Regulations 1994).

³⁹² See paragraph 293 above.

393 Collective insurance and social insurance.

³⁹⁴ Relating to authorisation of the company by its home state and notification and certification of matters to the Secretary of State by the supervisory authority of the company’s home state.

³⁹⁵ Exceptions to this exclusion (i.e. where provisions of Part II of the ICA 1982 continued to apply in some way to an EC company) related to the special requirements under Part I of Schedule 2F for EC companies carrying on business in the UK; restrictions on disclosure of information under sections 47A, 47B and Schedule 2B and the winding up provisions of sections 5459.

³⁹⁶ Regulation 43 of and Schedule 10 to the Insurance Companies Regulations 1994 SI No. 1516 specified, by description, the property and stipulated the indices by reference to which linked benefits were to be determined.

³⁹⁷ See paragraph 315 above. The seven original grounds for intervention under section 37(2) of the ICA 1982 had been supplemented by an eighth ground in relation to Swiss insurance companies in January 1994 by the Insurance Companies (Switzerland) Regulations 1993 SI No. 3127.

³⁹⁸ Under the Directives, free disposal of assets by an insurance company could only be restricted in exceptional specified circumstances which were slightly extended by the Third Life Directive. See paragraphs 230 and 497 above.

³⁹⁹ See paragraph 576 above.

⁴⁰⁰ Formerly, the particular powers of intervention which were subject to section 37(3) could not be relied on unless the company’s solvency margin had fallen below the amount of the minimum margin (or ‘guarantee fund’) under section 33. See paragraph 497 regarding the change in the Directives.

⁴⁰¹ See paragraph 583. ⁴⁰² Referred to in paragraph 597.

⁴⁰³ Summarised in paragraph 574 above.

⁴⁰⁴ Which continued to be subject to the limitation in section 37(6) that it was only available where the purposes of section 45 could not appropriately be achieved by exercise of powers under sections 38 to 44 or by exercise of those powers alone.

⁴⁰⁵ Which, together with section 47B, had been inserted in the ICA 1982 by section 25 of the Companies Consolidation (Consequential Provisions) Act 1985.

⁴⁰⁶ By Regulation 9 of SI 1990 No. 1333, (see paragraph 416).

⁴⁰⁷ New sections 54(1)(bb) and 54(2)(bb) had been inserted by Regulation 8 of SI 1990 No. 1333.

⁴⁰⁸ See footnote 391.

⁴⁰⁹ The effect of such an objection being to debar the company from making the appointment or the proposed controller from taking control.

⁴¹⁰ In section 96(1) together with the new section 96C, inserted in the ICA 1982 by the ICTID Regulations 1994.

⁴¹¹ A ‘shareholder controller’ was defined as a person who was a ‘controller’ by virtue of section 96C(2) (being one of five categories of ‘controller’ as defined in section 96C(1)), namely a person who alone or with associates held 10% or more of the shares in the company or its parent, or was entitled to exercise, or control the exercise of, 10% or more of the voting rights at a general meeting of the company or of its parent, or was able to exert significant influence over the management of the company or of its parent by virtue of a holding in shares or entitlement to exercise or to control the exercise of voting power at a general meeting of the company or the parent. A ‘10 per cent shareholder controller’, ‘20 per cent shareholder’ and the related expressions were defined in section 96C(3) to mean a shareholder controller in whose case the percentage referred to in section 96C(2) was 10 or more but less than 20; 20 or more but less than 33; etc.

⁴¹² See previous footnote.

⁴¹³ Defined in the new section 96C as the managing director or chief executive of the company or its parent; a person in accordance with whose directions or instructions the directors of the company or its parent were accustomed to act; a person who satisfied the ‘shareholder controller’ requirements of section 96C(2) referred to in footnote 411; or in the case of a nonUK company, a person who alone or with any associates was entitled to exercise, or controlled the exercise, of 15% or more of the voting power at a general meeting of the company or its parent.

⁴¹⁴ Which had been inserted in the Act by SI 1990 No. 1333 (see paragraph 416).

⁴¹⁵ Inserted in the Act by SI 1990 No. 1333.

416 SI 1994 No. 3132.

417 SI 2001 No. 3649.

418 SI 1994 No. 1516.

⁴¹⁹ Certain of the amendments made to ICR 1981 up to 1990 are referred to in paragraphs 412 et seq. Further minor amendments were made by the Insurance Companies (Amendment) Regulations 1992 SI No. 445 and by the Insurance Companies (Cancellation No. 2) Regulations 1993 SI No. 1092, including amendments to the form of the statutory notice to be sent to long-term policyholders in relation to cancellation under section 75 of the ICA 1982.

⁴²⁰ Part of the Insurance Companies (Credit Insurance) Regulations 1990 SI No. 1181 and Regulation 13 of SI 1992 No. 2890, (referred to in paragraph 511).

⁴²¹ Part X which dealt with credit insurance business was revoked by the Insurance Companies (Reserves) Regulations 1996 SI No. 946 which introduced equalisation reserves for general insurance companies.

⁴²² ICR 1994 also dealt with matters relevant to conduct of business regulation such as the contents of advertisements.

⁴²³ The equivalent provision to Regulation 54 of ICR 1981.

⁴²⁴ This percentage was reduced in the case of shortterm contracts (of no more than five years) which provided only for benefits payable on death within a specified period.

⁴²⁵ Regulation 22(3) referred to ‘items that are not implicit items’ rather than to ‘explicit items’ (and defined ‘implicit items’ in Regulation 23(5) as being the future profits, Zillmer adjustment and hidden reserves valued in accordance with Regulations 2426).

⁴²⁶ ‘Mathematical reserves’ were defined in Regulation 2(1) as in ICR 1981 (see paragraph 265), save for a new exclusion in relation to ‘deposit back arrangements’: ‘the provision made by an insurer to cover liabilities (excluding liabilities which have fallen due and liabilities arising from deposit back arrangements) arising under or in connection with contracts for long term business’.

⁴²⁷ Regulation 23(1).

⁴²⁸ In a paper entitled ‘Statutory Regulation of Long Term Insurance Business’ prepared for the F&IA by William M. Abbott and revised by Nick C. Dexter in 2000 it was said that ‘hidden reserves’ were most relevant to nonUK companies as they adopted a different approach to the valuation of assets and liabilities, but in principle the concept might be used to disapply the admissibility limits relating to particular assets.

⁴²⁹ See paragraph 194. Guidance in implicit items under the former provisions of regulations 1013 of ICR 1981 in a Prudential Guidance Note for appointed actuaries, issued on 5 October 1984, explained that underestimation of the value of an asset might occur because of an express requirement of ICR 1981 which had the effect of excluding or limiting the value of certain assets which could be counted towards the margin of solvency. Paragraph 32 of that guidance stated that allowing items which were explicitly excluded under the Regulations to be counted towards the margin of solvency would be ‘tantamount to nullifying the effect of those regulations’. Consequently, it was envisaged that concessions to allow inadmissible assets would ‘rarely if ever be given’.

⁴³⁰ In SI 1974 No. 2203, see footnote 56 and paragraph 167.

⁴³¹ To allow for the valuation of assets in respect of such items as derivative contracts and stock lending transactions, to make provision for assets relating to regulated financial institutions and with revised definitions for secured debts and dependants (subsidiary companies).

⁴³² Section 35A(2) and (3) made special provision for assets to match liabilities under linked long term contracts, requiring the assets to be of descriptions prescribed in regulations made under section 78 (Regulation 43 and Schedule 10 to ICR 1994 on permitted links were made for the purpose of section 78).

⁴³³ In regulations 46 and 47 and Schedule 11.

⁴³⁴ Regulation 41 of ICR 1981.

⁴³⁵ Implementing article 21.1(vii) of the Third Life Directive.

⁴³⁶ ‘Derivative contracts’ were defined in Regulation 44(1) as ‘a contract for differences, a futures contract or an option’. Article 21.1(iv) of the Third Life Directive referred to ‘derivative instruments such as options, futures and swaps’ and required that they be valued on a prudent basis.

⁴³⁷ Reflecting articles 2022 of the Third Life Directive, which required prudence and diversity in the investments and other assets used as cover for technical provisions, and imposed limits on the kinds of asset and degree of investment in specified kinds of investment.

⁴³⁸ See paragraphs 261 et seq.

⁴³⁹ The paper entitled ‘Statutory Regulation of Long Term Insurance Business’ referred to in footnote 428.

⁴⁴⁰ Defined in regulation 2(1) as meaning, in relation to a contract for reinsurance, an arrangement whereby an amount is deposited by the reinsurer with the cedant (i.e. the insurance company which has arranged reinsurance).

⁴⁴¹ Article 21.1(iv) of the Third Life Directive specified that such instruments could be used as cover for technical provisions ‘in so far as they contribute to a reduction of investment risk or facilitate efficient portfolio management’.

⁴⁴² Implementing item A.(iii) of article 17.1 of the First Life Directive as replaced by article 18 of the Third Life Directive which specified that a prudent valuation was not a ‘best estimate’ valuation and should include appropriate margins for adverse deviations of relevant factors.

⁴⁴³ Item A.(i) of article 17.1 of the First Life Directive as replaced by article 18 of the Third Life Directive.

⁴⁴⁴ Regulation 54 of ICR 1981 had referred to the amount of the liabilities being ‘in the aggregate not... less than the amount calculated in accordance with regulations 55 to 64 below’. Thus if any valuation methods other than those prescribed in regulations 55 to 64 had been used for the ‘main valuation’ a second valuation, compliant with those regulations, would be needed in order to demonstrate compliance with regulation 54. In effect, regulations 55 to 64 provided a minimum ‘benchmark figure’ against which the aggregate figure for the liabilities produced by the main valuation was to be tested. In calculating the ‘benchmark figure’ in accordance with regulations 55 to 64 offsetting of provisions or margins required by those individual regulations was not permitted. The guidance in early versions of GN8 concerning regulation 54 of ICR 1981 (e.g. in paragraph 3.1.1 of version 1.0) advised that the actuary should interpret the tests in regulations 5564 in a prudent way, satisfy him or herself that, within the aggregate liability produced by his or her valuation, the various provisions and margins required by those regulations could be provided for in full, whether explicitly or implicity, and that, if he or she considered that one provision or margin required by the regulations for one category of contract was excessive, it was not permissible to offset part of it against another provision or margin required by those regulations for that or another category of contract, except in one specified circumstance. Under regulation 64 of ICR 1994 only one valuation was envisaged (subject to regulation 67(4) in respect of future premiums, see paragraph 679) and that valuation was required to be conducted taking account of specified factors and in accordance with the detailed regulations (65 75), without offsetting of any margins required by those regulations. The updated guidance to appointed actuaries in GN8 version 4 issued at the end of 1994 in relation to regulation 64 of ICR 1994 advised (in paragraph 3.1.1) that offsetting a perceived excess in one provision or margin required by regulations 6575 for ‘any element of the basis’ against another provision or margin required by the regulations was not permissible, save in one specified exceptional circumstance.

⁴⁴⁵ It is to be noted that no reference was made in Regulation 64 to ‘potential policyholders’, suggesting that the expectations of prospective policyholders’ were not considered to be relevant in this context.

⁴⁴⁶ See the comments of the GAD actuary quoted at paragraph 279.

⁴⁴⁷ See paragraph 514(g) (and paragraph 352 regarding the requirement introduced in 1983 for actuaries ‘to pay due regard to the future interests of with-profit policyholders’ in their valuations under paragraph 2.1.3 of GN8).

⁴⁴⁸ The note appears to have been prepared by another GAD actuary. It refers to the deletion of a paragraph proposed to be numbered (7) in the draft regulation concerning the method of calculation (Regulation 65 in the enacted version of ICR 1994) because of a ‘genuine concern that the regulation as drafted required companies to reserve for final bonuses, even though we have made it clear that this was not the intention. (We want UK companies to be able to continue their present practices with regard to the cover for the solvency margin, which will thus enable them to use the investment reserve for this purpose.)’. The note goes on to state that in order to ensure that the reasonable expectations of policyholders would be covered and proper allowance was made in the valuation for future bonuses, it had been decided to include the additional phrase quoted in the paragraph above, to amplify the meaning of ‘actuarial principles’.

⁴⁴⁹ The note indicates that this was the view of the three actuaries representing the actuarial profession on the implications of the originally proposed additional drafting, although each of them had interpreted it in a different way.

⁴⁵⁰ Chapter 10, paragraph 19. This view is based in part on the definition of ‘long term liabilities’ in Regulation 58 as being those arising ‘under or in connection with contracts’.

⁴⁵¹ In his 1966 paper on ‘A Solvency Standard for Life Assurance Business’: JIA 92 (1966) 5784.

⁴⁵² JIA 121, III, 597601 at page 597.

⁴⁵³ Implementing items A.(i) and (ii) of article 17.1 of the First Life Directive as replaced by article 18 of the Third Life Directive.

⁴⁵⁴ See paragraph 269.

⁴⁵⁵ Item B. of article 17.1 of the First Life Directive as replaced by article 18 of the Third Life Directive.

⁴⁵⁶ See paragraph 272.

⁴⁵⁷ The Report of the FSA on the Review of the Regulation of Equitable from 1 January 1999 to 8 December 2000 submitted as evidence to the inquiry conducted by Lord Penrose (16 October 2001) (the Baird Report), at paragraph 3.22.5 describes the interpretation of Regulation 72 as being at the heart of the debate on reserving between Equitable and the Treasury (and later, the FSA). See paragraph 978 regarding the amendments made to Regulation 72 in May 2000 by the Insurance Companies (Amendment) Regulations 2000 SI No. 1231.

⁴⁵⁸ Which had led to the practice of ‘resilience testing’.

⁴⁵⁹ By the Insurance Companies (Amendment No.2) Regulations 1994 SI No. 3133, which came into force on 31 December 1994, to make consequential amendments to ICR 1994 in the light of amendments made on 30 December 1994 to the ICA 1982 by SI 1994 No. 3132 (referred to at paragraph 625), implementing aspects of the Agreement on the European Economic Area.

⁴⁶⁰ By the Insurance Companies (Amendment) Regulations 1995 SI No. 3248 which came into force on 31 December 1995.

⁴⁶¹ The Insurance Companies (Amendment) Regulations 1996 SI No. 942; the Insurance Companies (Amendment No. 2) Regulations 1996 SI No. 944; the Insurance Companies (Amendment) Regulations 1998 SI No. 2996; SI 2000 No. 1231 (see footnote 457) and the Banking Consolidation Directive (Consequential Amendments) Regulations 2000 SI No. 2952.

⁴⁶² SI 2001 No. 3649.

⁴⁶³ SI 2000 No. 1231.

⁴⁶⁴ SI 1993 No. 946.

⁴⁶⁵ See paragraphs 401 et seq.

⁴⁶⁶ SI 1994 No. 1515.

⁴⁶⁷ Which made provision for the general implementation in the UK of the Oporto Agreement relating to the establishment of the European Economic Area (dated 2 May 1992, as adjusted by the Brussels Protocol of 17 March 1993) and specified that UK legislation which was limited by reference to the European Communities should, in general, have effect with the substitution of a corresponding limitation relating to the European Economic Area.

⁴⁶⁸ i.e. companies with their head office situated in and authorised by a member state other than the UK.

⁴⁶⁹ See paragraphs 499 and 715 et seq regarding the changes introduced by the Third Life Directive in relation to the value of subordinated loans and cumulative preference share capital being treated as an asset which could (within specified limits) count towards the required margin of solvency and the arrangements in the UK for a company to rely on a subordinated loan for this purpose if a successful application had been made by the company to the Secretary of State for an order under section 68 of the ICA 1982. The change to the ICASA Regulations 1994 referred to above simply required that additional information be provided about such loans (it did not permit their use for margin of solvency purposes).

⁴⁷⁰ As defined in section 96C of the ICA 1982, see footnote 410.

⁴⁷¹ The Prudential Guidance Notes (or ‘PGNs’) issued by the DTI to insurance companies referred to in paragraphs 715 et seq below were

considered to be ‘published guidance’ with which directors of insurance companies were required to certify compliance.

⁴⁷² See paragraph 509 regarding the amendment of section 21 in 1991 by SI 1991 No. 1997.

⁴⁷³ Namely, a person whose only appropriate qualification was authorisation granted by the BT under section 13(1) of the Companies Act 1967.

474 SI No. 1996 No. 943.

⁴⁷⁵ See paragraph 383.

476 SI 1994 No. 449.

⁴⁷⁷ By paragraph 5(4) of Schedule 4 to the Financial Institutions (Prudential Supervision) Regulations 1996 SI No. 1669 which inserted an additional paragraph (1A) in Regulation 3.

⁴⁷⁸ The ‘company concerned’ included a company which was closely linked by control to the company subject to audit by the auditor.

⁴⁷⁹ ‘Of material significance’ was defined to mean of material significance for the purpose of determining whether any of the powers conferred on the Secretary of State by sections 38 to 45 of the ICA 1982 should be exercised.

⁴⁸⁰ See paragraph 685 regarding SI 1993 No. 946.

⁴⁸¹ See paragraph 704 regarding the proposed criteria for the issue of practising certificates.

⁴⁸² A committee of the F&IA. Its current terms of reference are: ‘to assist the Professional Affairs Board (PAB) by guiding members of the profession in all professional matters, particularly those relating to interpretation of and compliance with professional guidance...’.

⁴⁸³ Section 35B was inserted in the ICA 1982 by the ICTID Regulations 1994. Under paragraph 9 of Schedule 6 to the ICAS Regulations 1983 (regarding the certificate given by the actuary to be annexed to the returns) as amended by Regulation 18(5) of the ICASA Regulations 1994 the actuary was required to state (if it was the case) ‘that, in his opinion, premiums for contracts entered into during the financial year and the income earned thereon are sufficient, on reasonable actuarial assumptions, and taking into account the other financial resources of the company that are available for the purpose, to enable the company to meet its commitments in respect of those contracts and, in particular, to establish adequate mathematical reserves’.

⁴⁸⁴ In regulation 28 of the ICAS Regulations 1983.

⁴⁸⁵ JIA 118, III, 517521 at page 519.

⁴⁸⁶ Apparently a reference to the disciplinary tribunal of the F&IA.

⁴⁸⁷ Apparently a reference to the Form B which had appeared in Schedule 6 to ICR 1981, requiring particulars to be given of a proposed controller or newly appointed director or manager.

⁴⁸⁸ According to a letter from an actuary who been involved in developing the system of practising certificates for the F&IA to the DTI, dated 21 November 1991.

⁴⁸⁹ Which contained details of the minimum criteria for the determination of liabilities.

⁴⁹⁰ Which required the nature and term of the assets representing the liabilities to be taken into account when determining the amount of the long term liabilities, including prudent provision against the effects of possible changes in the value of the assets on the ability of the company to meet its obligations under long term contracts as they arose and the adequacy of the assets to meet the liabilities determined in accordance with Regulations 65-74.

⁴⁹¹ See paragraphs 499 to 502.

⁴⁹² Which, under the Third Life Directive, could also count as cover for the solvency margin and, unlike subordinated loans, could count against the entire margin. The Prudential Note described the members’ account as being a loan made by a member of the company (subject to a number of significant specified conditions), intended to be part of the core capital of the company, to be available to meet losses.

⁴⁹³ Prudential Note 1994/1 referred to the discretion being that of the DTI.

⁴⁹⁴ Equitable considered the possibility of taking out a subordinated loan in 1993 but did not proceed at that time. The company eventually obtained an order under section 68 of the ICA 1982 in respect of a subordinated loan of £346 million on 19 August 1997.

⁴⁹⁵ Paragraph 6A of Schedule 6 to the ICAS Regulations 1983 inserted by the ICASA Regulations 1994 (see paragraph 693).

⁴⁹⁶ References to or copies of opinions and notes of advice indicate that advice from counsel had been provided in 1987, 1989 and 1993.

⁴⁹⁷ Loosely meaning assets held in excess of those to meet liabilities (and meeting PRE, including terminal bonus); often used in a context of most relevance to proprietary offices rather than to mutuals (but Equitable’s policy was to pay out any such surplus in any event). Sometimes referred to as a company’s ‘free estate’ or simply its ‘estate’.

⁴⁹⁸ Hansard Debates, House of Commons, 24 February 1995, columns 390391.

⁴⁹⁹ For most years from 1993 onwards, the guaranteed annuity rates contained in certain policies issued by Equitable between 1956 and 1988 exceeded the then current annuity rates, but no reserve was being made for them until the time of the 1998 returns (which would have been submitted after the advice in DAA11 had been promulgated, see paragraphs 882 et seq.). As at 1998, some 100,000 Equitable policies containing GARs remained in existence (according to a joint counsel’s opinion obtained by the company at that time).

⁵⁰⁰ Withdrawn following the decision of the House of Lords in Equitable Life Assurance Society v Hyman [2002] 1 AC 408.

⁵⁰¹ See paragraphs 404 et seq.

⁵⁰² Audit recommendations were not made in respect of all the findings noted in the report of the June 1994 meeting and it appears that some of the initial findings and proposed recommendations may have been revised following further discussions with officials in the DTI.

⁵⁰³ See paragraphs 450 et seq.

⁵⁰⁴ The DTI management response to this item noted that most companies had the same year end and there were only a limited number of experienced auditors, making it difficult for all companies’ returns to be submitted on time.

⁵⁰⁵ Apparently a reference to the 1984 service level agreement referred to at paragraphs 355 et seq.

⁵⁰⁶ The DTI’s Insurance Division’s management response to this finding indicated that the situation was under review. It stated that there were ‘difficulties in relying on GAD’ and that it was ‘[i]mportant for supervisors to realise that they are responsible for supervision and not just [a] post box’. It was also noted that DTI would have liked to have had GAD ‘in house’ (and that this had been suggested six or seven years earlier but had been rejected by GAD as it was concerned that its expertise would be dissipated). It was noted that employing external actuaries would be expensive.

⁵⁰⁷ See paragraphs 355 et seq regarding the 1984 agreement. The management response to this item stated that it was agreed that ‘clarification of the informal arrangements is necessary’.

⁵⁰⁸ The DTI’s Insurance Division’s management response noted that there was a ‘a desire in GAD for more independence’ and a debate as to whether GAD should copy all correspondence to the DTI or just the outcome (with a potential for embarrassment to the DTI if it was not aware of what GAD was doing).

⁵⁰⁹ The DTI’s Insurance Division’s management response suggested that a ‘bring forward’ system was needed rather than monthly reports.

⁵¹⁰ A copy of the action document was attached to a memorandum from the Head of DTI Internal Audit to the Director of Insurance Division, dated 11 May 1995.

⁵¹¹ Letters of complaint from policyholders would not be copied to GAD (unless there were actuarial issues involved) and it appears that notification of management changes were not to be copied to GAD.

⁵¹² See paragraphs 766 et seq.

⁵¹³ Section C of the SLA indicates that all documents received by DTI from life offices were to be copied to GAD and GAD was to be ‘always free to comment on any document’ (see paragraph 769).

⁵¹⁴ Again, at this point the SLA referred to the DTI rather than specifically to its Insurance Division.

⁵¹⁵ ‘Notices of Requirements’ were served on companies by the Secretary of State in relation to authorisation, change of control and the exercise of intervention powers under sections 3845 of the ICA 1982 to require a company to take, or refrain from, certain action (see paragraph 455 regarding the internal DTI guidance).

⁵¹⁶ In simple terms a ‘free asset ratio’ is the amount by which a company’s free assets exceed its required minimum margin, expressed as a percentage of its total assets as determined for the purpose of its regulatory returns.

⁵¹⁷ Apparently, May of the following year.

⁵¹⁸ It is not clear whether this was intended to refer only to a situation in which advice from GAD was being sought by the DTI, or that all such documents would be copied to GAD routinely. The reference to GAD being ‘free to comment on any document’ in the quoted section suggests the latter.

⁵¹⁹ Which might arise, for example, where a company wished to rely on implicit items or hybrid loan capital in its margin of solvency calculations: see paragraphs 337 and 715 et seq.

⁵²⁰ Most of the provisions of the ICAS Regulations 1996 came into force on 23 December 1996, other than Regulation 34 which came into force on 30 April 1996 and substituted various provisions of the ICAS Regulations 1983 until they were revoked (the substitute provisions related to the meaning of ‘receivable’ in Regulation 3, the value of assets and liabilities in Regulation 4 and the required additional information on derivative contracts in Regulation 22B).

521 SI 1996 No. 943.

⁵²² In terms of the statutory regime, matching rectangles provided the regulator with a means of establishing or checking the interest rates used in the valuation. They were described in general terms in a paper presented to the Institute of Actuaries in 1989 as ‘a powerful tool for understanding the interactions within a life and pensions company. They also provide an excellent control on the interface between the work of accountants – which largely relates to assets – and to the valuation work of actuaries – which largely relates to liabilities.’ They consisted of a balance sheet which was not presented simply as two columns, but was broken down more fully into a two dimensional table in which the row and column totals corresponded to the liability and asset entries in a traditional balance sheet. The matching rectangle showed the collection of assets used to match each classification of liability (C.M. Johnson: JIA 116 (1989) 673690 at pages 684685). Form 57 was in such a format. Appendix D contains copies of the prescribed form as it appeared in the ICAS Regulations 1996 and as it appeared in the amendment regulations of the following year (see paragraph 800).

523 SI 1996 No. 2102.

⁵²⁴ In a paper entitled ‘Statutory Regulation of Long Term Insurance Business’ prepared for the F&IA by William M. Abbott and revised by Nick C. Dexter in 2000.

⁵²⁵ See paragraphs 643 et seq.

⁵²⁶ Paragraph (1) of Regulation 67 of ICR 1994 required a net premium method to be used for most contracts unless paragraph (3) of that regulation applied or, under paragraph (4), an alternative method could be shown to produce equally strong reserves (see paragraph 269 regarding the provisions from which paragraphs (1)(3) of regulation 67 were derived and paragraph 679 regarding paragraph (4)). See further below regarding the amendment of regulation 67 by SI 2000 No. 1231 to permit the use of a gross premium method where the policyholder was not entitled to participate in profits (paragraph 975).

⁵²⁷ This expression does not appear to be defined in the ICAS Regulations 1996.

⁵²⁸ SI 1997 No. 2911.

⁵²⁹ Or the secretary if any, if the company had no chief executive.

⁵³⁰ Regulation 28(a).

⁵³¹ These included statements to the effect that the return had been prepared in accordance with the Regulations; that proper accounting records had been maintained; that an adequate system of control had been established over the company’s transactions and records; and that a margin of solvency had been maintained throughout the financial year in question and a statement in the form of a list of published guidance with which the systems of control complied and in accordance with which the return had been prepared.

⁵³² Covering such matters as the actuary’s opinion as to whether proper records had been kept by the company; that the mathematical reserves (plus any additional surplus shown in Form 14 and specified in the certificate) constituted proper provision at the year end for the long term liabilities; that the liabilities had been assessed in accordance with Part IX of ICR 1994; the actuary’s opinion on the sufficiency of the premiums for contracts entered into during the financial year to meet commitments under those contracts; and, by way of a list, that the professional guidance notes which had been complied with (in place of the earlier requirement which had referred only to compliance with GN1 and GN8).

⁵³³ Such as whether the balance sheet, profit and loss account and revenue account had been prepared in accordance with the ICAS Regulations 1996; whether or not it was reasonable for the directors to make the statements given in their certificates; the extent to which, in giving the opinion, the auditor had relied on the certificate of the actuary with respect to the mathematical reserves and the required minimum margin and the identity and value of any implicit items (for which authorisation had been given by an order made by the Secretary of State under section 68 of the ICA 1982).

⁵³⁴ SI 1997 No. 2911.

⁵³⁵ Appendix D includes a copy of Form 57 as substituted in 1997.

⁵³⁶ SI 2000 No. 1231 (referred to in paragraph 683).

⁵³⁷ SI 2001 No. 3649 (referred to in paragraph 683).

⁵³⁸ This guidance was reissued in a slightly corrected form in February 1997 (with the same version number), in which the layout of one paragraph (5.8) was revised, apparently, to make the intended meaning clearer.

⁵³⁹ In 1994, the Government Actuary (then president of the Institute of Actuaries) expressed the view that ‘the whistleblowing role of the appointed actuary is significant, but most effective if it does not ever have to be used. The appointed actuary acts not so much as an arm of the supervisor, but instead of a supervisor, by providing the management of the company with an internal control mechanism which obviates the need for heavy regulatory intervention .... Clearly the relationship [with the senior management of the company] is not a simple one, but the role is of as much to the benefit of the company as the supervisor. There should rarely be a true conflict of interest’. (This extract of the address was circulated within the DTI on 18 July 1994).

⁵⁴⁰ See paragraph 574 regarding the criteria set out in Schedule 2A to the ICA 1982.

⁵⁴¹ See paragraph 178.

⁵⁴² In contrast, resilience testing considers the impact of various changes in conditions instantaneously at the date of the valuation.

⁵⁴³ In the extract of the presidential address given in 1994 mentioned in footnote 539, the Government Actuary had also stressed the benefits of DST. The extract referred to the position in Canada, where there was said to be a strong emphasis on the role of the appointed actuary in reporting to the board of the company on the future financial condition of the company. The Government Actuary expressed the view that DST was an ‘invaluable tool in exposing the weakness in the company’s financial condition and in focusing management attention on strategies to reduce risk and increase resilience. It also provides the appointed actuary with a basis for discussing strategy with the Board and senior management in a way which is dynamic and relevant to the business decisionmaking process, rather than being defensive or regulatory in its emphasis.’

⁵⁴⁴ JIA 121 III, 597601.

⁵⁴⁵ Mathematical models involving specific selected assumptions which of themselves have no element of randomness.

⁵⁴⁶ Mathematical models in which, for each run of the model, the values for key assumptions (e.g. interest, inflation, mortality, and lapse rates) are selected randomly from statistical distributions. These runs are repeated many times so that the likelihood of a variety of outcomes can be investigated.

⁵⁴⁷ The speaker had noted that, based on his experience, it could be difficult to reduce the amount of information in the report to an intelligible level.

⁵⁴⁸ Memoranda from the Director of the DTI’s Insurance Division dated 20 June 1994 (which was copied to GAD) and from GAD to the Director of the Insurance Division dated 6 July 1994.

⁵⁴⁹ ‘Statutory Regulation of Long Term Insurance Business’ prepared for the F&IA by William M. Abbott and revised by Nick C. Dexter in 2000.

⁵⁵⁰ Paragraph 35 and paragraph B of Appendix 8.

⁵⁵¹ Version 6.0 of GN1 which was issued on 1 December 2001 required the appointed actuary to prepare and submit to the board either a financial condition report in accordance with GN2 or a report ‘in whatever format he or she considers necessary to ensure that the board is sufficiently well informed of the foreseeable risks which could jeopardise the insurer’s financial position’ (paragraph 6.1).

⁵⁵² The Penrose Report (paragraphs 85 and 86 of Chapter 6) suggests that many life offices, including Equitable, were slow to take account of improvements in life expectancy which had been taking place up to that time.

⁵⁵³ See paragraphs 540 et seq.

⁵⁵⁴ It was said that the accountancy bodies recognised that the valuation and certification of the long term liabilities under the ICA 1982 were the sole professional responsibility of the appointed actuary; hence the actuary’s certificate and Schedule 4 of the statutory returns (abstract of the valuation report) were not subject to audit.

⁵⁵⁵ See paragraphs 549 and 550

⁵⁵⁶ Statement of Standard Accounting Practice 2: Disclosure of accounting policies, issued by the Accounting Standards Committee in 1971; since superseded by Financial Reporting Standard (FRS) 18 – Accounting Policies issued by the Accounting Standards Board.

⁵⁵⁷ The statutory basis for calculation of the long term liabilities under the ICA 1982 was modified for the purposes of the Companies Act accounts, particularly as regards the treatment of reserves. This was known as the ‘modified statutory basis’.

⁵⁵⁸ Association of British Insurers (ABI) Guidance Note – Accounting for Insurance Business (Excluding Accounting for Investments) 1995.

⁵⁵⁹ Issued by the Audit Practice Committee (later the Audit Practice Board).

⁵⁶⁰ The current Professional Conduct Standards of the F&IA require that members of either Institute avoid any action which would unfairly injure the professional reputation of any other member.

⁵⁶¹ See paragraphs 693 and 724 regarding the requirements for directors’ certificates to list certain Prudential Guidance Notes issued by the DTI if they had been complied with.

⁵⁶² In the case of Equitable, the guaranteed annuity rate exceeded the current rate from October 1993 until May 1994 and from May 1995 onwards. The interest rate offered on GARs in policies issued by Equitable between 1975 and 1988 (when the company ceased to offer them on new policies) was 7%. As at December 1998, Equitable had some 100,000 GAR policies still in existence (according to a joint opinion of counsel dated 18 December 1998 obtained by the company).

⁵⁶³ The joint counsel’s opinion obtained by Equitable in December 1998 records that the company had notified the DTI in its annual returns from 1993 to 1997 that it made no explicit provision for GARs. The advice expressed the view that whether ICR 1994 required any reserve at all was a matter for ‘actuarial judgment on which we are not qualified to comment’, although the parameters within which that judgment was to be made were a matter of law. The view expressed in that advice was firmly rejected by the prudential regulator and GAD.

⁵⁶⁴ Starting with the 1994 bonus declaration, Equitable had declared different final bonuses for GAR policyholders based on whether or not they elected to take benefits in guaranteed annuity form. The Society’s intention was to ensure that policyholders received the same level of benefits, whether they took those benefits in guaranteed annuity form or at the current rate.

⁵⁶⁵ A separate F&IA working party, which reported early in 1998 on the net premium method of valuation, recommended the retention of this approach as a minimum standard for with-profits business, but a gross premium method for nonprofit business, leading to the amendments to ICR 1994 made by SI 2000 No. 1231 referred to in paragraph 975.

⁵⁶⁶ Suggesting, perhaps, that if such an approach were to be a universal requirement, it might be less unattractive (but this was not explored).

⁵⁶⁷ Equitable had adopted this third approach, in terms of making adjustments to terminal bonus payments and not making any specific provision for guarantees. The Society’s justification for not reserving for GARs had been that reserving could reflect actual and expected experience as to whether policyholders elected to take benefits in guaranteed annuity form. According to the Society, up to and including the end of 1997 the number of policyholders so electing was virtually nil. Equitable made the point that it had notified the DTI (and later the Treasury) of the absence of any specific provision for GARs, by means of a note in the annual returns which appeared from the time of the 1993 returns.

⁵⁶⁸ See footnote 497.

⁵⁶⁹ See paragraph 908.

⁵⁷⁰ DD1998/5.

⁵⁷¹ Whilst noting that the nature of the guarantees offered by companies varied widely.

⁵⁷² with-profits.

⁵⁷³ The inclusion of ‘all’ appears to suggest a need for companies to be aware of the potentially competing interests of different classes of policyholders when deciding on their approach.

⁵⁷⁴ Subject to the caveats mentioned above regarding the appropriateness of any such adjustments in the context of PRE (paragraph 880) and any decision of the courts (paragraph 874). Those involved at the time have told me that the letter was interpreted by Equitable as providing support for its approach of making adjustments to terminal bonuses.

⁵⁷⁵ To which the Treasury had, by then, delegated its prudential regulation functions in relation to insurance (with effect from 1 January 1999).

⁵⁷⁶ [2002] 1 AC 408.

⁵⁷⁷ Several later references to this letter (including those in DAA13) refer to it being dated 13 January 1999; however, they appear to relate to the same letter.

⁵⁷⁸ In the case of accumulating with-profits contracts under paragraph 4(1)(a) of the Schedule a ‘full description of the benefits, including ... any guaranteed investment returns ... and; any material options’ was required.

⁵⁷⁹ SI 1997 No. 2781.

⁵⁸⁰ Examples of such concurrently held functions were the powers to require the production of documents under section 44 of the ICA 1982 and to petition the court for the winding up of an insurance company under section 54.

⁵⁸¹ By SI 1992 No. 1315, see footnote 257.

⁵⁸² See paragraphs 744 et seq.

⁵⁸³ The Baird Report refers to the ‘GAD SLA’ as being ‘the service level agreement between GAD and the DTI (originally, then the Treasury and now the FSA as the prudential regulators) dated 6 November 1998’.

⁵⁸⁴ SI 1998 No. 2842.

⁵⁸⁵ SI 1997 No. 2781, see paragraphs 905 et seq.

⁵⁸⁶ Which the Treasury was not, therefore, empowered to contract out.

⁵⁸⁷ From 1 June 1998, in consequence of amendments made to that Act by the Bank of England Act 1998 (a date referred to as ‘N1’).

⁵⁸⁸ The authorisation containing the schedule of functions was signed on behalf of the Treasury on 18 December 1998, the day on which the FSA SLA was entered into.

⁵⁸⁹ Defined by section 79(1) of the DCOA 1994 to include the holder of an office created or continued in existence by a public general Act or whose remuneration is paid out of money provided by Parliament.

⁵⁹⁰ The date on which the new legislation was to come into force giving the FSA direct statutory responsibility for both prudential and conduct of business regulation of insurance companies was referred to as ‘N2’ (this date was 1 December 2001, pursuant to the FSMA 2000).

⁵⁹¹ Defined in clause 1 of the FSA SLA to include potential policyholders where appropriate.

⁵⁹² Paragraphs 1618 of Schedule 1 to the FSA SLA.

⁵⁹³ The Baird Report, Chapter 2 section 2.6.

⁵⁹⁴ DAA6, see paragraph 524.

⁵⁹⁵ Which required resilience to be tested against assumptions of a reduction in fixedinterest yields of 10%, combined with a fall in equity values of 25%.

⁵⁹⁶ British Actuarial Journal (BAJ) 2, III, 527621 (1996).

⁵⁹⁷ Presented in March 1998 to the Faculty of Actuaries and April 1998 to the Institute of Actuaries: BAJ 4, IV, 803864 (1998).

⁵⁹⁸ Although not entirely (and the proposed drafting was revised).