Submission of the 1992 regulatory returns

Equitable submit their 1992 regulatory returns to DTI. Accompanying those returns are copiesof the Society’s annual report and accounts for 1992, prepared in accordance with the Companies Act 1985 and dated 24 March 1993.

Equitable also send DTI a declaration under section 94A of ICA 1982 and pay Insurance Fees of £17,000 in respect of their 1992 returns.

These documents include the following information about Equitable’s business and their financial position as at 31 December 1992.

Companies Act annual report and accounts

In their President’s Statement, Equitable explain that, in common with most other financial institutions, Equitable believe they are probably entering a period of low investment returns and that bonuses, particularly reversionary bonuses, would have to reflect this. Equitable say the reductions in bonus they are making are in line with the market and that they are maintaining their competitive position in terms of the real returns provided to policyholders.

Equitable’s President goes on to say:

In The Equitable we pride ourselves on allocating earnings from our investments across all classes and durations of contract in as fair and consistent a manner as possible. The fundamental philosophy is that each generation of policies should receive benefits commensurate with the earnings produced during its lifetime. Beyond the bounds of normal commercial prudence, it would be alien to our culture to hold back benefits from one generation to build reserves for a future generation. As we say in our literature, for new policyholders future bonuses must depend primarily upon the earnings produced on the investment of the new premiums. Any deliberate cross subsidies between generations would not be “equitable”. I believe that we can rightly claim that for as long as comparative tables of policy results have been published, the Society can demonstrate that it has provided consistently good value across all types and durations of product.

In their Management Report, Equitable explain that they had recently sent with-profits policyholders notices of their bonuses and statements together with a letter explaining Equitable’s approach to bonuses for 1992. They state that the 1992 bonus declaration had once again demonstrated how the with-profits system smoothed fluctuations in investment performance and that Equitable had taken the opportunity of the good investment returns in 1992 to recover part of the ‘support’ previously given by the smoothing process, particularly in respect of 1990 when investment returns were poor and below the returns allocated to policies.

In their Directors’ Report, Equitable state that, in light of the current investment conditions, in particular the lower gilt yields, they had reduced reversionary bonuses to a level consistent with these gilt yields, which was their traditional approach.

The returns

Equitable’s returns are again submitted in two parts covering Schedules 1, 3 and 6 and Schedule 4 to the ICAS Regulations 1983.

Schedule 1 (Balance sheet and profit and loss account)

As in previous years, Schedule 1 of Equitable’s returns consists of Forms 9, 10, 13, 14 and 16. Form 9 summarises the Society’s financial position at 31 December 1992 as follows:

Equitable do not use in their returns the future profits implicit item that has been agreed with DTI.

Schedule 3 (Long term business: revenue account and additional information)  

As in previous years, Schedule 3 consists of Forms 40 to 51, which have been supplemented by various notes providing further information about/explanation for the figures provided.

Form 45 shows that 43% of Equitable’s non-linked assets are invested in equities, 8% in land and 40% in fixed and variable interest securities (compared with 51%, 11% and 27%, respectively, in 1991).

As in previous years, Equitable disclose in Form 46 that the gross redemption yields on fixed interest securities issued or guaranteed by any government or public authority are, for certain durations, higher than for those not issued or guaranteed by any government or public authority.

In the notes to this part of the returns, Equitable disclose that a provision has been made for the contingent liability for tax on unrealised capital gains in respect of non-linked business, which they estimate to be £1.2m.

Equitable state that they have been granted a section 68 Order which permits them to include in aggregate form details of their ‘Personalised Funds’ in Forms 49, 50, 51 and 57, instead of the separate details for each Personalised Fund required by the ICAS Regulations 1983.

Schedule 6 (Certificates by directors, actuary and auditors)

Three Equitable Directors provide the certification required by Regulation 26(a) of the ICAS Regulations 1983. Equitable’s Appointed Actuary provides the certification required by Regulation 26(b) of the ICAS Regulations 1983. As required by Regulation 27 of the ICAS Regulations 1983, Equitable’s Auditors provide their opinion that Schedules 1, 3 and 6 of the returns have been properly prepared.

Schedule 4 (Abstract of valuation report prepared by the Appointed Actuary)

As in previous years, Equitable present two valuations of their long term liabilities (their main and appendix valuations). The results of the main valuation are carried forward, unadjusted, from Form 58 to Form 14 and on to Form 9.

Schedule 4 – main valuation (text)

Schedule 4 of Equitable’s returns answers the questions set out in paragraphs 1 to 19 of Schedule 4 to the ICAS Regulations 1983 and includes Forms 55 to 58 and Form 60. Equitable state that this valuation conforms to Regulation 54 of ICR 1981.

In response to paragraph 3 of Schedule 4, Equitable provide 14 pages of information about their non-linked contracts. Most of the information about the contracts remains unchanged from previous years.

As in previous years, in paragraph 3(xii) Equitable again disclose that they applied a guaranteed annuity rate to the accumulated cash fund generated by certain types of with-profits pension policies, stating that the guarantees applied to policies issued prior to 1 July 1988.

As in previous years, Equitable provide a description of their principal guarantees of terms. Equitable disclose that recurrent single premium and variable premium deferred annuity policies carry guaranteed terms under which future premiums could be paid.

In response to paragraph 4, Equitable provide 35 pages of information about their linked contracts. Most of the information about the contracts remains unchanged from the previous year.

As in previous years, in paragraph 5 Equitable disclose that they have tested the ability of the Society to hold reserves which satisfy Regulations 54 and 56 to 64 of ICR 1981 in the changed investment conditions described in DAA1. Equitable state:

In these conditions the Society would be able to set up reserves which satisfy [Regulations 54 and 56 to 64 of ICR 1981] without needing to have recourse to the assets whose current value is shown at line 51 of Form 14 [in Schedule 1] of these Returns. No provision was made for any mismatching between the nature (including currency) and term of the assets held and the liabilities valued.

(Note: the entry at line 51 of Form 14 was the excess of the value of admissible assets representing the long term fund over the amount of those funds and represented the difference between the market value and book value of those funds.)

Equitable again state that, in determining the provision needed for resilience reserves and tax on unrealised gains, they have taken account of the fact that the long term fund has been valued at book value.

In paragraph 5(1)(e), Equitable disclose that a reserve for the prospective liability to tax on unrealised capital gains (losses) is held in respect of policies where benefits are linked to the Society’s internal funds. Equitable also disclose that the contingent liability for tax on unrealised capital gains in respect of other business is estimated not to exceed £1.2m. The returns state that the Society considers that there are sufficient margins in the valuation basis to cover this amount and, accordingly, they hold no specific reserve.

As in previous years, in paragraph 5(1)(f) Equitable state that, in current conditions, they do not consider it necessary to hold a specific reserve for the guarantee they offer on a unit-linked annuity.

As in previous years, in paragraph 6(1) Equitable disclose that, for certain non-profit deferred annuities, the valuation rates of interest used were those assumed in the premium basis. Equitable, again, do not elsewhere disclose the rates used in the premium basis.

As in previous years, in paragraph 7(b) Equitable do not explain the method by which they have made provision in the main valuation for expenses on recurrent single premium business.

As in previous years, at paragraph 7(d) Equitable state:

A further valuation has been undertaken using the net premium valuation method. The bases employed are in accordance with Regulations 55 to 64 of the Insurance Companies Regulations 1981. The resultant aggregate liability is less than the aggregate liability on the methods and bases described in this report. The report on the net premium valuation is given in an appendix following Form 60 of this report.

As in previous years, in paragraph 11 Equitable state that they have ‘no business where the rights of policyholders to participate in profits relates to profits from particular parts of the long term business fund’.

As in previous years, in response to paragraph 12, Equitable simply state that they distribute profits in accordance with the principles determined by their Directors and their Articles of Association.

Equitable disclose in paragraph 13 that they had set the reversionary bonus for the main policy classes at 5.0%, compared with 6.5% in 1991. As in previous years, Equitable disclose that some retirement annuity and individual pension policyholders have been offered loans under a ‘loanback’ arrangement.

In response to paragraph 16, Equitable describe their system for determining final bonus.

Schedule 4 – main valuation (forms)

In Form 55, Equitable set out the mathematical reserves held for the various types of non-linked contracts, along with information on number of contracts in force, the benefits guaranteed and the rates of interest and mortality assumptions used in valuing them.

In Form 56, Equitable set out the mathematical reserves held for the various types of linked contracts along with information on the number of contracts in force, the value of current benefits, the level of benefits guaranteed on death or maturity and the rates of interest and mortality assumptions used in valuing them. Equitable again disclose that they hold reserves for non-investment options and other guarantees for many of their unit-linked policies.

In Form 58, Equitable set out the valuation result and the composition and distribution of the fund surplus.

Schedule 4 - appendix valuation (text)

Equitable explain that the appendix valuation:

… was undertaken for the purposes of demonstrating that in aggregate the mathematical reserves determined by the valuation undertaken using the gross premium method, the results of which are reported on the preceding pages, are not less than an amount calculated in accordance with Regulations 55 to 64 of the Insurance Companies Regulations 1981.

Equitable’s appendix valuation provides the information required by paragraphs 1, 5, 6, 7, 9, 17 and 18 of Schedule 4 to ICAS Regulations 1983. They say that the information required for the other paragraphs (apart from paragraph 19 – being a statement of the required minimum margin in the form set out in Form 60 of Schedule 4 which, having had ‘regard to the purpose of the valuation’, has not been provided) is identical to that given in the main valuation.

As in previous years, in response to paragraph 5(1)(a) Equitable state: ‘In these conditions the Society would be able to set up reserves which satisfy [Regulations 54 and 56 to 64 of ICR 1981]  without needing to have recourse to the assets whose current value is shown at line 51 of Form 14 [in Schedule 1] of these Returns. No provision was made for any mismatching between the nature (including currency) and term of the assets held and the liabilities valued’.

As in the main valuation, in paragraph 5(1)(f) Equitable state that, in current conditions, they do not consider it necessary to hold a specific reserve for the guarantee they offer on a unit-linked annuity.

As in previous years, in paragraph 5(1)(g) Equitable disclose the ages that retirement benefits could be taken on their recurrent single premium with-profits pension business.

Unlike in the main valuation, in paragraph 7(b) Equitable explain the method by which they had made provision for future expenses on their recurrent single premium business.

Schedule 4 – appendix valuation (forms)

In the appendix version of Form 55, Equitable set out the mathematical reserves held for the various types of non-linked contracts on the appendix valuation basis.

In the appendix version of Form 56, Equitable set out the mathematical reserves held for the various types of linked contracts on the appendix valuation basis.

Accompanying the initial scrutiny check are two forms (Form B and Form C1) tabulating key figures disclosed in the 1988 to 1992 returns. GAD also produce a new ‘Form B – Initial Scrutiny Form’. As with the previous version, this includes certain key figures disclosed in the returns.

Equitable’s Chief Executive/Appointed Actuary writes to the Government Actuary following a

The relevant press article quotes the Government Actuary as saying:

The Department of Trade and ourselves are considering sending out a questionnaire to get information on two fronts – what companies say to policyholders when they market the contracts, and what their actuaries actually do when deciding on bonus allocation and distribution among their different types of policyholder.

The article also reports:

There are two main areas of concern, says [the Government Actuary]. First, the Department of Trade is worried that proprietary companies, those that have outside shareholders, may be putting the interest of shareholders above those of policyholders and giving them more than their fair share of company profits …

Second, it will investigate whether marketing pressures may be causing certain groups of policyholders to receive less than they deserve, while other groups may be getting more.

The Government Actuary replies to Equitable’s letter of 05/07/1993. He explains that the

The Government Actuary adds:

In one sense there is nothing new in this, since GAD and the DTI have always taken a close interest in policyholders’ reasonable expectations. Indeed, this has been the central issue in many Section 49 Transfers [i.e. transfers of the whole or part of a company’s long term business], in the setting up of sub-funds, in changes to the proportion of surplus going to shareholders and in a number of other areas.We have been signalling for some time that asset share calculations would be one of the aspects on which we would seek to focus during the next round of company visits. On top of this, there have been particular pressures on companies because of falling investment returns and some evidence that proprietary companies are under more than usual pressure to demonstrate value to shareholders These and other factors pointed to the need to focus on this area and for DTI to be seen to be doing something positive to indicate that it has policyholders’reasonable expectations very much in mind.

The Government Actuary concludes by saying:

It is certainly no part of our remit to weaken confidence in the industry, but we do want to ensure that policyholders’ reasonable expectations are given their due place in the thinking of all life offices, and not just the best ones. In my view a debate on these issues can only be a healthy thing.

Lastly, I should reassure you that there is no intention of making any fundamental changes to the style of supervision. As I have already mentioned, PRE has always played an important part in the thinking of DTI and GAD and will continue to do so.We are keen to ensure that best practice prevails but have no intention of introducing statutory regulation on bonus rates.

The Department has an ongoing responsibility to keep itself informed of developments within the life insurance industry, and a particular responsibility to protect policyholders’reasonable expectations. In this context we wish to gain a clearer picture of current industry practice in respect of bonus methodology.

We have therefore asked the Government Actuary’s Department to conduct a survey of leading UK offices which write with-profits business, in order to obtain more detailed information about companies’ bonus philosophies, and the actuarial techniques used in assessing bonus payments.

DTI enclose a letter from GAD to Appointed Actuaries, giving more detail on the survey and attaching the questionnaire. In that letter, GAD explain:

As I am sure you are aware, there is a growing debate within the life insurance industry over the most appropriate method for determining the distribution of surpluses arising in the long-term funds of with-profit offices. Actuaries have introduced some new methodologies for assessing bonuses including the technique known as “asset shares”,although there is no clearly accepted definition of how these asset shares are calculated,and the art or science of asset shares is still not fully developed in actuarial literature. Moreover, there is no information available in the DTI returns about how appropriate rates of bonus are assessed.

GAD continue:

Accordingly, we have decided to conduct a survey of leading U.K. offices transacting with-profits business to ascertain how they determine and distribute surplus arising in their long-term funds for policies becoming payable on surrender, death or maturity. This survey is intended to obtain more detailed information about companies bonus philosophies and the actuarial techniques applied in the assessment of appropriate final or terminal bonuses to be paid on (non-group) with-profit policies than is available elsewhere.

The survey is sub-divided into two broad headings, (i) the content of current marketing literature, combined with information on the principles of distribution in the constitution of the company and (ii) the company’s actual methodology in respect of the determination of appropriate levels of final or terminal bonus payable on with-profit policies.

Within the first heading, we are seeking information about references in current marketing literature, including those contained in offices’ with-profit guides, to a number of specific aspects regarding the allocation of surplus to policyholders. For the purpose of this section of the survey, we are asking by way of example about references in any specific or general marketing literature and product particulars in respect of the current series of endowment assurance contracts. However, if there have been recent changes of significance in your marketing literature to references to the allocation of surplus between policyholders and shareholders, we would be grateful if you would draw this to our attention by suitable responses to the relevant questions, as we would also if different principles are applied for other classes of with-profits policies (both conventional and unitised, if appropriate).

Under the second heading of the survey, we have asked a number of questions about the methods and rationale by which rates of final or terminal bonus are assessed for endowment assurance contracts (though, again, additional information should be provided if differences of approach apply to other contracts).We have included some specific questions about the methods of determination and allocation of surplus arising from various potential sources.

GAD also state that they ‘would not wish to rule out the possibility of publication of a summary of the results, though, if we did so, we would ensure that the responses of individual participating offices could not be identified’.

Equitable write to GAD enclosing their completed questionnaire for the with-profits survey. Within their responses to part (i) of GAD’s survey (about marketing literature and principles of distribution), Equitable say that their Articles of Association give:

… the Society’s Directors absolute discretion as to bonus allocations. Beyond that, there is no statement of bonus philosophy in the Society’s constitution.

… The main statement of the Society’s long-standing philosophy on bonus distribution in marketing literature is contained in … the With Profits Guide …

The Society explains further that their With-Profits Guides give no specific information on the period and magnitude of smoothing or the likely frequency of changes to final bonus rates. However, general comments in the Guide could be expected to lead policyholders to expect relatively infrequent changes to the latter.

Equitable enclose copies of their Articles of Association, their with-profits Guide (dated May1993), product particulars for endowment assurances (dated March 1993) and for personal pensions (dated October 1992), and the current version of their leaflet on bonuses (dated May1993).

Equitable provide the detailed information sought in part (ii) of GAD’s survey (about actual methodology for determining final or terminal bonuses). Equitable explain in particular:

      
• that, for surrenders, ‘the full policy value (including final bonus) is normally adjusted to ensure that the surrender value paid does not exceed the underlying asset share.The level of adjustment required is monitored monthly’;
      
• that, when determining the annual expense level attributed to with-profits contracts for recurrent single premium business, ‘allowance is made for an implicit fund charge of ½% pa. That is, the gross rate of accumulation … is taken to be ½% pa higher for conventional contracts, such as endowment assurances, than for recurrent single premium contracts’;
      
• that, when assessing appropriate final or terminal bonuses, Equitable make no allowance for a charge for the guarantee provided in respect of benefits payable on maturity or for a contribution to an ‘estate’;
      
• that Equitable do not discriminate between different contracts in their smoothing process;
      
• that the smoothing of final or terminal bonuses ‘is determined by the relationship between the accumulation rates determined each year and actual investment earnings. That smoothing is also reflected in the comparison of the aggregate total policy values with actual asset values. In normal circumstances the Directors look to apply a 3 to 5 year averaging cycle but expect to apply that more flexibly in more unusual circumstances’; and
      
• that, when valuing their assets for the above comparison, ‘allowance is made for the accumulated new business strains which will be recouped from future premium loadings’.

Equitable add: ‘Part of the Society’s stated philosophy is to achieve a reasonable degree of stability in proceeds with gradual, rather than sudden, changes in proceeds. The approach to smoothing needs to reflect that philosophy, particularly in volatile investment conditions’.

DTI’s Line Manager B writes again to an Equitable policyholder (see 23/07/1993 [entry 2]). He explains that: ‘The Secretary of State does have extensive powers to intervene in the affairs of insurance companies if, in his opinion, this is necessary to protect the reasonable expectations of policyholders’. However, the Line Manager says that he does not consider on this occasion that it would be appropriate to use these powers, as ‘Equitable appear to have taken the view that equity amongst all policyholders is best served by setting final bonus rates which are very similar (in terms of % per year of policy term) for policies of all terms’.

Line Manager B continues that he ‘would be very surprised if this turned out to be an unreasonable approach’ and that ‘it is very much in line with the approach taken by the market generally’. Line Manager B suggests that the policyholder may wish to pursue the matter with the Insurance Ombudsman and he provides their details.

The Directing Actuary concludes by saying:

Finally, and very importantly, free asset ratios as published in the DTI returns reflect the reserving basis used by the actuary in determining the company’s liabilities. The ratios shown in the tables, therefore, do not take account of the varying strengths in those reserves, and some caution should be expressed when using them to indicate the relative financial strengths of companies.

… a significant attraction to policyholders in having access to an interest paying deposit type contract – and I would certainly rather give our members fatter returns rather than fund managers generally. The ensuing strengthening of the balance sheet would be useful by product.

The Appointed Actuary asks if DTI would be willing to support an application for a section 68Order.

I leave it to your judgemental as to how precisely to define “significant”, but for non-life companies I am thinking of at least a five percentage point deterioration, and for life at least two or three. Clearly “significance” becomes greater if the company is actually close to the minimum required margin (or double it for non-life).

The Director says that he is not concerned for this purpose with:

• companies that are already on our lists of companies causing concern;
            
• subsidiaries in groups where group accounting concessions operate, unless there are particular problems in a group you want to draw to my attention;
            
• very small companies which are not of commercial or regulatory significance.

with their comments, to DTI for them to reply.

A DTI official (and former Line Manager with responsibility for Equitable (Line Manager A))writes to the Head of Life Insurance with the results of the exercise to establish which companies had shown a significant deterioration in their 1992 solvency cover compared with1991. (See 24/09/1993.)

The official attaches a list of companies supervised and explains that slightly less than half have experienced a reduction in their solvency margin. He suggests that the Director of Insurance’criteria for identifying companies should be modified to exclude:

                  
1. companies in “intensive care”. These are slightly different from those we report as“causing concern”. Rather they are the companies which we recognise as weak or as having special problems, but which we do not actually report to the Minister, mainly because they have managed to struggle on over a number of years, mainly on the strength of “drip fed” capital. Reporting that they are in difficulties would be misleading.We nevertheless regard them as high priority and are in regular touch. Such companies are [five named companies] and many others. Almost all fall into [the Director of Insurance’s] third category – small without much commercial significance (although their regulatory significance is high); and
                  
2. managed pension fund subsidiaries; these cause few problems. The business they do results in very little financial strain and they can, in fact, survive on very thin margins.

Using this modified criteria and GAD’s note of 16/08/1993, the official highlights 16 companies which ‘we should be paying special attention to in the remainder of 1993 and 1994’. This list includes Equitable, with a note that they are one of eleven companies ‘from [Directing Actuary A’s] free asset ratio list’, but also one of four from this list which have shown a marked improvement in terms of solvency.

The official draws attention to Directing Actuary A’s ‘disclaimer about the various reserving bases used by different actuaries making it difficult to compare the strength of one office with another’.

As the rate of interest would presumably need to be fairly high, perhaps above the market rate, how would the issue of these deposits benefit the security and, more importantly, the reasonable expectations of members generally?

DTI conclude by saying:

Our view is that it would be particularly important that the rights of the [depositors]should be subordinated to those of the with-profits policyholders in respect of their reasonable expectations to future bonuses, not just their guaranteed benefits, and that this was clearly understood by the [depositors].

GAD write to Equitable’s Appointed Actuary. GAD refer to the very useful series of discussion son the effect of market conditions on life insurers which they have held with a number of Appointed Actuaries towards the end of 1992 (see 15/09/1992). GAD seek a further meeting with Equitable to take account of any developments over the last year. GAD set out the matters they wish to pursue under four main topics:

Financial position – saying GAD wish to discuss both the current and projected position. GAD ask for a copy, prior to the meeting, of any relevant report or business plan.

Bonus policy – saying GAD wish to confirm their understanding of how Equitable set their annual reversionary bonus rates and the investment return required to support current bonus rates; to discuss the likely bonuses for 1993 and their sustainability over the next few years in the event of low rates of investment return; and to obtain information about the relationship of current payouts to asset shares and the period over which it is intended to smooth these payouts. GAD add that they may wish to clarify some points from Equitable’s response to the with-profits survey.

Investment policy – saying GAD wish to discuss what rates of return Equitable are assuming for their projections and bonus policy.

Resilience reserves – saying GAD wish to discuss the potential effect of the modifications to the resilience test, as set out in the Government Actuary’s letter of 30/09/1993.

The meeting takes place on 30/11/1993 (see entry below).

Equitable’s Appointed Actuary provides GAD with some background documents ahead of the meeting on 30/11/1993. Those documents are in five categories, being:

1) Standard & Poor’s insurance rating analysis for Equitable dated November 1993

The rating given is ‘AA (Excellent)’, which is explained as: ‘Insurers rated “AA” offer excellent financial security. Capacity to meet policyholder obligations is strong under a variety of economic and underwriting conditions’.

The rationale for the rating includes that:

On the basis of its published valuation, ELAS appears to have relatively weak free asset and investment leverage ratios: 2%-5% (since 1990) and above 920%, respectively. However, free assets are understated by the use of a very conservative valuation basis. Adjusted to a more conventional reserving basis, the free asset ratio is much stronger,near 10% in 1992, with investment leverage at a much more moderate level around 480%.[Standard & Poor’s] expects these levels of strength to continue.

It continues:

Because of substantial holdings of equity assets, high profit distribution to policyholders,and mutual status, ELAS’s free asset base appears slightly more susceptible to sharp investment or economic fluctuations than some peers. However, [Standard & Poor’s]believes this apparent susceptibility is balanced by ELAS’s existing capital strength, limited sales of products with significant reserving strain, and the ability to maintain favourable balance between policyholder reversionary and terminal bonuses.

Under the heading ‘Management and Corporate Strategy’, the report says:

The Society minimizes any cross-subsidy of one group of policies by another. Its commitment to fairness has led to a high level of distribution and a strict limitation on any retention of today’s policyholder profits for the security of future policyholders. This implies a lower level of published free assets than some competitors, though [Standard &Poor’s] notes the use of a relatively strong valuation basis that significantly understates the level of the Society’s free assets compared with other major U.K. offices.

Under the heading ‘Capitalisation’, and in relation to Equitable’s main valuation presented in their regulatory returns, the analysis says:

… on the basis of the published valuation, which uses a gross premium basis, ELAS had modest free asset ratio at December 1992 of 5.1% [and a] ratio of available asset/minimum required margin of 236.5% …

The analysis goes on to say that Equitable’s main valuation basis:

… understates the level of the Society’s free assets, and that underlying financial strengths considerably stronger than published figures suggest.

The analysis explains that the reason for this view is because:

Using an appropriate alternative net premium valuation for year-end 1992, ELAS would have a much stronger free asset ratio of about 10% [and] ratio of available assets/minimum margin near 340% …

2) Monthly business statistics for the period ending 31 October 1993 (presented to theEquitable Board on 25 November 1993)

These monthly business statistics comprise of seven reports, being:

•  Revenue Analysis – Global Business
• The Equitable Life Assurance Society Balance Sheet
• “Equitable Management Company” – Global Business Profit & Loss Account
• “Equitable Management Company” – Non UK Business Profit & Loss Account
• Investment of net addition to fund
• UK with profits investment performance
• UK Linked business investment performance.

3) Paper entitled ‘Bonus Declaration at 31 December 1993’ (presented to the Equitable Board on25 November 1993)

The paper says that earnings on the with-profits fund are expected to be high at around 20 to25%. However, it says that, due to the fall in interest rates, some of the return is spurious, and:‘If we took, as a board measure of the intrinsic return on assets for 1993, a weighted mix of the overall equity returns and the income yield only on fixed interest, the outcome would be a return of around 17%’. The paper then advises that:

The relatively high level of nominal earnings in 1993, coupled with some relaxation on the regulatory side, as described in the quarterly review of revenue considered last month,means that, virtually irrespective of the bonus decisions taken this year, our published position at 31 December 1993 will be significantly “stronger” than last year. The presentational implications of our decisions are therefore much less important than has been the case in recent years. This year we can focus predominantly on fundamentals informulating decisions and that is to be welcomed.

Under the heading ‘Total policy values’, the paper says:

For our main classes of business, total policy values and, hence, final bonuses, are determined by rolling forward the value at the end of the previous year, together with subsequent premiums, at a “total growth rate”. The key decision which the board needs to take regarding bonuses is the level of that total growth rate which then needs breakingup into declared and final bonus rates. The determination of appropriate bonus rates forother products is essentially a technical exercise.

For 1990 and 1991 the total growth rate was 12% p.a. For 1992 a rate of 10% was applied tothe benefits in force at the start of the year and 12% to premiums applied within the year i.e. for new money. That was in reflection of the relatively high earnings in 1992 and the need, on the older business, to recover part of the over-distribution in respect of 1990.Policy pay-outs are currently being determined by rolling forward 31 December 1992 values, together with subsequent premiums, at 10% p.a.

It continues:

For 1993 we need to decide what is the appropriate rate or rates in the light of the earnings position described … above. An intrinsic return comparable to that earned in1992 would indicate that similar total growth rates are appropriate – i.e. around 12% p.a.we also need to bear in mind that total policy values are still above the value of the underlying assets. To some extent 1993 might be regarded as the converse of 1990.Allocation of a relatively modest rate of around 12% when “usable” earnings are about17% will restore a position of balance between assets and policy values. If earnings in future years are at relatively low levels the opportunity for such action may not recur for some time.

4) Paper entitled ‘Revenue – Review of First 9 Months’ (presented to the Equitable Board on27 October 1993)

The paper sets out the premium and investment income received and the payments made to policyholders.

Under the heading ‘Earnings and solvency position’, the paper says that the earnings on the with-profits fund for the first nine months of 1993 is 17.3%. The paper then explains that:

The relatively high earnings level to date has been associated with corresponding falls in income yields on both fixed interest securities and equities. The board are reminded that, in solvency terms, the effect of high earnings can be offset by the effects of thecorresponding reduction in the income yield on the assets. As income yields fall, thediscount rate which can be used in valuing the liabilities also falls. Purely on technical grounds, therefore, the liability valuation can grow as the capital values of the assets rise.

As discussed on previous occasions, the statutory minimum basis for liability reserves islaid down in regulations. These regulations have been supplemented by informal requirements specified by the Government Actuary. Although those requirements are notmandatory, most offices, including the Society, have chosen to set reserves at a level which meant the informal requirements were satisfied. That is, the requirements have ledto an effective minimum basis somewhat stronger than the bare statutory minimum.That is the basis on which we have discussed “Form 9” presentations. The GovernmentActuary has recently announced a modification to those requirements in the face of ageneral view that the original requirements were unduly stringent in current investment conditions.

The paper continues:

As mentioned above, these additional requirements are not mandatory and [theAppointed Actuary] may consider it appropriate either to challenge the requirements as inappropriate or set a basis somewhat stronger than that indicated by the requirements.To paint a picture of the range of outcomes the estimated “Form 9” position is shown below on 3 different bases – the valuation basis used at 31.12.92, the minimum indicatedby the new requirements, and the traditional “premium basis” valuation used in 1989 and earlier years. The actual 31.12.92 position is also shown for comparison:

(a) excluding accrued declared bonus

(b) including cost of declared bonus

Continued use of the 31.12.92 basis is probably not tenable in view of the reduction in yields this year. If [the Appointed Actuary] considered that use of a basis of similar strength to that indicated by current guidelines was appropriate, then that represents a point broadly mid-way between the 31.12.92 and 31.12.89 bases. At this level our published“strength” would be substantially greater than at 31.12.92. The figures indicate that a move back to our traditional basis is now possible but might result in an unacceptably “weak”published position at this stage. It should, however, be remembered that there is a hidden margin in the inadmissible assets. If either we sold the FTSE option before the year end or obtained a dispensation allowing us to bring it into account, some £60-70m would be added to the DTI value of assets and, consequently, the “free” assets.

5) Paper entitled ‘Cost Management and Control – Report on the First Nine Months’(presented to the Equitable Board on 27 October 1993)

The paper comments on the accounts of the Equitable Management Company.

GAD (Chief Actuary C and Scrutinising Actuary C) and DTI (Line Supervisor B) meet Equitable’s

Appointed Actuary. Scrutinising Actuary C’s note of the meeting records the documents sent by Equitable prior to the meeting, including the ‘recent very full report (paid for by Equitable!)from Standard & Poor’s … giving the company a very good rating’. He also records the Appointed Actuary’s view that some of the topics set out in GAD’s letter of 05/11/1993 ‘were not areas about which we as regulators had the right to enquire. Having said that, he was willing in practice to discuss anything we wished’.

The Scrutinising Actuary notes that the meeting first discussed the likely bonus at the end of1993 and that the Appointed Actuary had reported a further reduction in the declared rate of at least 1% leading to a bonus rate of 4% or less. This would need 7.5% to support, which approximated to the return on the gilt portfolio. The Scrutinising Actuary notes that the Appointed Actuary had said that he was expecting this to eliminate the recent excess of payouts over asset shares and that future bonuses would depend primarily on the returns earned on future premiums. The Scrutinising Actuary comments that this indicated possible further reductions and that Equitable ‘appeared to be moving to a lower proportion of the total bonus payout being guaranteed (i.e. declared as distinct from terminal)’.

Scrutinising Actuary C records that the meeting then turned to valuation issues and that the Appointed Actuary had indicated that the position at the end of 1993 would be significantly stronger than at the end of 1992, and that the new business strain expected in 1993 was only approximately £25m. GAD’s note continues:

There was a discussion on the resilience test and [the Appointed Actuary] commented that as markets were currently moving the new tests were becoming tighter. Pensions business has a guaranteed annuity rate at about 7% but this was not as onerous as it appeared since, because “old” policies had been given the benefit of more modern features and options, it would be reasonable (in his view) for the allocation of final bonus to be conditional on the waiving of this guarantee. [Chief Actuary C] asked particularly about the resilience test in the context of the net premium valuation described in the Appendix to Schedule 4, since it was not explicitly mentioned there; [the Appointed Actuary] was sure that resilience had been allowed for, but promised to investigate and confirm.

Scrutinising Actuary C notes that, in conclusion, the meeting had discussed investment policy and that the Appointed Actuary had explained that Equitable’s investment decisions were ‘a result of the judgement of the investment team and not driven by resilience concerns’. At the meeting Equitable undertake to provide GAD with some further papers (see 07/04/1994).

DTI’s copies of the papers Equitable provided to GAD prior to the meeting contain annotations made by Line Supervisor B at the meeting.

On the Board paper entitled ‘Cost Management and Control – Report on the First Nine Months’, Line Supervisor B notes:

Solvency position will be tightening. Guarantees – don’t reserve for them …We have no guarantees that bite. [Chief Actuary C]: PRE?

On the Board paper headed ‘Revenue – Review of First 9 Months’, Line Supervisor B notes that the current GAD minimum basis incorporates the resilience reserve.

On the Board paper headed ‘Bonus Declaration at 31 December 1993’, Line Supervisor B notes that Equitable are likely to declare a reversionary bonus rate for 1993 of around 4% and that‘GAD said they’d be happy with [this]’.

These calculations include, for the estimated annual profits, that:

Average annual profit = 1207.9/5 = £241.5m

Notes: (a) Surplus was increased by £557.0m as a result of changes in valuation bases during 1990.

(b) Surplus was reduced by £13.2m as a result of changes in valuation bases during 1991.

(c) Surplus was reduced by £89.4m as a result of changes in valuation bases during 1992.

The calculations state that the average period to run for the Society’s in-force contracts is eight years. The Society’s Appointed Actuary explains:

The periods to run have been reduced to take account of premature withdrawals based on the Society’s recent experience of such withdrawals. In respect of retirement annuity and personal pension contracts for which a range of retirement ages is available, it has been assumed that retirement benefits are taken at the lowest possible age, or immediately if that age has already been attained.

The calculations suggest that the maximum future profits permissible is 50% of £241.5mmultiplied by eight years – that being £966m.

DTI inform the Society’s Appointed Actuary that the questions in the Department’s letter of

01/11/1993 apply to all life companies seeking to raise hybrid capital. DTI say that the questions are ‘particularly relevant to with-profit offices, because of the need to take into account policyholders’ reasonable expectations’. There is no evidence of a further reply by Equitable.  

DTI ask GAD for their views on Equitable’s application for a section 68 Order.

GAD provide DTI with comments on the application made on 03/12/1993. GAD say that it is Equitable’s regular practice:

… to apply for such an Order shortly before the year end as a precautionary measure. So far as I can see they have never used it, and are most unlikely to do so as at 31 December 1993, but no doubt they feel that it is a useful protection against adverse market movements (for example) right at the end of the year. As usual the amount of the implicit item sought is well below the maximum allowed by the Regulations; on this occasion it is under half that maximum.

We suggest that you issue the Order in the usual way.

assessment of their potential liability to compensation claims from policyholders who had

received inappropriate advice about transfer or opt-out from occupational pension schemes.

DTI seek in particular:

• the best available indication of the total policies sold since 1988;
                              
• the percentages obtained through a direct sales force, independent financial adviser sand appointed representatives;
                              
• the percentages of business represented by both transfers and opt-outs from occupational schemes; and
                              
• the best provisional estimate of the potential cost of compensation.