1994

The Personal Investment Authority (PIA) becomes responsible for the regulation of the conduct of business by its member companies.

At the time [Line Manager A’s] list was drawn up, both [Equitable and the other company] seemed rather marginal candidates for inclusion, a view confirmed by the recent contacts. They are both well-managed and reasonably successful; neither appears to be anywhere near the slippery slope at present. I believe that they need no special attention before submission of the 1993 returns.

Line Manager B concludes: ‘In the light of the above I have not asked [Line Supervisor B] to attend your meeting in my place although I believe she is available if you should need her’.

DTI write to the Chief Executives of all life companies, following up their letter of 23/12/1993 about potential liabilities in respect of pension mis-selling. DTI explain:

This letter gives you guidance on how the Department expects companies (including branches where appropriate) to reserve for any such mis-selling of personal pension contracts in future Companies Act accounts and DTI returns.

DTI state:

Where a life office believes that it is likely to have a liability in respect of the mis-selling of pension business, the Department believes that such liability should be recognised in one or both of the following ways, depending on the specific circumstances:

  
• the liability may be recorded as part of the mathematical reserves;
  
• a provision may be made in the accounts, in accordance with generally accepted accounting practice.

DTI go on to clarify that:

Such liabilities should not be omitted on the understanding that they can be covered by the solvency margin.

DTI add: ‘It is recognised that there may be considerable difficulty in assessing the extent of any liability, but this does not remove the obligation of the office to compute the best estimate of the amount, based upon available data and reasonable enquiries’.

They advise that companies and Appointed Actuaries should consider if sums should be set aside to cover expenses in carrying out investigations into mis-selling.

Where the accounts or returns do not show explicitly the amount of the provision made resulting from mis-selling (eg. because it is included, in whole or in part, within the appointed actuary’s valuation basis), companies will need to supply this additional information to the Department, and the directors and auditors will, of course, need to satisfy themselves as to the total provision made in accordance with normal procedures.

Finally, DTI advise:

If the position when the DTI returns are submitted (no later than six months after the balance sheet date) is significantly different from the position when Companies Act accounts are drawn up, the returns should be adjusted as appropriate for such post-balance sheet events or other factors which result in changes being required to the provision estimates. Reference should also be made to any action taken by the shareholders to maintain the required solvency margin, if that has been necessary.

Equitable’s Chief Executive writes to DTI in response to their letter of 23/12/1993. He provides the following answers to the questions raised by DTI:

  
• the total number of transferred personal pension plans currently in force is 37,678;
  
• Equitable sell only through their own directly employed sales force but ‘much of the business was unsolicited and in “execution only” form’;
  
• Equitable cannot provide the detail requested, but they expect the number of opt-outs from occupational pension schemes to be minimal, as their policy is not to accept such cases in normal circumstances; and
  
• Equitable currently have no known liability for transfer compensation, and consequently no provision will be allowed for in their 1993 returns. He points out that they ‘do, of course, have significant free assets since our business is predominantly with-profits’.

The Chief Executive adds that he believes:

… the impact on the Society’s business caused by personal pensions transfers will not be significant. We ensure as far as we can that the policies for which we have a liability are valid policies which satisfy client needs. If there is any subsequent information to suggest otherwise, I will, of course, let you know.

Equitable’s Chief Executive writes to DTI, having now received the further letter of 18/01/1994. The Chief Executive says:

The Society has no known liability for compensation for mis-selling of personal pension transfers and I see no need to make any provision in the Companies Act accounts. Given the general standard of the sales process in the Society, I should be very surprised if there were any significant liabilities anyway. If one did emerge, I should expect to include it in the mathematical reserves. Your point about informing the Department of any such provision in the DTI returns is noted.

The DTI legal adviser raises with Line Supervisor B some queries about Equitable’s requested section 68 Order. The adviser says that she assumes Equitable’s need for a section 68 Order derives from the fact that the financial instrument is a contract for difference, rather than an option and she suggests, therefore, that it might be helpful to see the terms of the agreement. The adviser continues:

Before I let you have a draft Order, I think we need further confirmation that [the bank] is an “approved counterparty” as defined in the draft 1994 Regulations (Reg 50(1)).

Equitable provide DTI with the documentation requested on the call option. Equitable also explain:

Several of the forms in the Society’s annual returns to the DTI are dependent on the outcome of the Society’s application for this Section 68 Order. As work on the 1993 returns is in progress, it would be helpful if you could indicate when you expect to be able to let us know whether or not our application has been successful so that we may plan accordingly.

(Note: Equitable recorded internally that other offices had obtained section 68 Orders and that it was surprising that DTI were not being more efficient in dealing with their request.)

DTI’s Director of Insurance writes to the Head of Life Insurance in response to the briefing of

16/02/1994. The Director asks whether the Head of Life Insurance knows anything about Equitable’s overseas business or their future plans, as this is what the President of the Board of Trade was likely to be interested in.

DTI’s Line Supervisor B provides slightly expanded briefing for the President (which is agreed with the Head of Life Insurance). In the background section, DTI state:

The latest returns submitted to DTI show its solvency position to be strong. In late 1993, the company received an “AA” rating from Standard & Poor’s for its excellent claims paying ability.

On mis-selling, DTI refer to the survey on possible mis-selling of pensions and note Equitable’s response that they ‘did not see a need to make any provision for compensation in its accounts, given the high standard of selling techniques in the Society’.

Under the heading ‘Deregulation’, DTI state:

BACKGROUND – Insurance division deregulation subjects put forward are:

  
1. removal of the need for a five-yearly statement of life assurance business [i.e. Schedule 5 of the returns]
  
2. removal of the need for an annual statement of insurance companies’ connected intermediaries.

LINE TO TAKE – we have consulted interested parties on these proposals and have received universal support for the removal of (b) above. Regarding (a), some consulting actuaries have argued for its retention. We are considering the possibility of retaining some information from the present statement in the annual returns.

DTI’s Line Supervisor B provides the Head of Life Insurance with further briefing for the visit on 23/02/1994, which the Head is now attending on behalf of the President. She supplies solvency figures for 31 December 1991 and 31 December 1992. She refers to Equitable’s correspondence about hybrid capital and a section 68 Order on their call option. She notes the visit to Equitable on 30/11/1993, which had been to discuss:

… financial issues, eg resilience testing, bonus policies, investment strategy (follow-up to similar meeting a year before).

Line Supervisor B adds:

Managerial issue: [The same person] is currently [Managing Director] and [Appointed Actuary]. At our visit in May 1992, we expressed concern about possible conflict of interests of two roles. He did not see this as a problem. He is due to retire in c1995/6, by which time the two roles would be separated again.

The Line Supervisor attaches to the note a copy of Equitable’s 1992 annual report and accounts, prepared in accordance with the Companies Act 1985, and a copy of Standard & Poor’s rating report for the Society.

The Head of Life Insurance attends the lunch with Equitable. In a note to Line Supervisor B, the

Head of Life Insurance records that he was asked to talk about supervision and he ‘touched briefly on our philosophy of supervision; the way we operated; and current issues such as the Third Directives, FSA-related topics such as disclosure and personal pensions, and deregulation’. The Head of Life Insurance’s note continues:

I also described our interest in the future structure of the life industry, and our concern that the apparent over-capacity in the market should be reduced in as orderly a way as possible. This last point aroused considerable interest; several Board members (notably [Equitable’s President]) were in favour of the Department taking a very active and interventionist approach to reduce the number of companies. Their motives were not entirely disinterested; [Equitable’s President] said that he thought there was too much competition in the life insurance sector, and that Equitable would be glad if the DTI removed some competitors, so that the Equitable’s market share could go up! I said that I did not see this as the DTI’s role, a better response was greater disclosure, which a company like the Equitable, with low costs and no commission paid to intermediaries, should be able to benefit from.

He also records: ‘[Equitable’s Appointed Actuary] had not realised that it was DTI rather than GAD which supervised his company. I explained the position, and told him that you were his supervisor. He was grateful for this information!’.

DTI’s Line Supervisor B writes to the legal adviser in response to her queries of 09/02/1994.

She provides the documentation sent by Equitable on 17/02/1994. She comments that the American bank which wrote the option satisfies the draft 1994 regulations. She asks the official to prepare the section 68 Order.

GAD’s Scrutinising Actuary C prepares some ‘Detailed Scrutiny Notes’ for Equitable’s 1992 returns.

Under ‘Standard reporting items’, the Scrutinising Actuary notes the cover for the required minimum margin. He also includes two tables providing a ‘recent history’ of new business and of expenses. The tables cover the years 1989 to 1992.

Under ‘Initial scrutiny notes’, the Scrutinising Actuary reiterates the comments provided in the ‘Aspects which look worrying’ and ‘Other notes’ sections (see 05/07/1993 [entry 1]), those being: ‘[Unit-linked] parameters include a generously high real growth assumption (however this is not a major class)’ and ‘Fixed Interest proportion has risen to 38% (was 26%)’.

Under ‘Review of file’, the Scrutinising Actuary notes that the minute of 3 March 1992 and the note of the meeting held on 30 November 1992 ‘should be noted in particular’. (Note: It appears that the correct references are to the comments to DTI on 03/03/1993 and the note of the meeting on 30/11/1993.)

Scrutinising Actuary C includes the remarks ‘Nil’ under the headings of ‘Report & Accounts’ and ‘Returns – Schedules 1 – 3’.

Under ‘Returns – Schedule 4’, the Actuary notes that, according to Equitable’s letter of 09/03/1993, they had strengthened their valuation basis by about £100m. He also notes that reversionary and terminal bonus rates have again been reduced.

Finally, under ‘Miscellaneous’, the Scrutinising Actuary notes that Equitable consider their liabilities for mis-selling of personal pensions to be negligible. The Scrutinising Actuary states that he has checked Equitable’s reply to GAD’s survey on ‘With Profits Policies: Distribution of Surpluses’ and there is ‘nothing to note’.

GAD complete their scrutiny of the Society’s 1992 regulatory returns. GAD write to DTI with a report on the results of their work. (A copy of this scrutiny report is reproduced in full within Part 4 of this report.) GAD provide a two page report and say that Equitable have ‘again had a successful year overall’. GAD note that Equitable:

… publish, rather unusually, a Bonus Reserve Valuation (BRV) and then, as an Appendix  to Schedule 4, a Net Premium Valuation (NPV) in accordance with the Regulations. The reserves on the BRV are always demonstrated to be higher than those required using  the NPV.

GAD explain that the bonus reserve valuation shows cover for the required minimum margin of 2.36 (compared with 1.67 in 1991). GAD note that the net premium valuation shows cover of about 3.9. However, they ‘have one or two questions about the NPV valuation basis’. GAD state they are:

… satisfied that the BRV (and hence the overall returns as formally deposited) is, in aggregate, adequate according to the Regulations. As at the end of 1992 it was on a similar basis to 1991 but with some minor strengthening, amounting to some £100m overall.

GAD draw attention to the fact that Equitable’s business is largely with-profits and nearly all on a single or recurrent single premium basis. GAD say: ‘As we have discussed before – see in particular my minute of 3 March 1992 – this makes it difficult to compare Equitable with other with profits companies’.

GAD continue:

We have been concerned in the past that they have over-distributed and weakened their reserves. More recently matters seem to have been brought under better control. The situation as at 31 December 1992 is more satisfactory than the previous year, and as you will know from recent reports (eg the notes of the meeting held on 30 November last) we expect the position as at the end of 1993 to have improved still further. Reversionary and terminal bonus rates were reduced at the end of 1992 and it has just been confirmed that reversionary bonuses have been reduced again from the end of 1993.

GAD set out two tables showing the recent history of new United Kingdom business and of expenses. GAD explain that Equitable have responded to the letters about liability for mis-selling of personal pensions ‘indicating that they expect any such liability to be negligible; from our knowledge of the company we would have no reason to doubt this’. GAD conclude that they still had some questions on the 1992 returns:

… relating to particular features of the NPV basis which might appear somewhat weak. We have also asked the actuary for some formal information about bonuses, and also for his indication of the position as at the end of 1993.

On DTI’s copy of this note, they have underlined the words ‘formal information’ and written ‘OK’.

GAD attach a copy of their letter to Equitable, in which they take up outstanding questions on the 1992 returns. GAD say that they have noticed recent press comment regarding Equitable’s bonus announcement and ask for a copy of all the new rates of bonus. GAD also ask to be provided with a copy of the Society’s most recent With-Profits Guide. GAD add: ‘It occurs to me that you may have regular mailing lists of recipients of these two items, and if you could add my name to those lists it might save some routine correspondence in the future’.

GAD refer to ‘a most useful meeting here last November [see 30/11/1993] at which several points were cleared up’. GAD ask Equitable:

1. ‘In the Appendix (where the net premium results are set out) you mention in para. 5(a) on page 98 that resilience reserves could be set up without recourse to the Form 14 line 51 assets. However you do not give an indication of the amount of any resilience reserve which would be required on the net premium basis and which is not covered by the net premium liabilities. Could you please advise this amount as at 31 December 1992, and ensure that the corresponding figure is disclosed in future returns’;
2. to provide the figure for the growth rate of non-unit reserves, if the real rather than gross rate of return were used;
3. to explain the origin of a deduction in the capital gains tax reserve shown in Form 56, column 12; and
4. ‘Finally, the rate of 9% used to value the non-profit immediate annuities seems on the high side. Could you please supply more details of the assets that are deemed to be backing these liabilities, and their yields, having regard to Regulation 59(2) and (6)(a).’

GAD conclude:

It would also be helpful if you could let me have a preliminary estimate of the position as at the end of 1993, in a similar form to that in your letter of 9 March 1993; that is to say, an estimate of your Required Minimum Margin and the available assets, and also the rate earned on your fund during 1993. An indication of the quantum of strengthening of the valuation basis, as referred to in … the documents we had for the November meeting, would be appreciated also.

Equitable’s Appointed Actuary responds to GAD’s letter of 28/03/1994. The Appointed Actuary encloses a copy of the Society’s booklet entitled ‘Bonuses’ which details the most recent bonus rates. He explains that the Society will supply the With-Profits Guide when it has been updated and that, as they do not have a mailing list for this, he has added GAD’s name to the distribution list for all future press releases which would include one on the bonus declaration each year.

The Appointed Actuary also encloses copies of the Board papers he had undertaken to send at the meeting with GAD on 30/11/1993, being reports on Equitable’s valuation and bonus declarations for 1993 prepared for the Board’s meetings in November 1993 and January and February 1994. The Appointed Actuary explains that he has included only the actuarial part of the January report, as the rest deals with commercial aspects of the declaration which he considers it would not be appropriate to release.

In response to GAD’s four questions in their letter of 28/03/1994, Equitable’s Appointed Actuary explains that:

(1) The resilience reserve required on the net premium basis would have been £462m.

GAD’s Chief Actuary C annotates the letter at this point: ‘[Scrutinising Actuary C], What was the difference between the [bonus reserve valuation] and [net premium valuation] reserves. Your minute to DTI implies £450m. Perhaps you should ask [the Appointed Actuary] to explain the statement in para 5(a) [regarding Equitable’s provision for long-term liabilities] on [page 98]’. Someone adds two further annotations: ‘After adding “cost of [reversionary bonus] allocated” (see attached sheet) the difference is £476m which is (just) OK’ and ‘(This is now OK)’.

The Appointed Actuary adds that he is supplying this figure on a confidential basis, but is not prepared to publish it in future returns. The Appointed Actuary explains that the resilience of the office’s mathematical reserves is a matter for his professional judgment, subject to the required disclosure in the regulations and to require publication of the precise level of reserves needed to satisfy the GAD ‘test’ would impose a far more explicit level of disclosure on them than on offices publishing net premium office valuations. He says that ‘GAD have previously indicated that they feel the Society provides much fuller information than the norm in this area. To require even more from us seems unreasonable’. (Note: I have seen no evidence of any correspondence in the files which suggests that GAD had previously indicated this.)

Equitable’s Appointed Actuary concludes: ‘In any event, we may well change this form of presentation and move away from publishing a full net premium valuation when the new regulations are implemented with effect from 1 July 1994’.

(2) No additional non-unit reserves would have been necessary if a real rate of return of 2% rather than 3% had been assumed. GAD’s Chief Actuary C annotates the letter at this point:

‘I am surprised by this statement. But let it pass?’.

(3) It is the Society’s practice to set up a specific reserve for tax on unrealised capital gains on life funds. But, at 31 December 1992, the figure for unrealised capital gains was negative and accordingly the returns showed a deduction in the tax reserve.

Chief Actuary C annotates the letter at this point:

[Scrutinising Actuary C], We have challenged this in the past. He is effectively treating losses [brought forward] as an asset. If all units were liquidated at the valuation date there would be insufficient assets available to cover the amount paid out. It may be more equitable to price in this way but it is not prudent when setting reserves to give a value to [brought forward] losses. I think you should challenge [the Appointed Actuary] on this issue.

(4) The valuation of the assets backing the non-profit annuities in the ‘office’ reserve was based on the Appointed Actuary’s professional judgment. The Appointed Actuary explains that, within this group, there are different categories of annuities. He considers that the valuation rate used is suitable, as some assets actually yield a higher rate. Chief Actuary C annotates the letter at this point: ‘I suggest that you ask him to comment in relation to the net premium basis’.

Finally, the Appointed Actuary provides the following current estimate of the Society’s Form 9 solvency position at the end of 1993:

GAD’s Scrutinising Actuary C writes to DTI, enclosing a copy of Equitable’s letter of 07/04/1994. The Scrutinising Actuary says that Equitable have:

… provided full answers to our questions, but we are asking further questions (copy enclosed) although we are generally satisfied with [the Appointed Actuary’s] response. We note his comments regarding disclosure of some of this additional information.

Scrutinising Actuary C comments:

If the resilience reserve of £462m is added to the net premium reserves … the total … is almost the same as the reserve on the “office” basis. Accordingly the cover for the [required minimum margin] on the corrected net premium basis is almost identical to that on the Bonus Reserve basis of 2.36 times. However, this is based on a net premium valuation basis which is weaker than that used by most offices.

He concludes:

Based on the figures at the end of the letter, the published cover for the [required minimum margin] (on the Bonus Reserve Valuation) at the end of 1993 will be about 3.75 times. The Board papers supplied reveal that bonus rates were reduced by less than was justified by the Equitable’s usual approach of relating declared rates to prevailing interest rate levels, primarily on account of the good performance of the assets during 1993. The actuary recommended a smoothing of the reduction but has warned his Board that further reductions will be needed at the end of 1994 if interest rates do not rise during the year.

GAD write to Equitable’s Appointed Actuary to pursue some further questions arising from Equitable’s response to points (3) and (4) in their letter of 07/04/1994.

On (3) (the deduction in the capital gains tax reserve), GAD say that:

… for statutory reserving purposes it does not seem to us to be prudent to take credit for tax relief on unrealised losses. If the amount had instead been treated as an asset it would have been inadmissible, and if all units had had to be liquidated on the valuation date there would be insufficient assets to cover the amounts paid out. I hope that you will agree to follow our interpretation if the point should arise again.

On (4) (the valuation of the assets backing non-profit annuities), GAD say:

You will appreciate, I am sure, that our primary concern is with the net premium valuation published in the Appendix to Schedule 4, rather than with the office basis. This question was posed in the context of the net premium assumption (where 9% was also used), and I am sorry if that was not clear. Could you please now provide the information that we are seeking; the yields shown in Forms 45 and 46 do not, after allowing for the 7½% margin, seem to support the 9% assumption.

DTI advise Equitable and the regulatory authorities in the Republic of Ireland and Germany that DTI have no objections to the proposed changes. On the same day, DTI send a copy of Equitable’s letter of 25/05/1994 to GAD. DTI explain that they have no guidelines as to how involved GAD should be in the process, but invite them to look at the product particulars. On receipt of the letter, GAD’s Scrutinising Actuary C says to Chief Actuary C: ‘This is no doubt interesting but I do not see that there is anything for GAD to do here. Do you agree?’. In reply, the Chief Actuary writes:

Maybe not in this case, but we should consider the financial implications of the changes and comment. As it happens the [information] supplied … is inadequate as it does not take [account] of the transfer to reserves …

This is typical of [Equitable’s Appointed Actuary], to provide only what the legislation strictly asks for when in fact we need the transfer to reserve to be regarded as an expense. Perhaps you should suggest to DTI that the [information] supplied is inadequate, therefore they ought to seek our advice before accepting the proposed changes. (GAD later do this – see 22/08/1994.)