Submission of the 1993 regulatory returns

Equitable submit their 1993 regulatory returns to DTI. Accompanying those returns are copies of the Society’s annual report and accounts, prepared in accordance with the Companies Act 1985 and dated 23 March 1994.

Equitable also send DTI a declaration under section 94A of ICA 1982 and pay Insurance Fees of £19,460 in respect of their 1993 returns.

These documents include the following information about Equitable’s business and about their financial position as at 31 December 1993.

Companies Act annual reports and accounts

In their ‘President’s Statement’, Equitable explain that the 28% investment return in 1993 to some extent masked a significant fall in interest rates. Hence Equitable had decided to increase the overall rate of return granted to policies but reduce the rate of declared bonus to a level broadly supportable by fixed interest securities at current rates of interest.

In their ‘Management Report’, Equitable explain that they had recently sent with-profits policyholders statements of their 1993 bonuses, together with a letter explaining Equitable’s approach to bonus allocation. Equitable say that the 28% return for 1993, which took full credit for the changes in market values of fixed interest securities, fell to 17% for the purpose of ‘averaging’ once ‘transitory’ changes in the market value of fixed interest securities were excluded. Equitable had, for many years, linked reversionary bonuses to yields on fixed interest securities. In the light of the sharp reductions in such yields, the Board had decided to reduce reversionary bonus appropriately.

In their ‘Directors’ Report’, Equitable reiterate that they had reduced reversionary bonuses to a level consistent with gilt yields.

The returns

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

GAD’s copy of the 1993 returns (the first year for which their original copy is still available) includes various annotations which were made by GAD’s new Scrutinising Actuary with responsibility for Equitable (Scrutinising Actuary D) during the scrutiny programme. I am satisfied that these annotations were made on or around 24/10/1994, at the time Scrutinising Actuary D prepared his ‘Detailed Scrutiny Notes’. These annotations correspond to the items listed in those notes, some of which are notified to DTI and later pursued with Equitable. However, for ease of reference, mention of these annotations is made here.

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 1993 as follows:

GAD annotate the form with the figures, on the appendix valuation basis, for ‘Total mathematical reserves (after distribution of surplus)’ and ‘Total of available assets and implicit items’, being, respectively, £11,125,463,000 and £2,038,758,000.

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

GAD note with a question mark the figure of £12,443,000 included in Form 13, line 32 (Analysis of admissible assets) for debts in insurance companies not authorised to transact insurance business in the United Kingdom. GAD also note with a question mark the figure of £53,950,000 included for share options and debenture options.

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.

In the Form 40 (Revenue account) included in the returns for Equitable’s Pension Business Fund, GAD circle and note with a question mark the figure included for taxation of minus £6,970,000.

GAD annotate Form 42 (Analysis of claims) with the corresponding figures from the previous year’s returns. For life assurance contracts and the claims payable on death, the figures show that claims are up 29% on the previous year.

Form 45 shows that 43% of Equitable’s non-linked assets are invested in equities, 7% in land and 43% in fixed and variable interest securities (compared with 43%, 8% and 40% respectively in 1992). GAD have annotated the returns with these earlier figures. GAD tick the figures provided for the yield on fixed interest securities. GAD also annotate the form with the total yields shown on line 12 that were included in the 1989 to 1992 returns.

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. Against line 1 of Form 46, GAD note with a question mark the gross redemption yield for securities issued or guaranteed by any government or public authority with a redemption period of one year or less (the figure being 1.40%). These assets are stated to have a value of £238,000.

In the notes to this part of the returns, Equitable disclose that no provision has been made for the contingent liability for tax on unrealised capital gains in respect of non-linked business, which is estimated to be £42m.

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 answer 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, Equitable provide 18 pages of information about their non-linked contracts. Most of the information about the contracts remains unchanged from previous years. The increase in information from the previous returns is largely due to a new section on German policies.

On GAD’s version of the returns, they note the changes that have been made and the new information provided. GAD tick the following paragraph (3(xiv)):

Pensions business with profits contracts described as retirement annuity, transfer plan, individual or group pension are deferred annuities, the premiums being of the recurrent single premium (or variable premium) type. The premiums provide a cash fund at the pension date, to which (for policies issued prior to 1 July 1988) a guaranteed annuity rate is applicable.

GAD also tick paragraph 3(xvi), which describes Equitable’s personal pension business. This paragraph includes text which says:

Pensions business termed individual pension (2nd series) are individual pension plans effected since 1 July 1988 …

With profits retirement benefit segments are deferred annuities, the premiums being of the recurrent single premium (or variable premium) type. The premiums provide a cash fund at the pension date used to purchase benefit. There is no guarantee of annuity rates to be applied to the cash fund.

As in previous years, Equitable provide a description of their principal guarantees of terms. GAD tick or mark as being new each of the descriptions provided.

In response to paragraph 4, Equitable provide 38 pages of information about their linked contracts. Most of the information about the contracts remains unchanged from the previous year. GAD tick or mark as being new each of the descriptions provided. GAD also write: ‘“Special Group Pension Arrangement” omitted’; and, in relation to the policies issued with links to the Equitable Pelican Unit Trust only: ‘Comment re A(v) omitted’. GAD note that, in relation to the description of unit-linked international personal pension plan retirement benefit, the cross referencing to another type of contract is ‘Not Revised’.

Equitable disclose in paragraph 5 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 three scenarios of changed investment conditions described in DAA6. The relevant sentences have been marked ‘new’ by GAD. 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.)

As in previous years, Equitable 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. They also disclose that the contingent liability for tax on unrealised capital gains in respect of other business is estimated not to exceed £42m. Equitable say that they consider there are sufficient margins in the valuation basis to cover this amount and, accordingly, they again hold no specific reserve. GAD tick this paragraph and note that the figure for the previous year was £1.2m.

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. GAD tick this paragraph.

As in previous years, in paragraph 5(1)(g) Equitable state:

The premium rate guarantees and options under the Society’s policies are described in paragraph 3. Where the right to effect further policies without medical evidence of health is carried a reserve equal to one year’s extra premium deemed or actually charged was set up. It was considered unnecessary in current conditions to make explicit provision for the other guarantees and options described in paragraph 3.

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 in the returns disclose the rates used in the premium basis. GAD tick this paragraph.

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.

GAD tick this paragraph.

As in previous years, in paragraph 11 Equitable disclose: ‘The Society has no business where the rights of policyholders to participate in profits relates to profits from particular parts of the long term business fund’. GAD tick this paragraph.

As in previous years, in paragraph 12 Equitable state: ‘The Society has no shareholders and the principles upon which the distribution of profits among the policyholders is made are determined by the Directors in accordance with the Society’s Articles of Association’. GAD tick this paragraph.

In paragraph 13, Equitable disclose that they had set the rates of reversionary bonus for the main policy classes at 4.0% (compared with 5.0% for 1992). GAD annotate this section with figures for the bonuses declared in the previous year. As in previous years, Equitable disclose that some retirement annuity and individual pension policyholders have been offered loans under a ‘loanback’ arrangement. GAD tick this paragraph.

In paragraph 16, Equitable describe their system for determining final bonuses. In part (vi), Equitable set out how they allocate final bonus for retirement annuities, personal pension retirement benefits, individual and group pension arrangements and recurrent single premium deferred annuities. Equitable disclose, on page 71 of the returns, that:

Where the contract terms guarantee any increase in benefits by way of interest or other addition for the period from 31 December 1993, or such later date of purchase of benefits as applies, to the date of payment of benefits, the amount of final bonus allotted by the operation of (1) and (2) above is reduced by the amount of any such increase.

Equitable then disclose, also on page 71 but running on to page 72 of the returns, that:

Where benefits are taken in annuity form and the contract guarantees minimum rates for annuity purchase, the amount of final bonus payable is reduced by the amount, if any, necessary such that the annuity secured by applying the appropriate guaranteed annuity rate to the cash fund value of the benefits, after that reduction, is equal to the annuity secured by applying the equivalent annuity rate in force at the time benefits are taken to the cash fund value of the benefits before such reduction.

Scrutinising Actuary D marks both of these paragraphs as ‘New’. The Scrutinising Actuary also comments on those paragraphs in his ‘Detailed Scrutiny Notes’, prepared on 24/10/1994, where he says ‘New rules reducing final bonus, see page 71’.

(Note: this paragraph was also sidelined in pencil (rather than the red ink used by Scrutinising Actuary D). The marking of this paragraph is consistent with those other markings made by Scrutinising Actuary E in respect of the 1995 returns, during his scrutiny of those returns (see 28/06/1996)). (See also the 1994 returns at 30/06/1995.)

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 the 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 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. GAD have annotated this form with equivalent figures from the appendix valuation.

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 the ICAS Regulations 1983. Equitable 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’. GAD tick this paragraph.

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. GAD tick this paragraph.

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. GAD tick this paragraph.

As in the previous year but unlike in the main valuation for this year, in paragraph 7(b) Equitable explain the method by which they had made provision in the appendix valuation 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. GAD note changes from the previous year’s returns to some of the interest rates and mortality tables used.

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.

GAD complete the A2 Initial Scrutiny check on the Society’s 1993 regulatory returns.

In response to question 3, ‘Do the interest rates used look supportable in terms of Regulation 59 – for with profit business?’, GAD answer ‘Yes’, and write: ‘On NF’.

In response to question 5, ‘Do the unit linked parameters look reasonable?’, GAD answer ‘Yes’, and write: ‘except g=8%, i=5% again.’

In response to question 10, ‘Is all reinsurance with UK authorised companies?’, GAD answer ‘Yes’, and add: ‘All but a trivial amount’.

In response to question 12, ‘Have the company set up any identifiable provision to meet potential exposure to Personal Pensions transfer problems?’, GAD answer ‘No’, and write: ‘but [these are] very unlikely to be significant’.

GAD identify no worrying aspects and no items to notify to DTI, to be taken up immediately with Equitable. GAD give Equitable a priority rating of 3 (unchanged from the previous year).

GAD complete the A1 Initial Scrutiny check on the Society’s 1993 regulatory returns.

GAD note the cover for the required minimum margin is 3.75 (increased from 2.36 the previous year). In response to check number 24, ‘Does [Form] 13.86* equal [Form]47.4?’, GAD answer ‘No’ and write ‘Equals [Form]47 + Line 1 of [Form] 48’. They do not identify any concerns. Accompanying the Initial Scrutiny check is a Form B Initial Scrutiny Form, which includes certain key figures disclosed in the 1990 to 1993 returns.

GAD provide DTI with comments on Equitable’s letter of 25/05/1994. GAD say that they do not wish to comment in detail, but:

… we notice that in one or two areas the information supplied is not really adequate; for example the projected revenue accounts for the Irish business do not include an entry for “increase in reserves” and therefore give a rather misleading impression of the planned progress.

GAD suggest that, in future, such applications should be sent to GAD for comment before approval. GAD return the files of ‘product particulars etc.’, having retained copies of some of the material.

DTI write to Equitable to propose a further visit by DTI and GAD as part of their three year rolling programme of meeting life insurance companies. DTI list the main subject areas they would like to cover as being:

1. The business plans of the company for the next five years, with particular reference to solvency and any requirements which there might be for additional resources.
2. Marketing philosophy.
3. Corporate/Management structure.
4. Reinsurance programme and security.
5. Investment policy and asset management.
6. Management systems and procedures.
7. Implications of the regulatory changes following the Third Directives — especially sound and prudent management, derivatives, reinsurance of linked liabilities.
8. The role of the Appointed Actuary.
9. Resilience testing and asset shares.
10. Bonus Philosophy.
11. Potential liabilities in respect of personal pensions.

DTI propose that the visit should take the form of a series of meetings in a single day with appropriate members of the Appointed Actuary’s team. DTI say they would be pleased to receive any internal papers that would facilitate discussion (for example, structure charts or corporate plans).

Further to GAD’s suggestion of 22/08/1994, Line Supervisor B seeks approval for the policy of asking GAD to comment before DTI grant approval in relation to the establishment by companies of operations overseas.

The following day, Line Manager B agrees, but says that DTI would need to give GAD strict deadlines in which their comments would need to be provided.

Equitable write to DTI to apply for a section 68 Order to remove the restriction on the level of Eurobonds they can hold.

On the same day, Equitable notify DTI that they intend to offer a new product through their Republic of Ireland branch and provide notice of the changes to the requisite details.

DTI’s Line Manager B writes to Line Supervisor B, in response to Equitable’s letter of 30/09/1994 requesting a section 68 Order. The Line Manager says:

I don’t want to be bothered with s68/s78 orders unless absolutely necessary (i.e. impending year end).

[Please] reply that we are content for Equitable to proceed on the basis [Equitable’s Appointed Actuary] proposes and that an order will follow in due course.

In practice I hope an order won’t be necessary because the [regulations] will have changed.

(Note: a section 78 Order was the same as a section 68 Order (see 08/09/1986) but applied only to linked long term policies.)

GAD’s Scrutinising Actuary C informs Equitable’s Appointed Actuary of his imminent departure from GAD, and introduces his successor.

On the same day, DTI ask Equitable if they regard the new product that they wish to sell in the Republic of Ireland as Class III or IV. DTI explain that they have no objection to the change in details provided by Equitable.

GAD’s Scrutinising Actuary D prepares ‘detailed scrutiny notes’ for the 1993 returns. His note contains seven sections:

• ‘Standard reporting items’ — under ‘New business’, GAD detail 19 policy types (13 being overseas business), and remark that the Society’s expenses are ‘still low’;
• ‘Initial scrutiny notes’ — GAD state that there are ‘nil of note’;
• ‘Review of file’ — GAD set out details of the section 68 Orders requested or issued and the introduction of operations internationally;
• ‘Report & Accounts’ — GAD note some details from Equitable’s 1993 Companies Act annual report and accounts, including that Equitable do not consider that they need to make any provision for pension mis-selling and that Equitable have provided comments on their bonus philosophy;
• Under ‘Returns — Schedules 1 — 3’, GAD’s note records (with original emphasis):

• Above table seems odd.
• F13.32 new debt from dependant unauthorised insurance company of £12.4m
• Share options and debenture options £53.95m
• Negative tax on [pension business fund] does not relate to form 40 note
• Life death claims up 29%, probably in linked business
• Non linked surrenders, forfeitures and pups by about 4.0% life and 6.8% pensions
• Unit linked 10.8% life and n/a pensions.
• Recurrent [single premium] figures are not available.
• Doubtful figures in form 46 line 1 but not material.

Each of these issues is noted on GAD’s copy of the Society’s returns (see 27/06/1994). The three issues highlighted in bold by GAD are subsequently pursued with Equitable, and notified to DTI, as a part of GAD’s scrutiny of Equitable’s returns. (See 15/11/1994 [entry 1].);

• Under ‘Returns – Schedule 4’, GAD’s note records:
  • Where is “Special Group Pension Arrangement”?
  • Unit Linked Annuity A(v) link to Pelican [unit trust] no longer mentioned. This must be an oversight.
  • New FTSE link over twelve month periods as determined by Society.
  • [Capital gains tax] deduction now 13% (was 10%) on Pelican links
  • Description of unit linked international personal pension retirement benefit now refers to terms of Guernsey version whereas previously it was referred to international investment plan benefit.
  • Comments on the valuation basis:
    • Major Medical Cash reserve for unit linked not stated, but contract may not actually have any in force. But it is described. Check there were no such [in-force], and that basis will be similar.
    • FTSE links based on value of matching call options and deposits.
    • Interest rates look high … must be justified by a matching rectangle
    • Term mortality rates A67/70 -3? This is OK for “2nd series” with the refunds etc, but what about 1st?
    • Annuity basis a(90)?
  • Run-off expense provisions:
    • Unit prices grow at 8% => assets grow at 8.6875% or 8.75%; inflation of expenses is at 5%. No 25% drop referred to.
  • Bonus rate changes:
    • New rules reducing final bonuses, see page 71.
    • Various changes in bonus rates.
  • Use of asset shares:
    • Not used in the normal sense.

Again, each of these issues in bold is noted on GAD’s copy of the returns (see 27/06/1994). The eight issues highlighted by GAD in the list above are subsequently pursued with Equitable, and notified to DTI, as part of GAD’s scrutiny of Equitable’s returns. (See 15/11/1994 [entry 1].)

• ‘Miscellaneous’ — GAD’s note includes: Personal pensions liabilities? Not us!!!

DTI’s Line Supervisor B provides briefing for the visit by the Minister for Corporate Affairs to

Equitable on 26 October 1994. This briefing is substantially the same as that provided for the proposed visit of the President of the Board of Trade, on 23/02/1994 (see 17/02/1994 [entry 2]). The Line Supervisor says:

The latest returns 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.

The Line Supervisor refers to the survey on possible mis-selling of pensions and notes that Equitable ‘did not see a need to make any provision for compensation in its accounts, given the high standard of selling techniques in the Society’. The Line Supervisor expresses no concerns about Equitable.

On current insurance issues that may arise during the visit, the Line Supervisor says, under the heading ‘Deregulation’:

Background – DTI has issued a consultative document proposing major changes in the content of the annual prudential returns by insurance companies.

Line to take – The consultation period ends this month. Feedback so far has been reasonably positive. In particular, we have proposed to abolish the tedious chores of producing a quinquennial statement of long-term business [i.e. Schedule 5 of the returns] and annual statement of connected parties. Many other changes have been proposed to reflect the requirements of the 3rd Insurance directives and to make returns more relevant to current market conditions and practices.

On the same day, DTI’s Head of Life Insurance writes to the Chief Executives of all life

insurance companies. He notes that the Securities and Investments Board have announced the criteria and procedures for assessing whether compensation should be made to people who were wrongly advised to transfer or opt out of an occupational pension scheme. DTI ask Equitable (and other companies) to submit, by the end of February 1995, a revised estimate of their potential liability for compensation payments in the light of the Securities and Investments Board’s requirements.

DTI say that they may seek periodic updates in the light of experience over the next year or so. In relation to who should pay for any compensation, DTI advise:

Each office will also need to consider where the costs should fall on its funds. The precise arrangements will vary according to the circumstances of each office. The first principle is that as a general rule compensation payments should not be made out of funds to the extent that these are required to meet the contractual entitlement of policyholders. Beyond that, the reasonable expectations of participating policyholders must be taken into account. For this purpose, the following general considerations appear to the Department to be relevant (and we would expect directors to follow similar principles in deciding how to attribute losses arising from other instances of compensation or regulatory action):—

1. With profits funds which (in normal circumstances) stand to profit from the sale of pensions business can reasonably be expected to bear a corresponding share of the costs associated with that business. However:-
2. Compensation costs should not be regarded as a normal expense of the business for the purposes of assessing bonus rates; and
3. The Department would expect proprietary offices to consider whether it is appropriate that some part of the compensation cost be met from outside the long-term fund, to enable the reasonable expectations of policyholders to be fulfilled.

(DTI later have to chase Equitable for a response to their letter — see 13/04/1995.)

GAD provide DTI with their detailed scrutiny report on the Society’s 1993 regulatory returns.

(A copy of this scrutiny report is reproduced in full within Part 4 of this report.) The report follows a new standardised format adopted by GAD and has 13 sections, as follows:

(1) Summary

Under ‘Key features’, GAD state that cover for solvency remains healthy at 3.75, expenses remain low, new business continues to grow (with the emphasis remaining on pensions business), and a new branch was opened in Germany in 1993, adding to existing Guernsey and Republic of Ireland branches.

GAD comment that Equitable, ‘no doubt influenced by the favourable figures they can properly demonstrate’, voluntarily introduced the disclosure regime early in July 1994.

Under ‘Action points’, GAD explain that they have pursued eleven points with Equitable in the light of the Society’s returns, including:

• that there is a surprising sum due from a dependant insurance company not authorised in the UK, of which GAD were not aware;
• that the treatment of single premiums in the returns appears inconsistent;
• that interest rates used in the valuation look high;
• that a mortality table looks ‘light’;
• that an annuity table looks ‘too heavy’;
• that the expense reserves are determined on an optimistic basis. GAD note that this has been the case before, and that they are trying to determine how great Equitable’s exposure is; and
• that the amount of resilience reserve required is not given, only that it can be met.

(2) Background

GAD refer to Equitable’s pride in the Society’s position as the oldest mutual life assurance society in the world and the fact that Equitable have never paid commission to third parties. GAD explain that Equitable have a:

… somewhat unusual approach to bonuses, unit linked products (which often have discretionary surrender values) and valuation using a gross premium bonus reserve method. The DTI returns also show the results of applying a net premium basis with assumptions close to the minimum permitted by the regulations.

Although Equitable applies for a section 68 Order for an implicit item each year, it has never used this order, it being a precaution only. It does however also enjoy an order exempting full description of its personalised funds in the return. There is also an order in relation to [a] call option for FTSE links on some policies.

GAD also note that ‘The Appointed Actuary and Managing Director posts are both held by [the same person]’.

(3) New business

GAD provide details of the new products Equitable have developed and two tables setting out the regular and single premiums which Equitable have received for the various classes of policies sold from 1989 to 1993. GAD add a commentary:

These figures are somewhat strange, however, in that a great volume of pension business is regarded as recurrent single premium. This is reported in the year of issue as regular premium, in accordance with the guidance notes, but it does not appear in form 43 [of the returns] as regular premium. In 1993 the effect was for [£225.9m] new regular premium to appear in form 44 [of the returns] but not in form 43. It is also therefore impossible to reconcile form 41 [of the returns, on analysis of premiums and expenses] and form 43.

On her copy of the report Line Supervisor B adds two comments: ‘Should we ask for revised forms?’ and ‘GAD doesn’t mention [Form] 43 in letter to [a named company] — query this with GAD.’

(4) Expenses

GAD provide a table showing the history of expenses from 1989 to 1993. They comment that, compared with the industry as a whole, Equitable’s expenses are low. (Note: following scrutiny of the 1990 returns, GAD had queried a rise in Equitable’s management expenses — see 19/11/1991 and 22/11/1991. GAD’s A2 Initial Scrutiny check of the 1991 returns had identified Equitable’s other management expenses as a worrying aspect, although it appears that this was not pursued at the time.) GAD add:

There is no provision for mis-selling of personal pensions. This is due to the selling methods which are based upon largely approaches from prospective policyholders. It remains to be seen whether this is correct, but it is true that their exposure is likely to be very much lower than typical in the industry.

(5) Claims and withdrawals

GAD note an increase in death claims, but comment that this does not indicate any particular problem. GAD also note that the Society’s persistency rates are quite good but that the ‘prevalence of recurrent single premium contracts prevents proper analysis …’.

(6) Financial results

GAD explain that, on the bonus reserve basis (i.e. the main valuation), a surplus of £481m arose, compared with £331m in 1992.

(7) (Non-linked) assets

GAD provide tables showing Equitable’s mix of assets at the year end. GAD reproduce a table from Equitable’s 1994 With-Profits Guide showing assets attributable to with-profits business. GAD comment that the most noteworthy feature of the latter is the shift towards a higher fixed interest component. They note that, on Equitable’s own figures, the Society’s total investment return for 1993 was 28.3%.

(8) Valuation and solvency

Under ‘Strengths and/or weaknesses’, GAD explain:

The bases used for the gross premium valuation are primarily a tool to support the method of determining distributions. They are not particularly relevant to supervision. The adequacy of the valuation is demonstrated by publishing a net premium valuation on the minimum basis necessary to meet the regulations and except where explicitly stated otherwise comments and figures in this report are based upon this alternative basis.

GAD observe that:

The net premium bases have a number of apparent weaknesses, though in the light of the cover for the required minimum margin there is little concern as to the solvency. If, however, the reserves are too thin, it may lead to inappropriate conclusions being drawn by policyholders and prospective policyholders as to the financial strength of the society. We are therefore seeking confirmation of the prudence of certain of the assumptions.

GAD report that:

The rates of interest used are somewhat high in comparison with form 45. As this form does not provide sufficient information to draw a firm conclusion, we are seeking further information.

Some mortality tables look a little on the optimistic side, and again further information on their justification is required.

There is a somewhat weak reserving basis for unit linked expenses, which does not meet the standards this department normally expects. We normally expect the differential between the rate of growth of unit linked assets, and hence the prices, before all changes and taxation to be no more than 2% higher than the rate of inflation of renewal expenses. For this company the difference is about 3.7%. We are trying to determine the extent of exposure here to an adverse experience in costs.

Under ‘Changes since the previous year’, GAD note that:

• expense allowances on linked business have been increased, but costs are increasing only very slowly and expense allowances on unitised with-profits have also been increased;
• some mortality tables have been strengthened;
• the revised resilience test has been incorporated; and
• interest rates have been reduced, but not generally by quite as much as the fall in asset yields.

GAD provide three tables showing Equitable’s liabilities for linked and non-linked business and a valuation summary. The latter contains figures relating to both the bonus reserve (i.e. the main valuation) and the net premium (i.e. the appendix valuation) valuations for the years 1991, 1992 and 1993, and is presented as follows:

The notes to the table are:

* Section 68 order (for £420m in 1993) not used

† Estimated figure. The cover makes no allowance for the absence of a reserve to meet the resilience test. The amount required in 1992 was £462m, which wipes out the difference between the [bonus reserve valuation] and [net premium valuation] and reduces the surplus under the [net premium valuation] to only some £18m without recourse to the investment reserve which was £839m. As a result the cover for the required minimum margin would only have been about the 2.4x shown under the [bonus reserve valuation].

Line Supervisor B annotates her copy of GAD’s report at this point: ‘Why does Equitable have to do things different from everyone else?!’.

Under ‘Cover for the solvency margin’, GAD conclude:

… the cover for the required minimum margin remains substantial, and gives no cause for concern in itself. The only issues therefore revolve around whether the valuation basis itself is of sufficient strength. This is covered [under ‘Strengths and/or weaknesses’] above, but particular care is needed in reviewing the figures for the [net premium valuation], as the resilience reserve is omitted, and the figure is not known.

(9) Bonuses

GAD note that the cost of Equitable’s declared bonus, under the appendix basis, is £300.4m. GAD say that Equitable’s final bonus system ‘is somewhat different to the normal terminal bonus’, and explain that it:

… is a little unusual. It consists of a declaration of bonus which is not reversionary, in that it may be withdrawn, and/or reduced in future. However, it has a lot of features in common with reversionary bonuses. It is declared in a similar way as a percentage of benefit, and the amount paid at the end of the policy’s normal span is the sum of the annual “declarations”, subject to the proviso that a previously granted bonus can be withdrawn.

GAD quote Equitable’s own description of the final bonus system which GAD say is from the Society’s With-Profits Guide. (Note: the description was in fact from Equitable’s Bonuses booklet (dated February 1994). This mistake was repeated in GAD’s scrutiny reports for 1994 and 1995.) The relevant quote reads:

Final bonuses are also determined and applied retrospectively. The final bonus is calculated so as to top up the growth arising from the policy guarantees and the declared bonus rate for the year to the overall rate of return announced for the year. Final bonuses do not add a guaranteed element to the contract, and the final bonus element of a policy can be varied up or down in future.

GAD provide three tables of statistics showing changes in reversionary and final bonus rates. GAD also reproduce a table, from Equitable’s With-Profits Guide, of the actual investment returns on gross market value and the rate allocated in fixing bonuses:

* 12% on new benefits secured during the year

GAD explain that Equitable follow a policy of full distribution:

… with a basis designed to make up the implied guaranteed rate to a total earned rate. Part is in the form of the non-cancellable reversionary bonus and the rest in the form of final bonus.

The policy is to link declared reversionary bonus rates to the redemption yields on fixed interest stock. This has produced a series of reductions in recent years as yields have fallen, but the system of final bonus effectively balances this in total returns. Policyholders’ reasonable expectations are therefore influenced downwards in line with yields.

GAD make no reference to the ‘New rules reducing final bonuses’ (see 24/10/1994).

(10) Unit-linked funds

GAD set out key statistics about these funds.

(11) Reinsurance

GAD state that Equitable make little use of reinsurance.

(12) Compliance

GAD state that they know of no significant compliance problems.

(13) Miscellaneous

GAD repeat that Equitable have made no provision for mis-selling of pensions.

GAD’s scrutiny report runs to 14 pages.

As a result of their detailed scrutiny of the Society’s 1993 returns, GAD write to Equitable to ask them to clarify eleven points. These points are those highlighted in their ‘detailed scrutiny notes’ dated 24/10/1994. GAD’s questioning about Equitable’s 1993 returns is as follows:

1.   Form 13 line 32 includes a sum of £12.4m due from a dependent unauthorised insurance company. Who is this due from, how does it arise, and what is the relationship between this unauthorised insurer and Equitable?
2. We are unable to understand the size of discrepancy between form 41 and form 44 for amounts of single premium for General Annuity and Pension business. In the case of Pensions business, this seems to be over £100m. or about 19% of the form 41 figure. What accounts for this difference please?
3. There is no note to form 40 regarding the management agreement with University Life. Although we appreciate this is referred to in the Appointed Actuary’s report, could it be included as a note to form 40 in future please?
4. Can you please confirm that the “Special Group Pension Arrangement” described in previous returns has terminated, or alternatively where does it now appear?
5. The Unit-Linked Annuity A(v) is not stated as linked to the Pelican Unit Trust in this year’s return. Are we right in assuming this is an oversight?
6. The International Personal Pension Retirement Benefit is now cross-referred to the Guernsey version instead of the International Investment Plan benefit (page 47 of Schedule 4 refers). Is this correct?
7. The interest rates used in the valuation seem high compared to the rates in form 45 on simple inspection. Could you provide a matching rectangle in respect of the net premium valuation basis in the context of regulation 59?
8. The mortality table used for term assurances post 1982 is more optimistic than is normally used in valuations. Whilst this may [not] be of relevance particularly to the 2nd series, can you please comment considering the Society’s recent experience on the basis used?
9. Various annuity contracts are valued on the a(90) [mortality] table. How does the society’s recent experience compare to this table? Are you satisfied that this table is still sufficiently prudent?
10. Can you please advise how much the reserves in the net premium valuation would rise were the following scenario to occur:
    • An immediate fall of 25% in the value of unit-linked fund
    • Future investment returns before tax and management charges of 10% p.a.
    • Inflation of maintenance expenses of 8% p.a.
11.      What was the amount of additional resilience reserve required under the net premium basis in respect of the most onerous scenario tested?

GAD explain that the first three of their questions are for the Society, with the remaining questions being for its Appointed Actuary.

GAD write to DTI to respond to their request for advice on whether a critical illness policy Equitable propose to sell in the Republic of Ireland should fall into insurance Class IV. GAD suggest that DTI may wish to seek legal advice, but their view is that Equitable’s policies are Class IV business. GAD recommend that DTI write to Equitable to say that the business appears to be Class IV type. GAD also explain:

The consequences for the company if the business is class IV are that the unit linked version would require a 4% solvency margin instead of 0%, and the treatment for tax purposes would be different for both versions. This may alter the reserves required.

Equitable’s Appointed Actuary replies to GAD’s letter of 15/11/1994. The response to each of the questions about the Society’s 1993 returns is as follows:

In response to question 1, Equitable say: ‘The amount represents the dividend due (together with associated tax credit) from University Life as at 31 December 1993. I regret that this was erroneously included in line 13.32 rather than 13.30’. GAD tick this response.

In response to question 2, Equitable say: ‘Under our current range of pension products, the original contract terminates at the point of retirement and, if an annuity is to be secured with the Society, a new contract is issued. The relevant fund appears as a single premium in form 41 and the immediate annuity issued is shown in form 44. Our older contracts, such as retirement annuities, were written to provide an annuity at retirement, although we offer a full “open market option” as for our current products. Our accounting practice is to include the fund available on retirement in claims and the fund retained with the Society (if any) to secure an annuity in premium income – i.e. a consistent treatment to that for our current products. Form 41 reflects that practice. Where, however, funds are left with the Society to secure an annuity, that is normally achieved by endorsement of the original policy and, consequently, the annuity in payment does not appear in form 44’. GAD tick this response.

In response to question 3, Equitable say: ‘We will arrange to include an appropriate note to form 40 in future returns’. GAD tick this response.

In response to question 4, Equitable say: ‘I confirm that the plan surrendered during 1993’. GAD tick this response.

In response to question 5, Equitable say: ‘Subparagraph (d) of A(v) states “Equitable Pelican Unit Trust” (page 24) so I regret that I do not understand this comment’. GAD note next to this answer: ‘My mistake – meant reference to switch to [international] fund’.

In response to question 6, Equitable say: ‘The cross-reference in paragraph B(xviii)(b) should be to paragraph B(xvii)(b) not to paragraph B(xvi)(b). I apologise for this error’. GAD tick this response.

In response to question 7, Equitable provide the following information:

The non-linked net premium liabilities of £10150.9m can be matched by hypothecated assets from form 45 as follows:

The maximum permitted valuation interest rate in accordance with regulation 59 is 4.82% and the actual weighted average valuation interest rate, before tax, is 4.78%

GAD note: ‘Seems OK, but the averaging should only be assets’.

In response to question 8, Equitable say: ‘The bases used are essentially the same as in the premium bases for these contracts. Our analysis of surplus reveals consistent mortality profits from these classes and our returns from the [Continuous Mortality Investigation] Bureau indicate an experience consistently lighter than that assumed in the valuation basis. I am, therefore, satisfied that the basis is satisfactory’. GAD tick this response.

In response to question 9, Equitable say: ‘In recent years the Society’s mortality experience for purchased life annuities has been quite close to a(90). The analysis of surplus has tended to show either a modest surplus or stain from year to year. I think we are, perhaps, just about at the point were a slight strengthening to a(90) -1 may be appropriate and we are reviewing that as part of our general review of our bases in preparation for the 31 December 1994 valuation’.

In response to question 10, Equitable say: ‘On the basis you describe, an additional sterling reserve of approximately £12m would have been required’. GAD tick this response.

In response to question 11, Equitable say: ‘If we had published our office valuation at the level of the net premium valuation in the appendix to Schedule 4, we should have needed to establish an additional resilience reserve of £236m’. Against this answer, GAD write that the difference between the main and appendix valuations is £322.2m.

GAD write to DTI enclosing a copy of Equitable’s letter of 22/11/1994. GAD state:

In view of the nature of the net premium valuation for this company, which is published to demonstrate the adequacy of the published main bonus reserve valuation, and the undoubted adequacy of the reserves in aggregate, we are satisfied with the replies received.

GAD conclude: ‘We regard this scrutiny as complete’.

GAD enclose a file note headed ‘Effect of Resilience Test on Apparent Solvency’. This updates the table set out in their scrutiny report (see 15/11/1994 [entry 1]) to take account of the further information received from

Equitable. The table is as follows:

* Section 68 order (for £420m in 1993) not used

† Estimated figure.

The table shows the resilience reserve figure for 31 December 1993 as £263m rather than £236m. Using the correct figure very slightly increases the estimated cover.

GAD write to Equitable in response to their letter of 22/11/1994. GAD apologise for raising question number 5. GAD explain:

The variation I had noticed is in the footnote on pages 19 and 20 referring to the introduction of a switch option in 1984. It is purely a “for the record” comment, and not of great significance.

GAD say that they are puzzled by Equitable’s reference to an average valuation rate of interest in their response to question 7. GAD say:

Although regulation 59 provides for the averaging of asset yields, it does not appear to allow the same method to apply to liability interest rates. While I appreciate that your valuation is not attempting to distort the results by using an averaging method, I do feel it does not accord with regulation 59, which requires in paragraph 8 that “In no case shall a rate of interest … exceed the adjusted overall yield on assets”. This requirement is carried forward into the 1994 regulations in regulation 69(11).

If you disagree with my interpretation, please let me know. Otherwise, may I suggest that, in setting the bases for the 1994 net premium valuation, you hypothecate assets to each category of contracts for which a different interest rate is used.

GAD note that Equitable are considering strengthening the mortality basis for annuities in 1994.

DTI’s Line Supervisor B writes to Line Manager B to comment on the visit to Equitable arranged for 09/12/1994. She refers to GAD’s scrutiny report (15/11/1994) and their commentary on ‘New Business’. She states:

Equitable’s method of gross premium valuation (which they translate into a net premium valuation for the purposes of the DTI returns) seems to mean that GAD have to “translate” their figures to double-check on the cover for the [required minimum margin] — as per [GAD’s scrutiny report]. I don’t know of any other companies that do this — it seems to make more work for GAD! However, GAD’s comments of 23/11 show that they are happy with the adequacy of the reserves. Have you any comments on the scrutiny which I could pass to GAD before the visit?

In response, the Line Manager states that he thinks that just two or three other companies use a bonus reserve valuation. He also refers to GAD’s comment in their scrutiny report (in the section on the strength and/or weaknesses of Equitable’s valuation) on the prudence of certain of the assumptions. The Line Manager queries if GAD have followed this up. He comments:

The point which concerns me a little is that, as from the 1994 returns, it is not sufficient for the actuarial liabilities to be estimated prudently. Each of the assumptions which goes into the actuarial calculation has itself to be prudent. Equitable need to be alive to this.

Equitable apply to DTI for a section 68 Order which will exempt them from the limit of Eurobonds they can hold. This is the second application — see 12/10/1994. DTI’s Line Supervisor B passes the letter to Line Manager B with a note: ‘presumably there will be no need to do a S.68 order [because] the [Regulations] amendments are almost there?’. The Line Manager replies: ‘Keep fingers crossed!’. (Note: it appears that no section 68 Order was issued — see the note of the meeting on 09/12/1994.)

Equitable write to GAD in reply to their letter of 23/11/1994. Equitable say that they wished to comment on the interpretation of Regulation 59 of ICR 1981. Equitable write:

I can see how a literal reading of 59(8) has led to the point you make. I have, however, tended to feel that, reading regulation 59 in total, it is reasonable to interpret the “rate of interest” in 59(8) as permitting the possibility that this rate may itself be an average liability valuation interest rate.

If this interpretation is not valid, then the wording of 59(9) is somewhat curious in that it presents hypothecation as something one may chose to do but, by implication, need not. Under your interpretation, except in the unlikely case of there being only one valuation interest rate for all contracts, hypothecation would seem to be mandatory.

Interestingly, 59(9) itself talks of “the rates of interest to be used in valuing a particular category of contracts …” which seems to imply that, even where one is choosing to hypothecate, that need not be down to a level where there is a single valuation interest rate for the block of business in question.

Equitable say that they would be interested to receive any further comments that GAD may have on this point.

GAD write to Equitable to say that GAD disagree with the Society’s interpretation of the regulations on valuation rates of interest. GAD say:

We do not agree with your interpretation of regulation 59. Paragraph 8 is quite specific in saying that in no case shall a valuation rate of interest exceed the weighted average yield on the assets. Paragraph 9 introduces an optional relaxation allowing hypothecation for the purposes of valuing a particular category of contracts to prevent paragraph 8 proving excessively onerous. There is no mention anywhere in paragraph 8 or elsewhere in regulation 59 of the restriction applying only to the average valuation interest rate. Any interest rate used in the valuation which exceeds the limit in regulation 59(8) is therefore in [breach] of the requirement that “in no case shall a rate of interest exceed the adjusted overall yield on assets”. The position will be even clearer under the new regulations and the draft professional guidance notes.

GAD continue:

The points you raise are very interesting, but we feel there are valid explanations without interpreting regulation 59(8) (or what is now 69(11)) in the way you suggest.

Regulation 59(9) does not require hypothecation, in that it is quite acceptable to apply paragraph 8 to all categories of contract based upon the fund yield.

We also do not feel that regulation 59(9), by using rates of interest, conflicts with our interpretation. It is not uncommon for actuaries to use two rates of interest for valuing a single contract, especially where there is a material reinvestment issue involved. This may be particularly relevant for, say, deferred annuities written on younger lives, or widows’ annuities in payment, where assets may not be available of long enough term, and a reinvestment covered by 59(9) is unavoidable. It is of course quite acceptable for more than one interest rate to be used for contracts with the same hypothecated assets, provided each rate is less than the maximum supportable in terms of the yield on those assets.

GAD conclude:

For these reasons we believe our interpretation of regulation 59 is correct, and all interest rates used in valuing liabilities should be supportable in terms of the regulation by a particular set of assets, which may be all the assets. We trust that in considering your bases for the net premium test in the 1994 valuation you will verify that each interest rate can be supported in terms of the new regulation 69(11), with the application of paragraph 12 if required.

The Line Supervisor identifies five recent issues:

1. The section 68 Order application regarding Eurobond holdings.
2. Whether Equitable’s critical illness policy is Class III or IV.
3. In relation to GAD’s scrutiny of Equitable’s 1993 returns, the Line Supervisor says: ‘You had a query about prudence [see 29/11/1994] – as from the 94 returns, it will not be sufficient for actuarial liabilities to be estimated prudently – each of the assumptions which goes into actuarial calculation itself has to be prudent, and [Equitable] needs to be alive to this. GAD suggests that you bring this issue up – under 3rd [Life Directive] item on [the] agenda’.
4. The section 68 Order on the call option (see 09/03/1994), which is effective until 30 June 1994.
5. The solvency cover in the 1993 returns. Line Supervisor B says: ‘1993 returns form 9 shows [the required minimum margin] covered 3.75 times (ie by [bonus reserve valuation] method). Converted to [net premium valuation method] method over is 3.9 times’.

To this list the Line Supervisor adds, in manuscript: ‘Role of [the Appointed Actuary]: concern re [Managing Director/Appointed Actuary] all in one person’.

Equitable write to GAD in response to their letter of 02/12/1994. Equitable say that they ‘do not wish to prolong this correspondence unduly since, on this occasion, it relates only to our “appendix” demonstrations of compliance with the regulations’. Equitable say, however, that: ‘the issue will become more pertinent under the new regulations and I shall give further consideration to that’.

Equitable make two further observations:

(1) Your interpretation depends on the point that there is no explicit mention that “the valuation interest rate” can be a weighted average. My view, no doubt coloured by the fact that in the actuarial literature the valuation rate of interest typically refers to the average rate, is influenced by the fact that the regulations do not explicitly say that the average rate may not be used for a block of business.

(2) Looking back through my files I see that a similar presentation to that in paragraph 7 of my 22 November 1994 letter has been provided on a number of occasions in the past without being questioned by your predecessors.

Equitable conclude by saying they will ‘give the matter further consideration in relation to the 31 December 1994 valuation’.

DTI (Line Manager B and Line Supervisor B) and GAD (Scrutinising Actuary D and Chief Actuary C) meet Equitable’s Appointed Actuary/Chief Executive and their Investments Manager.

DTI prepare a note of the meeting. They summarise discussion on 13 broad topics, including:

(1)Corporate objectives

Equitable provide a copy of their Mission Statement and corporate targets for 1994. They explain that they see themselves as primarily a pensions office.

 (2)Marketing philosophy

Equitable explain that they employ a high calibre sales force. They say there have been:

… no problems with LAUTRO. [Equitable’s Appointed Actuary] was very pleased with how the PIA was developing. Equitable only had half a compliance officer — no need for any more because each branch manager was a compliance person. They saw no point in over-selling products.

Equitable’s Appointed Actuary explains that he keeps an eye on the mix of with-profits and linked business. GAD’s Chief Actuary C asks if recurrent single premium products were not ‘quasi-annual’. The Appointed Actuary replies that he ‘saw these as effectively annual. All marketing costs were based on the fact that the premium was renewed annually – but there were no penalties if the client stopped paying’.

In response to a question from GAD, Equitable confirmed that they applied a penalty on the surrender of a policy.

Equitable provide details of the growth in business between 1984 and 1993:

… annual premiums went from £79m to £323m and single premiums from £45m to £1087m. Equitable was top of the new business league for annual premiums in ’93 with £320m. They were about 4th from the top for single premiums …

(3) Management systems and procedures

Equitable provide details of their internal structures and IT systems.

(4) Role of the Appointed Actuary

Equitable’s Appointed Actuary explains that he would continue in his position as Appointed Actuary and Managing Director until Spring 1996 and that ‘there had been no problem combining both roles’. Chief Actuary C notes that combining the two roles might be more of a problem for a proprietary office. The Appointed Actuary confirms that the two roles would be split after his departure ‘more for personality than regulatory reasons — it was difficult to find an all-rounder. The two successors would almost certainly come from within the company’.

(5) Aetna/Fuji case

Under this heading, DTI’s note records: ‘For single premium products – from the beginning of 1995 110% of surrender value would be paid – at present it was 101%’.

(6) Pensions mis-selling

Equitable explain that they had received a lot of business from people contracting out, but these were viewed as ‘execution only’, i.e. no advice had been given. DTI’s note records that the Society ‘never advised people to opt out’.

(7) Overseas activities

Equitable outline their current activities in the Republic of Ireland and Germany and the possibility of writing business in Italy, France, Spain and Austria.

(8) Bonus philosophy

Equitable explain that the declared bonus rate for 1994 would be held at 4% and that there is a guaranteed roll-up in policies of 3.5%. GAD ask what Equitable’s technique for smoothing was. The Appointed Actuary explains that Equitable:

… looked at what was deemed the return on gilts for the year. They had to meet the guaranteed roll up of 3.5% plus the guaranteed addition of 4%. Any balance of the deemed return was the non guaranteed bonus. For ’94 he would be asking the board to deem an intrinsic value of 10%. In ’93 they had earned 29% on assets. 17% was available for distribution and 13% was distributed. They took a broad approach to smoothing. Policyholders were notified of the present value of their fund — this consisted of the premiums paid, the guaranteed interest added, and the guaranteed bonus. The terminal bonus element was accrued for the life of the policy.

[The Appointed Actuary] said it was expected they would “overshoot” in ‘94 — they were not worried — but DTI may be! They did not do a market adjustment – [the Appointed Actuary] saw this as a “young actuary’s idea”! It was determined in relation to indices. They tried to keep the total guarantees in line with what would have come in if investments were wholly fixed interest.

GAD’s Scrutinising Actuary D comments ‘that it looked like over-distribution, compared with market values’. Line Supervisor B’s handwritten notes taken at the meeting also record that Chief Actuary C also asks: ‘do you raise people’s expectations?’, and record that the answer given is ‘No’.

(9) Solvency

The Appointed Actuary provides an estimate of the solvency position at 31 October 1994. He explains that he:

… was not concerned at how small the free assets got. If there was a negative free asset ratio, he would use the implicit item which he applied for every year. If they couldn’t declare a bonus, they wouldn’t — but he said a well-managed with profit office could not go bust! In the past, you minimised the free assets and strengthened other areas. A vigorous expanding office may have a low free asset ratio — yet a dead-end office might have a high one!

(10) Investment management

Equitable outline their investment policies. They explain that ‘they had targets to outperform the all-share Index each year by 0.5% without taking significant risks’, but that in 1994 ‘they would not have as good a year against the industry as a whole’.

DTI refer to their Prudential Guidance Note 1994/6 on systems of controls over investments and say that they would welcome feedback from Equitable on it.

(11) Reinsurance – resilience testing – implicit items – valuation bases

Equitable’s Appointed Actuary explains that the Society do not go for financial reinsurance, and that, on resilience testing, ‘they followed DTI/GAD guidelines but not slavishly. He thought that some younger [Appointed Actuaries] treated them like tablets of stone!’. GAD ask why Equitable do not show the implicit item in their returns. In reply ‘[the Appointed Actuary] said that using it would make them look weak!’. Equitable also explain that:

… they always went for the weakest possible valuation. The weakest one was the gross premium valuation. GAD noted that recurrent single premiums were very similar to the net premium valuation method. [The Appointed Actuary] said they took no account that 90% of the recurrent single premiums would be renewed.

(Note: it does not appear from DTI’s note of the meeting that there was any specific discussion of DTI’s Line Manager B’s concerns about the prudence of each of the assumptions in Equitable’s valuation (see 29/11/1994 and 06/12/1994 [entry 2]).

At the meeting, Equitable provide the following documents:

– ‘Equitable Life – Estimated Solvency Position at 31 October 1994’

The information in this document is as follows:

If the Society had published a “Form 9” at 31 October 1994 the estimated position would have been as follows:

– ‘Equitable Life – Development Expenditure’

This document sets out the Society’s expenditure on information technology over the years 1989 to 1995, totalling £70m, and when repayment of the amounts borrowed to cover that expenditure is expected. Full repayment is anticipated by 1999.

– ‘New Business Financing’

The information in this document is as follows:

For “annual premium” type business, acquisition costs exceed the charges in the premium received in the first year and are recouped over the life time of the policy. Loans are required from the main fund to finance the costs of year one.

Single premium business requires no such financing.

The “loan account” has been monitored for some 20 years, from the time the Society developed its current sales force.

The net loan plus interest to the end of 1988 had amounted to £147.9m.

The movement since then has been:

* Based on “fund returns”. Now use rate of interest negotiated with our bankers.

On DTI’s copy, Line Supervisor B has written: ‘£300m is part of the assets’.

– ‘Equitable Life – Recurrent Single Premium Pension Bonus Rates’

Equitable provide the following table:

* The “equivalent return” is a combination of the declared rate and the basic accumulation rate of 3½% p.a. guaranteed within the contract.

– ‘Managing Director’s Report’

This document provides a brief summary of certain areas of the business. Under the heading ‘New Regulations for Liability Calculation’, the report states:

The DTI is introducing new regulations which will be effective for the year end. Some of these stem from the Life Directive. There are no points of significance for the Society.

– ‘Pension Transfer Problems’

This note sets out the background to the pension transfers and opt-outs mis-selling review, its effect on Equitable, and the potential number of mis-selling cases.

– ‘The Equitable Management Company –Accounts for the Period Ended 30 September 1994’

This document, which is presented to the Board every three months, is made up of the following reports:

1. Global business profit and loss account
2. Global business balance sheet
3. Non-UK business profit and loss account
4. Non-UK business balance sheet
5. UK business full ‘Equitable Management Company’ accounts

– ‘Monthly Business Statistics – Period Ending 31.10.94’

This document, which is presented to the Board every month, is made up of the following reports:

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

Report 6, ‘UK with profits investment performance’, includes:

(Note: the figures in brackets in the above table are negative.)

Below these figures, Line Supervisor B, in noting comments made by Equitable’s Appointed Actuary, has written: ‘If we want to deem 10% earned – above concentrates the mind!’.

– ‘The Society’s Corporate Objectives’

The corporate objectives of the Society include the mission statement of ‘Growing more contented customers’ and its principles of operation being:

1. We are a mutual Society, providing a service at cost to our clients
2. We aim to attract clients from the upper end of the market. Through packaged arrangements such as group pension plans we also offer the benefit of Equitable products to a wider community
3. We control the selling and marketing of our products, operating only through our own sales force and without payment of commission to third parties
4. We are, and are seen to be, an innovative organisation.

– Standard & Poor’s press release of 5 December 1994 entitled ‘The Equitable Life Assurance Financial Strength Rated “AA” (Excellent) By S&P’

The press release says:

The rating reflects the society’s strong market position where a very focused approach and highly efficient distribution system have fostered excellent new business growth and contributed towards ELAS’ remarkably good expense performance. Furthermore, S&P regards capital strength as excellent, while investment performance over recent years has continued to be strong.

On Equitable’s regulatory solvency position, Standard & Poor say:

Although ELAS uses a conservative valuation methodology, S&P still believes that it shows a significant degree of capital strength. The Society’s published returns display a strong level of capitalisation, despite a significant strengthening of the valuation in 1993, with the free asset ratio rising to 9.40% and coverage of the required minimum margin to 3.7 times (x), from 5.09% and 2.4x, respectively, in 1992. An alternative net premium valuation, more comparable with peers, would increase the free asset ratio to almost 12% and coverage of the required minimum margin to over 4.4x. While these levels can be expected to decline in 1994, as investment values fall, S&P believes that the society’s capital strength will remain substantial.

– Insurance Security Analysis Service’s analysis of Equitable and comparative market data

The rating given is ‘B+’. The commentary explains that ‘The company continues to perform well, although its free assets are relatively low for a with-profits office. A repeat of last year’s rating has been made’.

Under ‘Solvency & Security’, commenting on the Companies Act accounts for 1993 the rating states:

A transfer of £1.18 billion of capital appreciation was made in 1993 from investment reserve to the long-term business fund to support a significant strengthening of the liability valuation in the light of markedly lower interest rate levels and to enable bonuses at the appropriate levels to be declared, but the amount of Investment Reserve remaining at 31st December 1993 had doubled to £1.7 billion. The free asset ratio increased and the adjusted ratio, allowing for with-profits business, almost doubled to twelve per cent, although this is still well below the level for most with-profits offices.

DTI thank Equitable for their hospitality on 09/12/1994. DTI’s letter ends:

Looking at our files, it appears that we have not yet received a request for a Section 68 Order for a future profits implicit item. If you require such an Order for the 1994 returns, grateful if you could send in the necessary information as soon as possible.

Equitable’s Appointed Actuary writes to DTI’s Line Manager B to express the hope that the visit gave DTI as much information about Equitable as they were expecting. The Appointed Actuary invites DTI staff to visit Equitable’s Head Office to look at their new IT systems. He adds: ‘You can then meet some other colleagues which would help demonstrate that there are other people here besides myself, just to pick up on [Chief Actuary C’s] comments!’.

Equitable apply to DTI for a section 68 Order for a future profits implicit item of £500m, for possible use in their 1994 returns. Equitable provide financial calculations in support of the application which suggest they could seek an Order up to the value of £2,141.1m. Given the proximity of the year end and to save time, Equitable copy the application to GAD.

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

Average annual profit = 2379.2/5 = £475.8m

Notes:

1. Surplus was increased by £557.0m as a result of changes in valuation bases during 1990.
2. Surplus was reduced by £13.2m as a result of changes in valuation bases during 1991.
3. Surplus was reduced by £89.4m as a result of changes in valuation bases during 1992.
4. Surplus was reduced by £1,066.7m as a result of changes in valuation bases during 1993.

The calculations state that the average period to run for the Society’s in-force contracts is now nine 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 £475.8m multiplied by nine years — that being £2,141.1m.

GAD write to DTI, recommending that the section 68 Order is granted. GAD say, however, that they do not agree with Equitable’s detailed calculations. GAD explain:

The calculation includes “Exceptional Items” relating to basis changes. The Guidance Note requires that exceptional losses should be omitted to the extent that there are similar exceptional profits. Furthermore it suggests that there is no intention to allow basis strengthening to be allowed as an exceptional item. The note does however talk of “net strengthening”, and it would seem a little unreasonable to omit the surplus arising from a weakening and disallow the cost of re-strengthening in a later year; this is made more clear when it is realised that a simultaneous change would be offset. However, the requirement that a loss must only be disallowed to the extent that there is similar profit being disallowed must be right, and we should ensure this is pointed out to [Equitable’s Appointed Actuary].

GAD continue:

In the current calculation, there is a large strengthening of reserves added to the surplus for 1993, and only about half this amount in a disallowed profits from weakening. I have reworked the figures to eliminate all the exceptional items, and this permits a maximum implicit item of £1,590.3m, which is still comfortably more than the £500m being requested. If the exceptional profit were eliminated, but the losses were not, then the figure would still exceed the request, being some £1,088.9m.

Equitable’s Appointed Actuary writes to GAD to raise a query about the use of future profits

implicit items. The Appointed Actuary explains that ‘[for] various reasons we have, to date, decided not to make use of these orders in preparing our returns. I have, however, felt for some time that it would be professionally sound to recognise the ability to obtain and make use of such an order when considering the application of the resilience test’. He suggests that, in relation to the Society’s 1993 returns, it would have been reasonable to say that the additional margin of £236m indicated by the resilience test was well below the amount of the available future profits implicit item, and thus that no additional explicit reserve was required. He asks GAD for their views.

DTI send Equitable the section 68 Order for a future profits implicit item of £500m, for use in the 1994 returns. DTI add:

We have the following comment on the calculations supporting your application, which I would be grateful if you could note for future calculations. Your calculation included “exceptional items” relating to basis changes. The DTI Guidance Note (October 1984, paragraph 10) on implicit items requires that exceptional losses should only be omitted to the extent that there are similar exceptional profits.