1995

… have considerable sympathy with the professional argument you have made. There are, however, further explicit requirements in the regulations, some of which derive from European legislation. These will, I think, have the effect of limiting severely your ability to use the future profits implicit item in the way you suggest.

GAD explain:

The principal requirement is that in regulation 64(1) of the Insurance Companies Regulations 1994 which necessitates that the assumptions used in determining the long term liabilities “shall include appropriate margins for adverse deviation of the relevant factors”. This needs to be read in conjunction with regulation 75 which further requires that the liabilities “include prudent provision against the effects of possible future changes in the value of the assets”.

I believe these regulations have the effect of requiring the majority of the professionally required resilience reserve to form part of the mathematical reserves shown in form 14, or else the appropriate part of the entry in line 51 of form 14 needed to make the mathematical reserves sufficient must be stated.

They continue:

This, of course, relates only to the resilience reserve attributable to the liabilities themselves, and the assets supporting those liabilities. This may not be quite as stringent as your suggestion in one respect, namely that this need does not extend to the solvency margin.

GAD conclude that:

The position which meets your definition of “resilient” would seem then to become as follows:

a) the assets covering the mathematical reserve, including any resilience reserve necessary, are sufficient to cover at least the liabilities in the changed conditions (except the requirements of regulation 75)

and

b) the assets covering the mathematical reserves and solvency margin in current conditions are sufficient to cover at least the mathematical reserves and the amount of fund required by regulation 22(3) to be covered by explicit items (which for Equitable Life will be one-sixth of the total required minimum margin for the foreseeable future)

and

c) the future profits position in the changed conditions would be sufficient to support an implicit item to cover the balance between the cover provided by the assets and the required minimum margin.

The first of these three paragraphs would seem to be sufficient to cover the requirements of that part of the actuary’s certificate covering the determination of the liabilities, whilst the professional responsibilities of the Guidance Notes are, in my view, satisfied by the other two paragraphs.

Equitable write to DTI in reply to their letter of 29/12/1994. Equitable confirm that, in the calculation of average profits, exceptional losses were only excluded to the extent that those losses could be set against similar exceptional profits.

Equitable say: ‘As you are aware, in 1990 the Society moved from an approach using valuation bases which reflected the assumptions made in the premium bases to a more active approach in which the valuation bases reflected the yield on assets at market value. As a result of that change reserves decreased by £557.0m in 1990’.

Equitable continue:

When in 1991, a figure for average profits over the five years 1986 to 1990 was calculated in support of the Society’s application to take credit for a future profits implicit item, it was not clear as to whether an adjustment should be made to profits for the £557.0m release of reserves described above.

On the one hand, surplus had been increased by £557.0m from a change in valuation approach and, in accordance with the Guidance Notes on implicit items, such an exceptional profit should be excluded. It would then be consistent to also exclude any exceptional losses resulting from changes in valuation bases in subsequent years from the calculation.

On the other hand, however, paragraph 10 of the Guidance Notes state that “it is not intended, however, that any adjustment should be made for the effect on surplus of a net strengthening of reserves”. If, therefore, the effect on surplus arising from a strengthening of reserves should be excluded then, on the grounds of consistency, it would seem logical that the effect on surplus arising from a weakening of reserves should also be excluded.

Equitable ask for DTI’s advice ‘so that, in future, the Society’s calculations will accord with the DTI’s views on this subject’.

GAD write to DTI with some comments on Equitable’s letter of 25/01/1995. GAD begin by  saying that: ‘to understand the guidance notes, it is useful to remember the effect of an implicit item, and why it might reasonably be allowed. The purpose is to allow an office to hold less assets against the required minimum margin than would otherwise be required, on the grounds that over the life of the policies, based upon past experience, a surplus will be generated’.

GAD advise:

Changes of valuation basis can have various causes, but there are two main points to consider. A release of surplus from a weakening of the valuation basis is non-recurring, and indeed may even be at the expense of future surplus. It is therefore an exceptional item of surplus, and should properly be disregarded in the calculation.

A valuation strain arising from a basis strengthening could also be regarded as an exceptional item of deficit arising, but this is inappropriate if the reserve strengthening were required to meet the regulations, in particular to establish a prudent basis. This would tend to indicate that previous surpluses were overstated, for whatever reason. In general, therefore, the cost of reserve strengthening should not be excluded from the calculation.

GAD continue:

These comments relate more relevantly to significant changes of basis, such as Equitable made in 1990 … Most companies do make smaller changes from time to time, and these often are cancelling in effect from year to year. This will be less common under the 1994 regulations but will still occur. It seems unreasonable to exclude a surplus that arises from the release of a reserve the cost of setting up of which was included in a previous year. It is appropriate for reserve weakenings and strengthenings which relate to a similar item, such as the interest rate basis, should be allowed to be offset, so that the weakening need not be disregarded to the extent that the cost of strengthening the same assumption is included in a different year in the comparison …

It would not, of course, generally be appropriate in the context of the Insurance Companies Regulations 1994 to allow a strengthening of mortality basis and a weakening of interest basis to be offset in this way.

DTI write to Equitable in reply to their letter of 09/12/1994 about their critical illness policies.  DTI explain: ‘Our view is that the principal objective of these policies is the provision of [permanent health insurance] benefits and that they should therefore be classified as Class IV. The ultimate decision on this type of issue would of course lie with the courts’.

Having sought legal advice, DTI’s Head of Life Insurance responds on 27 March 1995. His short letter says ‘[DTI] are not aware of any reason in English law why a UK life insurance company should not appoint a trustee in Germany, if both parties are willing’.

(Note: I have found no evidence that DTI informed Equitable of this response.)

Equitable’s Chief Executive writes to DTI’s Head of Life Insurance to set out some concerns that the Society has about another taxation issue concerning the rules for business written in Europe. He begins his letter: ‘Following our luncheon earlier this week with your colleagues at which we discussed the role of the DTI as our “supporting agency”, I have already found a problem I hope you can help us with’. The Chief Executive explains:

… the simple changes required to the taxation rules for life offices have been so complicated by regulations that the legislation will not have the effect needed by the industry to take advantage of the current opportunities in Europe. The proposed regulations are so severe that we may well need to close our branches in Germany, Guernsey and the Republic of Ireland.

Equitable’s Chief Executive says that he has written to the Financial Secretary to the Treasury to request a change to the applicable regulations, but asks the Head of Life Insurance to use his influence to ‘ensure that something happens’.

DTI’s Line Supervisor B writes to Line Manager B enclosing a copy of GAD’s note of 07/02/1995. The Line Supervisor says: ‘I keep looking at this and putting it back in my tray! It all looks [very] involved!’. She asks if she should send the note itself to Equitable or request GAD’s Scrutinising Actuary D to draft a reply. She adds as a postscript: ‘[A GAD actuary] was saying to me yesterday that the calculation of the implicit item was essentially flawed, and he didn’t fuss too much about [very] technical details. But perhaps that’s just [him]!’.

On the same day, the Line Supervisor seeks views from DTI’s Legal Adviser A and GAD’s Scrutinising Actuary D on Equitable’s letter of 28/02/1995.

DTI’s Line Supervisor B writes to GAD in response to their note of 07/02/1995. The Line Supervisor says:

I am having problems with how to put your comments into a letter! Equitable’s arguments are all very theoretical as they don’t even use their implicit item!

I would be most grateful if on this occasion you could prepare a draft reply to [Equitable’s Appointed Actuary] which I can “top and tail”.

DTI’s Legal Adviser A comments on Equitable’s letter of 28/02/1995 about their critical illness  policy. Legal Adviser A takes the view that it is Class IV.

GAD write to DTI in relation to two issues. First, GAD confirm their view that Equitable’s critical illness policy should be classified as Class IV.

Secondly, in relation to the calculation of future profits implicit items GAD provide a draft reply to Equitable’s letter of 25/01/1995, reflecting the points in GAD’s note of 07/02/1995.

The German regulatory authority write to DTI about the sale by Equitable, in Germany, ‘of single premium annuity insurance policies with immediate effect, where the annuities payable monthly are guaranteed for life at a level which precludes participation in surpluses’. The regulatory authority point out that the yields required to meet the policies are unrealistic in Germany:

From my position I cannot assess to what extent the provisions on the interest rate of reserves applicable in the United Kingdom have been observed. It does however appear possible that the undertaking has not complied with the provisions of Article 19 in conjunction with Article 18(1)(c) of the Third Life Insurance Directive. The German press quotes the undertaking’s marketing manager … as saying … that no distinction is made between British and German people, or between men and women. The application of such a policy to annuities would in Germany be contrary to the actuarial principles which apply.

In connection specifically with the requirement on German life insurance undertakings to observe the new mortality ratios in annuity insurance and partially to reduce their guarantees in future policies, there is also naturally a competition policy aspect to this case and it has attracted considerable attention in the press. There is room for doubt, particularly in so far as Equitable Life’s product is to a considerable extent sold to women, as to whether the premiums received will suffice to meet the commitments entered into.

A DTI official advises Line Manager B that he and DTI’s Director of Insurance, along with GAD’s Directing Actuary A, are shortly visiting the German regulatory authority and could discuss the letter of 20/03/1995 at their meeting. The note is copied to Directing Actuary A.

In an undated note, GAD’s Scrutinising Actuary D informs the Directing Actuary that Equitable price German annuities on an a(90) select mortality table but do distinguish between men and women, although GAD are currently researching the position further. He points out that ‘as [Equitable] only have one in force policy, they aren’t too bothered about the reserve! Nonetheless, it seems under full control’.

DTI write to Equitable in reply to their letter of 25/01/1995. The letter largely repeats GAD’s note of 07/02/1995.

DTI’s reply crosses with a chasing letter of the same date from Equitable’s Appointed Actuary. In relation to the Society’s solvency position presented in Form 9, the Appointed Actuary says:

As at 31 December 1994 the excess of available assets over the required minimum margin will be of the order of £400m which will present a marginally stronger position than at the end of 1991. I am, however, considering the possibility of making use of the Section 68 order for a future profits implicit item which was enclosed with your letter of 29 December 1994. Our accounts for 1994 will be published in the new format under the Insurance Accounts Directive. Given such a significant change, and in particular the new asset of “deferred acquisition costs” it seemed an appropriate time to make full use of the margins available to us in the DTI returns. Hence both sets of documents may be described as “true and fair”!

The Appointed Actuary informs DTI that: ‘In 1994, the Society’s valuation bases were changed with the result that overall there was a release of reserves. The Society’s current approach to the treatment of profits and losses arising from valuation basis changes will for the five years 1990 to 1994 be the more conservative of the two possible approaches, as was the case for five year periods ending prior to 1993’.

The Appointed Actuary repeats his request for advice on the treatment of profits or losses arising from such changes to the valuation basis.

DTI later note on Equitable’s letter that they had provided the advice requested.

Equitable write to DTI in reply to their letter of 23/03/1995. Equitable say that this has provided the information DTI were seeking on the treatment of profits or losses arising from valuation basis changes. Equitable explain that: ‘By far the major part of changes in reserves due to valuation basis changes over the last five years has been due to changes in valuation interest rates reflecting the movements in asset yields’. They acknowledge that a few valuation bases have been strengthened, the cost of which should have been excluded from their calculations submitted in previous years. Equitable continue:

Those costs were, however, relatively small and I can confirm that they had no material effect on the applications for a future profits implicit item submitted by the Society in previous years.

When the Society submits its application for a Section 68 Order in respect of a future profits implicit item based on the average profits for the years 1990 to 1994, the effects of the strengthening of reserves other than those due to changes in interest bases will be excluded from the calculation of those average profits.

DTI’s Line Supervisor B seeks advice from Line Manager B about how to respond to Equitable’s letter of 28/02/1995 about the critical illness policy.

In an undated note, Line Manager B says to Line Supervisor B that he deduces from the note that no one at DTI agrees with Equitable that the business should be classified as Class III. The Manager informs her that he has asked Legal Adviser A about the solvency implications of classifying the business as Class IV. He also says that they could discuss the issue with GAD’s Scrutinising Actuary D when he is at DTI to discuss problems at another company.

GAD write to Equitable in response to their letter of 31/03/1995. GAD say that they explained to the journalist in question that:

… the grounds for intervention available to the Secretary of State are prescribed in the ICA 1982, as amended, and if higher bonuses are awarded than have been earned, this is principally a matter for commercial judgement provided the reasonable expectations of the other policyholders are not affected.

GAD deny that they are disseminating the results of the survey through the press and add:

In fact, during the conversation I told [the journalist] that it was decided not to publish the results of the survey due to the difficulty of not laying ourselves open to the charge that one could identify particular companies’ practices.

DTI’s Line Supervisor B prepares a note for Line Manager B, setting out the case for recommending Equitable’s Chief Executive and Appointed Actuary for an honour. The Line Supervisor gives brief details of his career with Equitable and some background to Equitable’s activities. Under ‘Grounds for Recommendation’, the Line Supervisor writes:

The Society has a good reputation. No known pension sales malpractice or LAUTRO compliance problems. Financial Strength rating by Standard + Poor’s 5/12/94 of Double A rating.

GAD comment on 1993 returns – expenses of Society remain low, with comfortably the best ratios in the industry. Cover for solvency margin is substantial.

(Note: during the relevant period, it was common practice for public bodies – especially those like DTI which had a ‘sponsorship’ role for an industrial sector or sectors in addition to their other functions – to consider whether to put individuals forward for recognition through the honours system.)

DTI’s Head of Life Insurance writes to the Director of Insurance to recommend Equitable’s Chief Executive and Appointed Actuary for an honour in the 1996 New Year list. The Head of Life Insurance explains:

… the Equitable’s achievements and reputation are undeniable; and there is a case for recognising through the honours system the Managing Director of a company which has so conspicuously got it right, both in terms of commercial results and in terms of avoiding the poor reputation which the sector as a whole suffers from.

[The individual] has been Managing Director and Appointed Actuary of the Equitable Life since July 1991, after service with the company in various capacities since 1953.

The Equitable Life has a well deserved reputation as a life office which has not only achieved outstanding results (regularly topping tables for high investment returns and low charges); but has also managed to avoid the poor image which currently afflicts the life industry generally, as a result of poor selling methods and breaches of regulatory rules. In particular, the Equitable Life does not pay commission to intermediaries (the main cause of inappropriate sales within the industry); the proportion of policies surrendered early is one of the lowest in the industry; and the payments for early surrender are among the highest.

The Equitable Life is also an industry leader in the application of Information Technology to improving services to clients; and is the chosen partner for [a leading retailer’s] new venture to distribute life insurance through its stores.

As Managing Director, and very much the driving force behind the Equitable Life, [the individual] can claim the main credit for these achievements. In addition, he is that rare specimen – an actuary who can communicate effectively in plain English.

The Head of Life Insurance copies his suggested citation to GAD’s Directing Actuary A for comment.

Equitable write to DTI to respond to their letter of 13/04/1995. Equitable apologise for not replying to the earlier letter of 25/10/1994. They say:

It is simply not possible to quantify, even crudely, the potential liability for compensation payments, given the uncertainty of the rules. My stance on that has not changed although we believe that our exposure is likely to be relatively small.

We are therefore making no explicit provision against this contingency in the accounts although I have “over estimated” the technical liabilities by £50m as a very full implicit provision. Our auditors have given a “true and fair” certificate on our accounts in the new Insurance Accounts Directive in the full knowledge of our approach.

GAD write to DTI in reply to their request for advice on the letter from the German regulatory authority. GAD suggest seeking Equitable’s comments on what has been said, as it appears Equitable are adopting an aggressive marketing stance, contrary to what they said at the company visit. (Note: DTI’s note of the visit – see 09/12/1994 – made no reference to Equitable’s marketing stance.) GAD end their letter: ‘No doubt [Equitable’s Chief Executive] will provide you with a satisfactory explanation which you could consider passing on to the German supervisor, if that is felt to be appropriate’.

Line Supervisor B passes the note to her Line Manager who replies: ‘Don’t do it! Let’s wait to see [a DTI official’s] report of the Berlin meeting’.

1993 returns    – Funds under Management of £13 billions

"        " – New premium income was £920 millions

Standard & Poor press release of 5/12/1994 rated Equitable’s financial strength as “AA” (Excellent).

Equitable write to DTI enclosing details of some changes they intend to make to the premium bases for Irish and German temporary assurances and annuities. Equitable explain that the new premium bases are being introduced to bring them into line with the bases already used, or those about to be used, in the United Kingdom. DTI copy the letter to GAD and ask if GAD have any comments.

28/04/1995 GAD’s Scrutiny Strategy Working Party (a group, established in June 1994, made up of GAD actuaries and DTI supervisors and including Chief Actuary C and Line Manager A) report to Directing Actuary A and DTI’s Head of Life Insurance on their work on the production of comparative information on the life insurance industry. The Working Party say that they have considered two possible approaches: to include comparative information within each company’s detailed scrutiny report or to produce an annual report on the life insurance industry. The latter approach is recommended and the Working Party attach a suggested format for such a report.

Under ‘Objectives’, the Working Party report:

The longer-term objectives identified in our December 1994 report, relating to comparative information, were to provide DTI with:

1. an understanding of how a company is performing in relation to its peers, and any problems this may cause if current trends in performance indicators continue
2. the basis of understanding the problems facing the various sectors of the industry
3. industry-wide analyses of certain key aspects of performance

It was recognised that an annual report could be designed to meet these basic objectives but that it need not be restricted to these. In particular, such a report provided an opportunity to give a far wider perspective on the industry as a whole, something for which DTI had been looking for some time.  

Following initial discussions with DTI, it became clear that the aim should be to provide a report that could be used for reference purposes by senior DTI management, and which would build into a useful series of documents over a number of years. In addition, the report was also seen as potentially useful to the GAD actuaries. They could cite the report when completing detailed scrutiny reports, to enable them to make more informed comments on a given company’s relative performance.

The following items are listed as being useful potential contents:

• an executive summary of the key points emerging from the report, generally at industry level but also commenting on individual companies or sectors, if required
• a background section, focussing on significant developments in the industry during the year
• analyses of new business, expenses and persistency
• analyses of free assets, maturity payouts and bonuses
• analyses of free assets and valuation bases
• remarks on compliance, press comment, etc.
• changes in composition of the industry, including new authorisations, take-overs, closures, mix of UK/overseas business, etc.
• views, opinions and predictions for the future.

The Working Party report that some initial work has already been undertaken to produce a dummy report for the 1993 returns and that this would be progressed over the following three months. They say that feedback on the dummy report is to be given in August 1995, ahead of the commencement of work on the report on the 1994 returns.

The Working Party also hold a meeting on this day, at which there is a general discussion on the period with which companies are permitted to file their DTI returns. The minutes record: ‘It was generally agreed that a reduction in this time would greatly improve the effectiveness of the detailed scrutiny process. However, it was recognised that this was not achievable without a change in legislation, and was, therefore, an impractical requirement, at least for the time being’.

Equitable’s Chief Executive writes to DTI’s Head of Life Insurance raising again Equitable’s concerns about the taxation rules applying to overseas business. The Chief Executive encloses a copy of correspondence with a Minister and says Equitable have made no real progress. The Chief Executive asks the Head of Life Insurance to exert any influence he can.

The Head of Life Insurance later notes on the letter that he does not see what more he can do at this stage.

GAD write to DTI to comment on Equitable’s letter of 26/04/1995 in relation to the proposed bases for Irish and German business. GAD say that they are:

… concerned at the proposed reserving basis for mortality. I am particularly concerned at the term assurances, where a table of adjustments to the base table is provided. We would only consider this appropriate for the UK if current experience were produced to support the basis, and are more concerned for Eire. I note that [Equitable’s Appointed Actuary] says the table of future improvements will not be used, but there is still the table headed “Age adjustments for [Equitable] experience”. In addition the AIDS adjustment is unusual.

GAD recommend that these points are pursued with Equitable. GAD also note that they have no reason to challenge Equitable’s view that they should use a UK mortality table for their business in Germany.

GAD write to DTI to acknowledge that Equitable have accepted the view that their critical illness policy is Class IV. But GAD question the comment made by Line Supervisor B (see 24/04/1995 [entry 2]) that the addition of a death benefit would not make the policy Class III. Line Supervisor B passes the note to Line Manager B and says she is loath to bring this up again, as Equitable have agreed to re-classify the policy as Class IV. The Manager’s advice is: ‘Let sleeping dogs lie!’.

GAD provide DTI with comments on the German regulator’s letter, requested on 01/06/1995.

GAD advise that:

… it is our view that the mortality table for the premium basis is not covered by the 3rd Life Directive, and indeed is not subject to supervision of itself. We broadly concur with the BAV statement if applied to reserving bases; we would expect a UK Appointed Actuary to have regard to the local experience though we take the view that, where the amounts involved are not significant, the use of a UK table can be acceptable on de minimis grounds.

Equitable’s Appointed Actuary writes to DTI, saying:

The Society has included a future profits implicit item of £249,985,000 in Form 9 of its annual returns to the DTI for the 1994 financial year. I am applying on behalf of the Society, therefore, for a further order under Section 68 of The Insurance Companies Act 1982 to allow that future profits implicit item to be counted towards the Society’s required solvency margin on 31 December 1994.

The Appointed Actuary says that the Society has used the future profits implicit item ‘for the purpose of achieving equality between the total net value of policyholders’ assets included in Form 9 (i.e. lines 21 + 31 – 24) and the corresponding total net asset value shown in the Society’s Companies Act accounts’.

The Appointed Actuary provides calculations in support of Equitable’s application. These calculations include, for the estimated annual profits, that:

Average annual profit = 1291.6/5 = £258.3m

Note:

In 1990 and 1994 surplus was increased as a result of changes in valuation interest bases. In 1991, 1992 and 1993, surplus was decreased as a result of changes in valuation interest bases. Those changes in surplus are included as exceptional items in column (B) above.

The calculations state that the average period to run for the Society’s in-force contracts is nine years. The 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 £258.3m multiplied by nine years – that being £1,162.4m.