Submission of the 1994 regulatory returns

Equitable submit their 1994 regulatory returns to DTI.Whilst in the same format as in previous years, the returns are now required to be made with regard to the new valuation regulations as contained within ICR 1994. Accompanying the returns are copies of the Society’s annual report and financial highlights and its statutory accounts, prepared in accordance with the Companies Act 1985 and both dated 22 March 1995.

Equitable also send DTI a declaration under section 94A of ICA 1982 and pay Insurance Fees of £20,250 in respect of their 1994 returns.

These documents include the following information about Equitable’s business and about their financial position as at 31 December 1994.

Companies Act annual report and financial highlights

In their President’s Statement, Equitable explain that 1994 had demonstrated the benefit of the with-profits system in smoothing out fluctuations in investment returns. Equitable say that they had been able to maintain the rates of reversionary bonus even though they had suffered negative investment returns. They also comment that possible pensions mis-selling costs are unlikely to be material.

In their Management Report, Equitable explain that with-profits policyholders have recently received notices of their bonuses and statements together with a letter explaining the approach to bonus allocation in 1994. They note that, in common with other such funds, Equitable’s investment return for the year was negative and that it was in such conditions that the benefits of the with-profits system, with its ability to smooth short term peaks and troughs of investment performance, became apparent. They explain that the Directors had decided to allocate an overall rate of return of 10% for recurrent single premium with-profits pensions business. Equitable say their reversionary bonuses had mirrored gilt yields for many years and fallen in recent years as gilt yields declined. Equitable had maintained the reversionary bonus for 1993 as it was consistent with yields at the end of 1994.

Companies Act statutory accounts

Equitable’s statutory accounts include a Directors’ Report for 1994. The report includes an example of how bonuses are allocated to policies, which is as follows:

… the rate of declared bonus for personal pension plans for 1994 was £4% (1993 – £4%) which, with the rate of roll-up already guaranteed by the policy, gave an overall allocation of benefits in guaranteed form of just over 7½%.

The total return allocated to this type of policy was 10% which was the rate which had applied for determining actual pay-outs during the course of 1994. The amount in excess of 7½% was in the form of final bonus which is a non-guaranteed addition and may be varied at any time before the policy benefits become contractually payable.

The returns

Equitable’s returns are again submitted in two parts covering Schedules 1, 3 and 6 and Schedule 4 to the ICAS Regulations 1983.GAD’s copy of the 1994 returns includes various annotations which were made by Scrutinising Actuary D during the scrutiny programme. For ease of reference, mention of these annotations is made here. However, I am satisfied that the annotations were made on or before 25/07/1995, at the time GAD prepared their A2 Initial Scrutiny check.

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 1994 as follows:

GAD annotate the form with the figure, on the appendix valuation basis, for ‘Total mathematical reserves (after distribution of surplus)’, being £12,077,193,000.

Equitable use for the first time a future profits implicit item of £250m.

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

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

Form 45 shows that 47% of Equitable’s non-linked assets are invested in equities, 8% in land and 40% in fixed and variable interest securities (compared with 43%, 7% and 43% respectively in 1993). A note to the Form explains that one of the yields shown in the Form (that for variable interest securities shown in line 5) would be higher if calculated in accordance with Regulation 69(6) of ICR 1994. GAD note that the yield would be 4.24% under the new regulations (rather than the figure of 2.76% stated in the Form). They also add the total yield shown on line 12 from the previous 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. GAD circle the gross redemption yields stated for fixed interest securities not issued or guaranteed by any government or public authority with redemption periods of between one to five and five to ten years. They also circle the figure supplied for the total yield for this group of assets and question whether it is ‘low?’.

In the notes to this part of the returns, Equitable disclose that no provision has been made for the contingent liability to tax on unrealised capital gains for non-linked business, which they have estimated as £21.9m.

Equitable disclose that they have been granted a section 68 Order permitting them to take into account a future profits implicit item with a value not exceeding £500m. The Society state that it has included an item of £249,985,000.

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 theseparate 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)

Under the new valuation regulations, the calculation of the mathematical reserves must comply with Regulations 64 to 75. It is no longer possible to hold reserves calculated under a basis that does not comply with these regulations even where, in aggregate, the reserves are higher than if calculated in accordance with the regulations. As in previous years, Equitable present two valuations of their long term liabilities (their main and appendix valuations). The results of the main valuation are carried forward, unadjusted, from Form 58 to Form 14 and on to Form 9.

Schedule 4 – main valuation (text)

Schedule 4 of Equitable’s returns answers the questions set out in paragraphs 1 to 19 of Schedule 4 to the ICAS Regulations 1983 and includes Forms 55 to 58 and Form 60. Equitable state that this valuation conforms to Regulation 64 of ICR 1994.

In response to paragraph 3 of Schedule 4, Equitable provide 20 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 new German policies. GAD tick the descriptions provided, or otherwise note where there has been an addition or change in the information provided from the previous year.

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 47 pages of information about their linked contracts. Most of the information about the contracts remains unchanged from the previous year. GAD tick the descriptions provided or otherwise note where there has been an addition or change in the information provided from the previous year.

In paragraph 5, on the general principles and methods adopted in the valuation, Equitable disclose that personal pension business has been valued on the basis that benefits are taken at age 55. This is the first time during the period under investigation that the retirement age assumption for personal pension business is disclosed in the main valuation.

Equitable disclose, in paragraph 5(1)(a), that they have tested the ability of the Society to hold reserves which satisfy Regulations 64 to 74 of ICR 1994 in the three scenarios of changed investment conditions described in DAA6. Equitable state:

In these conditions the Society would be able to set up reserves which satisfy [Regulations 64 to 74 of ICR 1994] 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.

(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 non-linked business is estimated not to exceed £22m. The returns  state that Equitable consider that there are sufficient margins in the valuation basis to cover  the discounted value of this amount and, accordingly, they again hold no specific reserve. GAD  note on the returns the figure for the previous year.

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.

GAD tick this paragraph.

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

Unlike previous years, in response to paragraph 7(b) of Schedule 4 to the ICAS Regulations 1983  (which asks in respect of non-linked contracts for a description of ‘the method by which  provision is made for expenses after premiums have ceased or where no future premiums are  payable or where the method of valuation does not take credit for future premiums as an  asset’), Equitable explain the method by which they had made provision in the main valuation  for future expenses on their recurrent single premium business:

For recurrent single premium business the valuation rates of interest shown in Form 55[the valuation summary of non-linked contracts] are net of a ½% interest rate reduction as  a provision for future expenses.

GAD mark this statement as ‘New’.

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 66 to 75 of the Insurance Companies  Regulations 1994. 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’.

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’.

In paragraph 13, Equitable disclose that they had set the reversionary bonus for the main policy  classes at 4.0%. As in previous years, Equitable disclose that they offered loans under a

‘loanback’ arrangement to some retirement annuity and individual pension policyholders. GAD note that the wording of this paragraph has been revised.

In paragraph 16, Equitable set out their system for allocating final bonus. GAD tick various parts of this description, note the rates of bonus applying in the previous year, and mark where the wording is revised or new.

The returns again contain, at paragraph 16 (vi), the statement:

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.

(Note: as for the 1993 returns (see 27/06/1994), in GAD’s copy of the 1994 returns this paragraph has been sidelined in pencil. This marking is consistent with that made by Scrutinising Actuary E in the 1995 returns, during the scrutiny of the 1995 returns. (See 28/06/1996.))

Schedule 4 – main valuation (forms)

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

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

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

Schedule 4 – appendix valuation (text)

Equitable explain that the appendix valuation:

… was undertaken for the purposes of demonstrating that in aggregate the mathematical reserves determined by the valuation undertaken using the gross premium method, the results of which are reported on the preceding pages, are not less than an amount calculated in accordance with Regulations 66 to 75 of the Insurance Companies Regulations 1994.

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. They say that the information required for the other paragraphs (apart from paragraph 19 – being a statement of the required minimum margin in the form set out in Form 60 of Schedule 4 which, having had ‘regard to the purpose of the valuation’, has not been provided) is identical to that given in the main valuation.

As in previous years, in response to paragraph 5(1)(a), Equitable state: ‘In these conditions the Society would be able to set up reserves which satisfy [Regulations 64 to 74 of ICR 1994] 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: on GAD’s copy of the returns, the words ‘at line 51 of Form 14’ have been underlined in pencil (rather than the red ink used by Scrutinising Actuary D during his scrutiny of these returns). This marking is consistent with that made in the 1995 returns by Scrutinising Actuary E during his scrutiny of those returns. (See 28/06/1996.))

As in the main valuation, in paragraph 5(1)(e) Equitable state that no reserve is made for any prospective liability for tax on unrealised capital gains in respect of non-linked business. GAD sideline this statement.

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 unitlinked annuity.

As in previous years, in paragraph 5(1)(g) Equitable disclose the ages that retirement benefits could be taken on their recurrent single premium with-profits pension business. Equitable state that, for the purposes of the statutory minimum valuation, they now assume a retirement age for personal pension policies of 55 (increased from the previously assumed retirement age of 50).

As in the previous years, in paragraph 7(b) Equitable explain the method by which they have 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.

A GAD actuary and member of their Scrutiny StrategyWorking Party provides some analysis to another GAD actuary on the emerging draft ‘Free assets & valuation bases’ section of their 1993 dummy report on the life insurance industry. (Note: the copy of the note that I have seen does not include all of the attachments referred to within the document.) The analysis held on file with this document includes data on the average gross valuation interest rates used by companies in their 1992 and 1993 returns. GAD’s data shows:

In commenting on GAD’s work to attempt to evaluate the relative strength of companies’ valuation bases (which is not attached to the document; however, see 30/08/1995), the GAD actuary says:

The “strength ratio” figures appear remarkably sensible. Equitable is silly because it uses a bonus reserve valuation method, I think.

(Note: in relation to the GAD’s comment that ‘Equitable is silly’, the bodies under investigation have told me that: ‘This refers to the fact that the result of the calculation was odd for Equitable, as its “strength ratio” was not comparable to those for other companies because the valuation interest rates used in its calculation were those used in the bonus reserve valuation (the main valuation). These interest rates were significantly higher (and the “strength ratio” therefore correspondingly lower) than those for other companies, which used a net premium valuation, as reflected in the table shown in this entry. This was naturally the case, because the bonus reserve valuation allowed explicitly for future reversionary bonus whereas the net premium valuations used by other companies made implicit allowance for future reversionary bonus, in part through the use of a significantly lower valuation interest rate’.)

GAD provide DTI with comments on Equitable’s section 68 Order request. GAD suggest that Equitable probably did mean to refer to using the Order in their 1994 returns, as the guidance note on implicit items requires a company using one to submit an application with the returns, covering at least the amount in the returns. GAD tell DTI that they assume, however, that this is also an application for the 1995 returns. GAD say:

This is a similar request to previously, in that not all the allowable amount is claimed. It is worth noting that Equitable are now, in part, using the order.

GAD continue:

There does seem to be some confusion still regarding the exceptional items. The surplus or deficit arising from changes in the interest rates in the valuation basis appears to have been excluded from the calculation, but the covering letter refers to previous correspondence and states they are included. The conclusion of our (protracted) correspondence with [Equitable’s Appointed Actuary] earlier this year [see exchanges on the issue between 25/01/1995 and 27/03/1995] was as described in his letter, and not as in the calculations. The result however does not impact the £500m requested implicit item, and this can properly be granted.

GAD also comment that DTI need not take any action in response to the information Equitable supplied (see 16/06/1995) regarding Irish and German term assurances. However, that information ‘is on record if there is any challenge from our friends in Germany’.

GAD complete the A2 Initial Scrutiny check on the Society’s 1994 regulatory returns. GAD note that the priority rating is 3, unchanged from the previous year. They note that the mortality rates look reasonable ‘but thin’ and that Equitable have not set up any identifiable provision to meet personal pension transfer problems. Under ‘Aspects which look worrying’, GAD write ‘Mismatching?’. GAD also note:

Derivatives – investigate

Ethical fund general investments

[paragraph] 4(2)(c) [of Schedule 4 to the returns] omitted

[capital gains tax] – “sufficient margins”

Check into mis-selling.

GAD identify no items to notify to DTI, to be taken up immediately with Equitable. Accompanying the Initial Scrutiny check is a Form B – Initial Scrutiny Form, which includes certain key figures disclosed in the 1991 to 1994 returns.

(Note: the Initial Scrutiny check was dated 25 July 1996, but this seems to have been a mistake.)

The final version, which was sent the same day, says:

Our view is that the mortality table for the premium basis is not explicitly covered by the Third Life Directive. Nor is it subject to supervision except insofar as it influences the adequacy of reserving bases which are indeed covered by Article 18(1)(c) of the Directive. We would expect a UK Appointed Actuary to have regard to the local experience – though as discussed between [Directing Actuary A] of the Government Actuary’s Department and [an official of the German regulatory authority] (following your letter to us of 20 March 1995) we take the view that, where the amounts involved are not significant, the use of a UK mortality table would be acceptable.Where the volume is significant, (and unless the company’s own experience in Germany justified an alternative assumption) we would expect the company to use a local table, or a suitably adjusted UK table that gave similar results.

GAD’s Directing Actuary A writes to Equitable’s Appointed Actuary, inviting him to a reception ‘for friends and colleagues whom I have had the pleasure of knowing over my actuarial career’ on the occasion of his retirement.

(Note: I have been told that an invitation was also sent to approximately 200 other people in the actuarial profession and the insurance industry.)

Line Supervisor B adds a note to DTI’s copy of the letter of 01/08/1995 to record a telephone call from Equitable:

They weren’t actually asking for a S.68 Order – just updating 94 calculations!

But they will want an Order for £500m. He’ll drop me a line confirming this …

Equitable write and confirm to DTI that the information provided in the Society’s letter of 28/06/1995 had been ‘to demonstrate that the amount of £500m in the Section 68 order dated 22 December 1994 did not exceed that resulting from the revised calculations at 31 December 1994’. The Society confirms that it is Equitable’s intention to include a future profits implicit item in Form 9 of their returns for 31 December 1995, and that they would have applied for the Order on the basis of the calculations enclosed with the letter of 28/06/1995. Equitable explain that, in future when submitting their returns and updated calculations for one year, they would seek a section 68 Order for the subsequent year.

Line Supervisor B notes on the letter: ‘No action – but confirms my query re their reference to end ’94 returns’.

For the section of the annual report on ‘Maturity Payouts’, GAD provide a description of the work undertaken so far, rather than the proposed draft text of this section. GAD explain that they have attempted to collate information on maturity payouts and to establish theoretical asset shares so that a comparison between the two can be made. GAD set out the ‘heroic’ assumptions which they have used in conducting this analysis, for possible discussion by the Working Party. The results of this preliminary work are presented as follows:

In the section on ‘Free assets & valuation bases’, GAD say: ‘A broad-brush attempt has beenmade to assess the relative strengths of the valuation bases adopted by the major with profitoffices’. GAD explain the method they have used to do this as being:

First, the yield on the total non-linked assets shown in Form 45 has been adjusted upwards by stripping out the lowest yielding assets until such time as sufficient assets remain to exactly match the total non-linked liabilities, net of reinsurance, from Form 55.

Second, an average valuation rate of interest in respect of the non-linked liabilities has been calculated. This is based on a weighted average of the actual rates used for the various classes of business, the weights being the corresponding net of reinsurance valuation reserves. Taxable business has been grossed up. For simplicity, a tax rate of 25% has been used throughout.

Finally, the adjusted asset yield, reduced by the 7½% margin in the valuation of liability regulations applicable in 1993, is divided by the average valuation interest rate, and the result expressed as a percentage.

The resulting percentages, which might be called “basis indices”, provide a crude measure of the strength of the valuation basis used. The higher the basis index, the stronger (i.e. more cautious, less worrying) the valuation interest basis relative to the minimum prescribed by the regulations. The basis index figures for 1993 are shown in [an appendix], and the companies with the highest and lowest figures are shown in [the table below].

The dummy report then includes the following table:

Basis indices giving a crude measure of the strength of valuation bases used in 1993

I have seen from GAD’s supporting documents that they had also calculated that the strength of Equitable’s valuation basis for 1992 was 66.1% and for 1989 it was 69.4%. (However, see also the note at the end of this entry.)

GAD’s report continues:

Within the limit of approximations inherent in the above method, a 100% figure indicates that the basis just complies with the regulations. Any company below 100% would normally have been closely monitored in the course of its detailed scrutiny, usually by examination of a “matching rectangle” to allow for hypothecation of different types of asset to different classes of business.

The highly simplified nature of the above approach requires these figures to be treated with caution. For example, the figure of 66.8% for Equitable Life results from their philosophy of effectively reserving for all future terminal bonus at currently declared rates. This should be regarded as indicative of strength rather than weakness, although the company is still out of line with the rest of the market.

The report says that GAD have repeated this analysis for the previous year to provide an indication of whether companies have strengthened or weakened their valuation bases. The report states that Equitable have strengthened their valuation basis by 1% between 1992 and 1993. For the period from 1989 to 1993, the report says that Equitable’s valuation basis has been weakened by 4%.

At the meeting of theWorking Party, GAD’s Chief Actuary C asks DTI’s Line Manager A to provide any further feedback on the report that he receives from DTI.

(Note: in relation to GAD’s measurement the strength of Equitable’s valuation bases, the bodies under investigation have told me that:

The dummy 1993 report was an internal GAD pilot and was not provided to the prudential regulator. This included an incorrect explanation for Equitable’s low “basis index” of 66.8% that this “results from their philosophy of effectively reserving for all future terminal bonus at currently declared rates”. The correct explanation is in fact that … the valuation interest rates used in the calculation of Equitable’s basis index were those used in its bonus reserve valuation (the main valuation), which were significantly higher than those used by other companies, which used a net premium valuation.

The comment should have referred not to Equitable reserving for future terminal bonus – which, in line with other companies, it did not do – but rather to the valuation on which the figure for Equitable was based making explicit provision for future reversionary bonus, unlike the valuations used by other companies. However, the essential point made – that the figure for Equitable was not comparable to those of other companies – was correct.

The error was corrected for the 1994 report, the first provided to the prudential regulator. This used the valuation interest rates used in Equitable’s net premium valuation (the appendix valuation) to determine its “basis index”, resulting in the marked increase in this index to 96.3% for 1994 recorded in the entry for 03/11/95. Had this approach also been used for the 1993 calculation, the corresponding index for 1993 would have been 99.6% (and 100.9% if allowance was additionally made for the resilience reserve required in the appendix valuation in that year).

No weight should be placed on the 66.8% basis index figure for 1993. It was not comparable to those of other companies, a point recognised by GAD at the time and stated in the 1993 dummy report.When it was adjusted to a basis comparable to other companies, it was close to 100% and did not give rise to any concern.

It would have been quite inappropriate for GAD to be influenced by the unadjusted index for 1993 when conducting its detailed scrutiny of the 1994 returns. This was because the 1993 index compared the weighted average valuation interest rate and the adjusted yield on the assets matching the reserves in the main valuation. That comparison was of no significance for the main valuation. This is because the main valuation was not required to comply with regulation 59 of the Insurance Companies Regulations 1994. It was required to comply only with the aggregate reserves test in regulation 54 of those Regulations.

The bodies under investigation have also told me it should be noted that: ‘the charts selected for this entry all show maturity payouts for regular premium contracts only. By contrast, the bulk of Equitable’s business was recurrent single premium. These charts therefore have very little significance for Equitable. This comment also applies to the corresponding charts provided in the reports prepared by GAD for subsequent years’.)

DTI send Equitable the requested section 68 Order.

According to the minutes of a meeting of GAD’s Scrutiny StrategyWorking Party held on 23/02/1996, GAD provide to DTI copies of their 1994 annual report on the life insurance industry ‘as planned’.

(Note: the bodies under investigation have been unable to provide me with a copy of this report. However, I have seen GAD’s detailed analysis which underpinned this report, along with certain tables and charts which appear to have been prepared for use in the main body of the report.)

As in the 1993 dummy report (see 30/08/1995), GAD undertake a comparison of maturity payouts against their own estimate of theoretical asset shares. GAD produce the following charts:

The supporting data shows that GAD calculate that, for endowment policies (based on contributions of £50 per month for 25 years), the with-profits industry median payout is £97,142. GAD calculate this to be 118% of the theoretical asset share. For Equitable, GAD calculate that they are paying £87,887. GAD show this to be 107% of the theoretical asset share.

The supporting data shows that, for endowment policies (based on contributions of £50 per month for ten years), GAD calculate that the with-profits industry is paying a median maturity value of £10,322. GAD show this to be 134% of the theoretical asset share. For Equitable, GAD calculate that they are paying £10,575. GAD show this to be 138% of the theoretical asset share.

The supporting data shows that, for pension policies (based on contributions of £200 per month for 15 years), GAD calculate that the with-profits industry is paying a median maturity value of £133,605. GAD show this to be 131% of the theoretical asset share. For Equitable, GAD calculate that they are paying £145,338. GAD show this to be 142% of the theoretical asset share.

GAD carry out a similar analysis of the strength of companies’ valuation bases as that used in the 1993 dummy report (see 30/08/1995). However, for these returns GAD assess the strength of Equitable’s appendix (i.e. net premium) valuation, rather than the Society’s main (i.e. gross premium) valuation which was not comparable to the valuation method used by most other life insurance companies. Their analysis again shows that Equitable have the weakest valuation basis with a figure of 96.3% (a figure of 100% being one that GAD had previously described as indicating that the valuation interest rates used only just complied with the regulations). I have seen from GAD’s supporting documents that they had also calculated the strength of Equitable’s net premium valuation basis for 1993, and that it was 102.1%.

(Note: the bodies under investigation have told me that it should be noted that: ‘the charts selected for this entry all show maturity payouts for regular premium contracts only. Bycontrast, the bulk of Equitable’s business was recurrent single premium. These charts therefore have very little significance for Equitable. This comment also applies to the corresponding charts provided in the reports prepared by GAD for [other] years’.)

Line Supervisor B obtains a copy of the article in question. The article suggests that Equitable were being secretive about their financial strength and were refusing to reveal the amount of cash they held in reserve. The Line Supervisor passes the article to Line Manager B, commenting:

I know [Equitable] has a different way of calculating their reserves than most [companies] – but surely their financial strength can be ascertained from the DTI returns – albeit … not necessarily from Form 9. Otherwise how [would Standard & Poor’s] be able to give them such a good rating?

DTI send GAD a copy of the article. DTI seek advice, saying:

I know [Equitable] has a different way of calculating their reserves than most companies, and there has been press criticism of their apparent low free asset ratio in the past. But surely there is a way for an advisor or commentator to see that they are financially strong? (Presumably Standard & Poor’s know what to look for – or they wouldn’t have given them a good rating.) Can one point to anything particular in the DTI returns, apart from Form 9?

There is no evidence of a reply from GAD.

Line Supervisor B passes Line Manager B a newspaper article about problems with the selling of managed annuities. The Line Manager comments: ‘Interesting, but if it comes to the crunch I think it is for the PIA rather than us’.

The Line Supervisor passes to Line Manager B a copy of an article, which had appeared in a financial journal on 21/09/1995, criticising Equitable’s practice of imposing high penalties on policyholders seeking to transfer their pension funds to another provider. Line Supervisor B comments: ‘I meant to show you this earlier. [Equitable] is suffering from a poor press recently!’. The Line Manager comments in return: ‘There seems to be a prima facie case that these penalties run counter to PRE. [Please] ask for GAD’s comments. Is this a standard industry practice?’. The Line Supervisor passes the papers to GAD seeking their comments. It appears that GAD advise DTI to check the position directly with Equitable.

GAD write to Equitable to suggest that the 1994 returns show that Equitable make ‘significant use of derivatives on a regular basis’. GAD explain that it will help them in their examination of the returns to understand better the investment guidelines and controls that Equitable apply. GAD ask a series of detailed questions about Equitable’s approach.

The article to which you refer was unfortunately a biased piece of journalism. You will be aware that the Society’s pension plans guarantee full value on retirement or earlier death. There are no guarantees on surrender or transfer for deferred benefits.What we do pay is a value based on the underlying assets – the adjustment made is expressed as a deduction from the full retirement fund value on the day of transfer. In that respect, the adjustment is a financial adjustment and is certainly not a penalty.

Equitable enclose a copy of their leaflet ‘The Society’s Approach to Transfers and Switches fromWith-Profits Personal (and Other) Pension Contracts’. The leaflet says:

The Society has not guaranteed the amount of a surrender (or transfer) value since 1762. Our approach today to surrender of with-profits policies is still to offer no guaranteed values.

What we do offer, however, is a clear and unequivocal statement of the procedure for calculating the transfer and to apply it systematically and fairly across the board. The general approach is to take the benefits currently attaching to the policy as the starting point for the calculation.

For with-profits it is the full value of the fund value attaching or, when markets are running behind the rate of build up of the with-profits fund, the Society’s estimate of the market value of the assets supporting the fund value.

In explaining the background to with-profits business, in contrast to unit-linked policyholders who take their own investment risk, the leaflet says:

For with-profits business, the policyholder joins in a common managed fund whose returns are averaged. Each policyholder benefits at the same rate as other policyholders in the class. On occasions the averaged return allotted falls behind the return actually earned in the period, while at other times it exceeds the return earned, depending upon market conditions. On contractual termination of the policy, the full averaged return allocated is paid out regardless of the market value.

The leaflet continues:

In other words, with-profits policyholders share the risk between them.Whilst it would be desirable to pay out full value on non-contractual termination there are financial conditions when to do so would be to favour the outgoing policyholder at the expense of those remaining in the fund. That would be quite inequitable – hence the use of the MVA.

The leaflet states:

The Society’s with-profits pension policies guarantee that the full policy value is available on retirement at any age or prior to death.

And explains:

We are able to offer those guarantees because we can model the expected number of policies coming into payment and so estimate the cost implications. In this way, by sharing the investment risks amongst the pool of with-profits policyholders, the guarantees implicit in the system can be honoured.

The leaflet then says:

We are unable to offer such a guarantee of the value available if a client selects against the other with-profits members by choosing to discontinue the policy and to transfer from the with-profits fund because no reasonable allowance can be made for such selfselection in the estimates. Such guarantees would open up the possibility for clients to time the withdrawal of funds to maximise the benefits of smoothing, thereby gaining at the expense of the remaining policyholders. For example, it would be possible to withdraw when the returns allocated are greater than those actually earned. The inevitable result would ultimately be a reduction in policy values for those clients who, as the majority, continue their policies until retirement or maturity. That would clearly be unfair.

Equitable set out in their leaflet a comparison of the annual returns on the with-profits fund against the smoothed returns allotted.

Under the heading ‘Current basis’, Equitable say that, as at September 1995, their financial adjustment is calculated as follows:

Up until 31 December 1993, the accumulated returns allocated were broadly in balance with the accumulated return earned over various periods of time. During 1994, the Society earned about -4% on its assets but allocated 10% for the year. In other words, earnings for 1994 ran 14% behind allocations. To date, in 1995, 11% has been earned and policies have accumulated at about 7%, hence earnings have run 4% ahead of allocations. The basis currently used is therefore to deduct 10% of the 31 December 1994 value from the current claim value to reflect the shortfall of earnings in 1994 compensated in part by excess earnings in 1995 to date. This adjustment is therefore intended to bring the value on surrender or transfer broadly in line with the market value of the underlying assets.

Equitable’s leaflet concludes:

The approach demonstrates the Society’s stated practice of giving policyholders fair returns based on their participation in the with-profits fund. It is worth remembering that the following basic features of our contract remain true:

• full value on death for our main pension contracts;
• full value on retirement at any age;
• full value for existing funds which remain with the Society should premiums have to stop for any reason.

Equitable write to GAD in response to their letter of 08/12/1995. Equitable confess:

… to some surprise at having received it. As shown in our 1994 Returns our maximum exposure to derivatives at 31 December 1994 was £15.8m and had not been materially different during the year. That is only around 0.1% of our assets. I would hardly have called that “significant”.

Equitable enclose a copy of their ‘State of Play Report at 31 March 1995’ which they had submitted to DTI on 28/03/1995. Equitable say this should answer GAD’s questions.