Submission of the 1995 regulatory returns

These documents include the following information about Equitable’s business and their financial position as at 31 December 1995.

GAD’s copy of the 1995 regulatory returns and Companies Act reports and accounts include various annotations. I am satisfied that those annotations were made by Scrutinising Actuary E during the scrutiny programme, on or around 18/07/1996, when Scrutinising Actuary E completed the A2 Initial Scrutiny check. However, for ease of reference, mention of these annotations is made here.

Companies Act annual report and financial highlights

Equitable provide information on their Directors. GAD note that there are five executive directors and eight non-executive directors.

In their President’s Statement to Members, Equitable explain ‘While we have been at the forefront of those raising bonus levels when investment returns increase, we have not been afraid in the past to reduce bonus levels to reflect reduced investment returns where this was appropriate’ and that they had been able to maintain bonus rates (both reversionary and terminal) at the 1994 levels, as there had been no justification on investment grounds to reduce them. Equitable argue that ‘This is in contrast to some of our competitors, who have decreased bonus rates this year having deferred the decision from an earlier year’.

GAD mark some of the statements made in the President’s Statement, including that:

• they had secured a record level of new business;
• their expense ratio had fallen from 5.5% to 4.8%;
• Equitable are ‘satisfied that we can safely and securely continue to develop our business and maintain the interests of our policyholders without the need for any injection of shareholder capital’;
• they have continued to develop the business outside the United Kingdom; and
• on bonus policy that, ‘There should be no deliberate holding back of profits from one generation to the next’.

In their Management Report: an appraisal of the Society today, Equitable provide a statement of the principles on which they operate. Under ‘Investment Performance’, Equitable say:

A full distribution policy does not lead to investment considerations different from those applying to life assurance companies generally. The asset mix from time to time reflects relative price movements and preferences on investment grounds over the years rather than blind adherence to any particular “culture”. Over many years there have not been any particular technical restrictions placed on the investment team.

GAD sideline the following table which appears in this section under the heading ‘The factors contributing to the cost-effective internally financed growth’:

GAD also highlight that the fund charge for internal-linked funds had been reduced to 0.5%.

In their Management Report, features of 1995, Equitable provide information on: ‘New Business and Sales’; ‘Investment’; ‘Bonus Declaration’; ‘Customer Service’; ‘Systems and Consultancy’; ‘Staff’; and ‘Looking Ahead’.

GAD note that the Society has operations in Germany and the Republic of Ireland and an international branch based in Guernsey.

Under the ‘Bonus declaration’ section, Equitable note that with-profits policyholders had recently received notices of their bonus statements, together with a letter explaining Equitable’s approach to bonuses for 1995. Equitable note that in 1995, when investment returns on their with-profits assets had been 16.6%, the Directors had decided to allocate an overall rate of return of 10% for recurrent single premium business, the same as in 1994 when the investment returns on the with-profits funds had been –4.2%. Equitable say that this demonstrated how the with-profits system smoothed out the relative peak of performance in 1995, as well as the troughs in earlier years.

Companies Act statutory accounts

In their Directors’ Report for 1995, Equitable provide an example of how bonuses are allocated to policies. The example (using a personal pension plan policy) includes mention of the 3½% ‘roll-up rate’ guaranteed by the policy.

GAD make various annotations against the figures provided in the Profit and Loss Accounts and the Balance Sheets.

The returns

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

Schedule 1 (Balance sheet and profit and loss account)

As in previous years, Schedule 1 of Equitable’s returns consists of Forms 9, 10, 13, 14 and 16. Form 9 summarises the Society’s financial position at 31 December 1995 as follows:

GAD tick some of the figures provided and note the cover for the required minimum margin with and without implicit items (being x2.89 and x2.44), along with the equivalent figures for the previous year (being x2.36 and x1.85).

Equitable use a future profits implicit item in their 1995 returns of £263.4m.

In Form 13, GAD circle the figure disclosed for investments in dependent non-insurance companies and query what companies these are.

Form 13A (Analysis of derivative contracts) includes a note which reads: ‘Included in column one are convertible securities of £185,274,823, warrants of £22,345,129 and partly paid securities of £4,963,931’. GAD circle these figures and question whether they should be shown on this Form. However, GAD also write: ‘Seems acceptable, following Prudential Note 1995/2’.

In Form 14 (Long term business liabilities and margins), GAD circle the previous year’s figure for liabilities due to ‘Other creditors’.

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 version of Form 40 (Revenue account) relating to ‘Ordinary Long Term (Life, General Annuity and Permanent Health Fund)’, GAD circle the figures provided for the value of non-linked assets brought into account. Next to this GAD write: ‘as necessary!’.

In the annex to Form 40, Equitable disclose the principles and methods applied. Under ‘Increase/Decrease in the value of assets brought into account’, Equitable disclose:

The increase/decrease in the value of linked assets brought into account has been allocated directly to the relevant part of the fund. In respect of other assets the allocation is such as to give in each case, a “fund carried forward” of at least the amount of the mathematical reserves (including those arising from a distribution of surplus at the end of the financial year) in respect of the business attributable to the part of the fund in question.

GAD underline the second sentence and write: ‘ie. allocation from investment reserves as necessary!’.

In Form 41, Equitable provide information on premiums and expenses. GAD annotate the forms with corresponding figures from the previous year’s returns. They also add some corresponding figures taken from Form 44.

In Form 43, Equitable provide a summary of the changes in ordinary long term business. The instructions to this Form say that figures for annual premiums shall not include any recurrent single premiums. GAD underline the words ‘any recurrent single premiums’.

In Form 44, Equitable provide an analysis of their new ordinary long term business. GAD make various annotations on the Forms, checking the figures provided. In relation to UK non-linked with-profits pension business and Equitable’s regular premium contracts, GAD calculate the total amount of business to be just over £307m. Against this they note: ‘But FORM 43 excludes recurrent [single premiums] + shows only 1,398k!’.

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 tick the Form.

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 on non-linked business, which they have estimated as £37.4m. GAD underline that no provision has been made and sideline the paragraph.

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 states that it has included an item of £263,731,000 for the purpose of ‘achieving equality between the total net value of policyholders’ assets included in Form 9 … and … total net asset value shown in the Society’s Companies Act accounts’. GAD underline the quoted part of this sentence.

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.

Equitable state that they have been granted a section 68 Order permitting them not to submit a statement of their long term business as at 31 December 1995 (i.e. a Schedule 5 of the returns).

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 provides the information required by 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, Equitable provide 23 pages of information about their non-linked contracts. Most of the information about the contracts remains unchanged from previous years. GAD make various annotations to this section of the returns.

As in previous years, Equitable disclose that certain deferred annuity policies carry guaranteed terms under which future premiums could be paid. In paragraph 3(xiv) Equitable also, again, disclose that they applied a guaranteed annuity rate to the accumulated cash fund generated by certain types of with-profits policies, stating that the guarantees applied to policies issued prior to 1 July 1988. GAD tick the paragraph and underline ‘prior to 1 July 1988’.

As in previous years, Equitable provide a description of their principal guarantees of terms. GAD tick each description.

In response to paragraph 4, Equitable provide 48 pages of information about their linked contracts. GAD tick some of the descriptions provided or otherwise note where there has been an addition or change from the previous year.

As in the previous year, on the general principles and methods adopted in the valuation set out in paragraph 5(1), Equitable disclose that personal pension business has been valued on the basis that benefits are taken at age 55. GAD tick this paragraph.

As in previous years, in paragraph 5(1)(a) Equitable disclose that they have tested the need for resilience reserves against the three scenarios contained in DAA6. They state the changed conditions examined were: ‘an immediate 20% fall in property values combined with (1) a 20% reduction in fixed interest yields and a 10% fall in equity values; (2) a 10% reduction in fixed interest yields and a 25% fall in equity values; (3) a rise in fixed interest yields of 3% and a 25% fall in equity values’.

GAD underline ‘immediate 20% fall in property values’ and write against it ‘not needed in all scenarios!’.

As in previous years, Equitable disclose 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.

As in previous years, in paragraph 5(1)(d) Equitable set out the rates of future bonus valued for each class of business. GAD add corresponding figures from the previous year and write: ‘Mainly unchanged (at levels much lower than 1993)’.

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 £37m. GAD underline this figure and add next to it the previous year’s figure of £21.9m.

As in previous years, Equitable continue: ‘It is considered that there were sufficient margins in the valuation basis to cover the discounted value of the liability. Accordingly, no other additional reserve was made for any prospective liability for tax on unrealised capital gains’. GAD sideline these two sentences and note them with a question mark.

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 that they do not consider it necessary to hold an explicit provision for the guarantees and options described in paragraph 3, except where the right to effect further policies without medical evidence of health is carried. 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.

As in the previous year, in response to paragraph 7(b) of Schedule 4 to the ICAS Regulations 1983, in respect of their life assurance, general annuity and pension business, Equitable state:

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.

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 sideline 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% (unchanged from the previous year). GAD tick or mark as new the information in this section. As in previous years, Equitable disclose that they offered loans under a ‘loanback’ arrangement to some retirement annuity and individual pension policyholders. GAD sideline this paragraph.

In paragraph 16, Equitable set out their system for allocating final bonus. GAD make various annotations to this section. The returns, again, contain the statement at paragraph 16(vi):

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.

GAD sideline this paragraph.

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. GAD note some of the changes from the previous year to the rates of interest and mortality tables used.

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 to 7, 9, 17 and 18. 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 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 underline the words ‘at line 51 of Form 14 of these Returns’ and write: ‘i.e. margin between [bonus reserve valuation] liability + [net premium valuation] liability covers mis-match reserve’.

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 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 disclose the ages that retirement benefits could be taken on their recurrent single premium with-profits pension business. Equitable state that they assumed a retirement age for personal pension policies of 55. GAD underline the number.

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

Schedule 4 – appendix valuation (forms)

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

DTI’s Line Supervisor B asks Legal Adviser A for advice on the proposed sale of critical illness policies through Permanent Insurance. She queries in particular if the use of Equitable’s staff to sell Permanent’s products might breach section 16 of ICA 1982.

GAD complete the A2 Initial Scrutiny check on the Society’s 1995 regulatory returns. GAD reduce Equitable’s priority rating from 3 to 4. GAD identify a number of matters:

• the AIDS reserve is contained within the reserve for future bonus in the main valuation;
• unit costs have not been updated from the previous year (except for annuities);
• it remains the case that not all reassurance is with UK authorised companies; and
• the company has not set up any identifiable provision to meet exposure to personal pension transfer problems. Against this is a note ‘April 1995 letter indicated that technical liabilities “overstated” by £50m’.

GAD also note:

S68 Order permitted implicit future profits item of up to £500m. £263,731K used — cover for [required minimum margin] of 2.89

[Company] provides [management] services to University Life … + Permanent [Insurance].

[Paragraph] 4(2)(c) [of Schedule 4 of the returns] still omitted … - (covered in 4(2)(a))

Reduced management charges for Funds!

Unchanged expense allowance for linked contracts, but raised allowances for annuities.

New reinsurance treaty with connected [company] for Major Medical Cash Plans. – No current reassurance seems to be in place.

GAD identify no worrying aspects and no items to notify to DTI, to be taken up immediately with Equitable. Accompanying the scrutiny check is a Form B Initial Scrutiny Form, which includes certain key figures disclosed in the 1992 to 1995 returns. GAD tick some of the figures provided.

Equitable’s Appointed Actuary writes to GAD’s Scrutinising Actuary D (who about this time becomes a Chief Actuary (Chief Actuary D) and retains responsibility for Equitable), enclosing the latest version of the With-Profits Guide (dated July 1996). The Appointed Actuary adds:

I should also like to take this opportunity to thank you for your kind letter about the award I received in the Queen’s Birthday Honours. It was a surprise as well as an honour, as you can imagine.

As you indicate, I hope the award will be interpreted as a recognition of the standing and regard in which the Equitable is held. Many have contributed to that and to the work we have all been doing to benefit the industry’s clients. The award should, in that way, be shared by all involved.

DTI send GAD a copy of Equitable’s application for a section 68 Order of 26/06/1996. On GAD’s copy of the letter, a new Scrutinising Actuary (Scrutinising Actuary E) has annotated the following statement with a question mark:

In 1994 surplus was increased as a result of changes in valuation interest bases. In 1991, 1992, 1993 and 1995, surplus was decreased as a result of changes in valuation interest bases. Those changes in surplus are included as exceptional items in [the calculation of average annual profit]

Equitable give formal notice to DTI that they intend to sell permanent health insurance  policies (wholly reassured through Permanent Insurance) in the Republic of Ireland. Equitable supply details of the proposed changes to the requisite European Community and United Kingdom details.

GAD advise DTI that Equitable’s application for a section 68 Order for a future profits implicit item (see 26/06/1996) is ‘well within the maximum figure calculated and can be properly granted’.

GAD also say that they could see no problem with the proposed changes to the requisite details for Equitable’s Republic of Ireland business. GAD suggest that the possible problem about the blurring of regulatory boundaries does not really exist, as an amendment to the requisite details ‘indicates that the contract sold will be “similar in nature” to the UK version written by Permanent Insurance, of which details were provided, but we infer that it will actually be an Equitable contract — albeit wholly reassured with Permanent Insurance’.

GAD write to DTI about the detailed scrutiny programme for the 1995 returns. GAD say that they have completed the initial scrutinies for all life insurance companies and have prioritised the order of the detailed scrutinies, for agreement by DTI. The attached list gives the target date for the detailed scrutiny of Equitable’s returns as December 1996. GAD also say:

I am also enclosing a copy of the criteria we are currently applying in determining priorities. These are as agreed with [Line Manager A] at the Scrutiny Strategy Working Party, and you will note that we have replaced the old “priority 5” category with two new categories.

“Priority 5” now conveys the meaning that the company is not such that GAD considers a scrutiny desirable, bearing in mind our limited resources, but that we will reconsider the position later in the year, when we have a greater feel for the time and resources available. “Priority 6” will be reserved for those companies to be omitted from the 1995 programme when this review takes place.

In response to GAD’s proposed programme for the detailed scrutiny of all life companies’ 1995 returns, DTI’s Line Manager B suggests that the target date for completion of Equitable’s detailed scrutiny is advanced from December to October (with a corresponding demotion of one of two suggested companies that come under the responsibilities of Scrutinising Actuary E).

(Note: in his witness statement to Penrose, Scrutinising Actuary D/Chief Actuary D said that the scrutiny report was completed early because of an impending visit to Equitable as part of DTI’s rolling programme of visits. A meeting between DTI, GAD and Equitable took place on 08/11/1996.)

DTI write to Equitable to arrange the next visit to Equitable as part of DTI’s and GAD’s three year rolling programme. (DTI and GAD last visited Equitable, under this programme, on 09/12/1994.)  DTI set out the main subject areas they would like to discuss:

(1) The business plans for the next five years, with particular reference to solvency and any requirements which there might be for additional resources. DTI ask for a copy of Equitable’s most recent business plan.

(2) Equitable’s purchase of Permanent Insurance.

(3) Equitable’s experience of doing business in Europe.

(4) Equitable’s ‘managed annuity’ product.

(5) Use of genetic information in the underwriting of long term business products.

(6) Equitable’s potential liability for compensation relating to personal pension transfers, opt-outs and non-joiners.

DTI also seek a guided tour of the ‘paperless office’ which Equitable have established.

DTI propose that ‘the visit should take the form of a series of meetings with appropriate members of your team to discuss these areas, and would hope to cover them all adequately in a single day’.

DTI explain that it is not essential for Equitable to send any documentation in advance, other than the business plan referred to above, but that they would be pleased to receive any internal papers which might facilitate the discussions, such as structure charts and corporate plans. The visit is arranged for 08/11/1996.

GAD provide DTI with their scrutiny report on the Society’s 1995 regulatory returns. (A copy  of this scrutiny report is reproduced in full within Part 4 of this report.) The report uses the detailed format adopted for the 1993 and 1994 returns (see 15/11/1994  [entry 1] and 23/01/1996 [entry 1]) and comprises 12 sections as follows:

(1) Summary

Under ‘Key features’, GAD state that Equitable are the seventh largest company, measured in terms of long term business. GAD explain that Equitable are classified as priority 4 (reduced from priority 3 the previous year). They note that:

Unusually, the company publishes a gross premium bonus reserve valuation — and a net premium comparison. For the second year, Equitable has used an implicit profits item in Form 9, amounting to about £264m.

GAD note that, in a year when the industry struggled, Equitable achieved record sales and that their main line of business is pensions ‘somewhat unusually structured, with almost all on a recurrent single premium basis’. They note that expenses ‘remain the lowest in the industry, and the ratios continue to fall’. GAD also note that:

Reserving bases are fairly weak, by design, to maximise the disclosed free asset ratio, while permitting fair bonus distributions to the current generation of policyholders. The [required minimum margin] was shown as comfortably covered by a factor of 2.89 at the end of 1995 (cf 2.36 at end 1994) — the factor would be 2.44 without crediting the implicit future profits item.

Under ‘Action points’, GAD state that they have raised no points directly with Equitable, but that, at the planned visit (see 08/11/1996 [entry 2]), it would be interesting to discuss:

1.  Details of the continued fall in its actual overhead expense levels, and its potential ability to continue on this creditable path.
2. How the company views the sustainability of its present contract structures — largely based on accumulating funds to which regular bonuses are added. What scenario tests has it performed in relation to possible falls in asset values, and how would it react to sustained unfavourable market movements?
3. The increased investment in non-insurance companies — £75.4m in shares and £18.7m in debt (previously, £49.3m and £2.8m respectively).

(2) Background

GAD repeat information included in the Background section of their reports on the 1993 and 1994 returns, namely that Equitable are the oldest mutual life assurance society in the world, that they never pay commission to third parties, that they demonstrate ‘a determination to provide fair bonuses to policyholders, with no deliberate holding back of profits from one generation to another’, and that they use a bonus reserve valuation method. GAD note that, as well as using a future profits implicit item for the first time in 1994, Equitable obtained an Order in the sum of £500m for 31 December 1995 and have used £264m. GAD explain that Equitable have been active overseas in recent years (in Guernsey, Republic of Ireland and Germany) and that these branches are producing ever increasing amounts of new business. GAD state, as in their report on the 1994 returns:

Equitable regard this as an exercise in extending the numbers of people who can benefit from the Society as an institution. It is almost like missionary work, rather than a purely commercial move in the interests of UK policyholders. The mutual concept is extended to all policyholders, and is even part of Equitable’s dealing with UK non profit policyholders.

GAD also note that they and DTI visited Equitable in December 1994, that a further visit is planned for 08/11/1996, and that: ‘The Appointed Actuary and Managing Director posts are both held by [the same person], but the Board is chaired by a non-executive … and the total Board of 13 includes 8 non-executives’.

(3) New business

GAD provide details of the new products Equitable have developed and produce two tables setting out regular and single premiums Equitable have received for the various classes of policies sold from 1991 to 1995. The tables show that regular premium business has increased by 10.5% and single premium business by 30.4% since the previous year. GAD produce a third table, showing the year on year increase in new business over the same period. GAD provide no commentary on the figures.

(4) Changes in business in force

GAD produce tables showing:

• Recent history of regular premiums
• Claims experience
• Persistency experience
• Recent history of combined surrender, lapse & paid-up conversion rates.

GAD identify no concerns.

(5) Expenses

GAD produce a table showing the history of expenses from 1991 to 1995. They comment that Equitable’s expense ratios keep improving and have again reached ‘astonishingly low levels’. GAD note, as in the scrutiny report for the 1994 returns, that Equitable are a non-commission paying office and pride themselves on their low expense ratio. They state that the revealed total of ‘other management expenses’ has continued its ‘amazing fall’. GAD suggest: ‘It would be interesting to determine at the next visit exactly how this has been achieved’.

(6) Non-linked assets

GAD produce a table showing Equitable’s ‘Recent history of asset mix’. They state:

Increased investment in non-insurance companies has been noted — £75.4m shares and £18.7m in debt at the end of 1995 (previously, £49.3m and £2.8m respectively), and it would be interesting to receive details of these holdings.

GAD produce a table showing Equitable’s ‘Change in portfolio over the last year’. They identify no concerns.

GAD produce a table showing Equitable’s ‘Investment performance’. This states a return on investments in 1995 of 16.5%. GAD comment:

1. The Equitable’s own figure for its with profits fund was a rise of 16.6%.
2.  The overall result is close to expectations, based on known market movements and after allowing for investment expenses having absorbed about ½%.
3. A slightly higher figure might have been hoped for in relation to a with profits fund, but it may be that the expanded overseas equity portfolios (referred to in the 1996 With-Profits Guide) were biased towards far eastern markets that performed poorly in 1995.

(7) Unit-linked funds

GAD provide details of this class of business.

(8) Valuation and solvency

Under ‘Strengths and/or weaknesses’, GAD first provide an overview, which is similar to that provided in their report on the 1994 returns:

The company produces its published Return on the basis of a gross premium valuation, with some allowance for future bonuses, but the results of a net premium valuation are also shown in the Returns. It is known from the company visit at the end of 1994 that Equitable’s Actuary has decided that the interests of the Society are best served by using a weak valuation basis to show as strong a free asset position as is possible. This means that interest bases are selected near the limits of the regulations. Detailed matching rectangle data was sought in relation to the 1994 Returns and was found acceptable.

Additionally, the Equitable tries to provide a fair bonus allocation to each generation of policyholders — without holding back an excessive estate. The result is that lower free asset margins are revealed than might have been expected for such a well thought of institution. It may be noted that the Society has, for the last two years, found it desirable to utilise a future profits implicit item to improve the disclosed free assets position — although at nowhere near the maximum that could be justified under the guidelines.

There is one obvious hidden strength in the valuation — the treatment of recurrent single premium pensions business, under which it is assumed that no more premiums will be received. Although arguably only in line with the best practice, this is an extremely strong basis. If the business were treated as regular premium, margins in future premiums and charges on the funds built up might allow lower reserves. It is likely that some credit is being taken implicitly for this in the expense reserves …

GAD go on to discuss four particular areas:

Mortality — GAD explain that they are satisfied with the bases used for Assurances and German business. For Annuities — general, they explain that Equitable use:

… the a(90) table with a two year down rating. This follows discussions last year with the Appointed Actuary about the inadequacy of a one year down rating, which he claimed to be able to justify last year. It would seem desirable to keep pressing him quite vigorously on this point — as longevity improves.

For Annuities — pension, GAD explain that Equitable’s table is out of date. However, ‘this is close to the effect of using the more recent table with a fair adjustment for improving mortality, and we are not currently minded to press the Actuary regarding use of this table’.

Interest rates — GAD produce tables showing the interest rates used for major classes and compare these with assets and yields. They comment that the assumptions made are acceptable.

Expenses — GAD state that these are well controlled and continue to fall. They repeat that: ‘There is little reason to question the low expense allowances in the valuation. Increased provision has been made this year for the cost of paying annuities. A substantial hidden margin in respect of the pensions recurrent single premium business could cover any apparent shortfall elsewhere’.

Resilience and special reserves — GAD explain:

The Actuary indicates that the resilience reserve required in relation to his net premium valuation would be covered by the difference between the bonus reserve gross premium valuation liability and the net premium valuation liability.

This difference is revealed as £436m, and we have no reason to doubt its adequacy — although managing the distribution of bonuses and consequent growth in guaranteed liabilities in respect of the very substantial (over £8.6bn) portfolio of unitised with profit type business is a potential problem to be monitored.

(The actual resilience reserve that would have been required at the end of 1994 was disclosed in correspondence with the Actuary as £171m.)

Other reserves seem to be on a reasonable basis, although the failure to set up a specific reserve in relation to the contingent liability for tax on capital gains of £37.4m is dubious — relying on other margins in the valuation basis.

Under ‘Changes since previous year’, GAD note that Equitable had revised their interest rate bases to reflect falling interest rates and rising asset values and that they had strengthened annuitant mortality and expense reserves following correspondence on the 1994 returns.

Under ‘Summary of results for main classes’ GAD produce three tables, showing liabilities for non-linked and linked business and a valuation summary.

Under the table for non-linked business, GAD explain that they presume that, in the bonus reserve valuation, any additional reserve required for AIDS is covered by the bonus margin. They note that most of the margin between the total bonus reserve and net premium valuations would be needed to cover resilience.

Under the table for linked business, GAD note that the appendix valuation included an additional AIDS reserve of just £11,000.

The valuation summary shows, under the main valuation, that Equitable’s cover for the required minimum margin is 2.89, compared with 2.36 in 1994. As in the scrutiny report on the 1993 returns (see 15/11/1994 [entry 1]), there is no estimated figure for the appendix valuation. The table shows Equitable’s free asset ratio has risen to 5.13%, from 3.12% in 1994.

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

It should be appreciated that this bonus reserve valuation includes only an allowance for modest levels of future bonuses, with the result that the disclosed liability is actually very similar to that that would be derived from an acceptable net premium valuation with due allowance for resilience reserves.

Thus, the picture shown above may reasonably be compared directly with other offices who prepare Returns on standard net premium valuation bases. Without the implicit future profits item, cover for the [required minimum margin] would be by a factor of 2.44. This is satisfactory.

(9) Financial results

GAD provide the following table:

(10) Bonuses

Under ‘Cost of bonuses declared’, GAD include the following table:

GAD provide a description of Equitable’s final bonus system similar to that used in their reports on the 1993 and 1994 returns. GAD reiterate Equitable’s own description of their final bonus system. GAD produce three tables of statistics showing changes in reversionary and final bonus rates and reproduce Equitable’s table of earned investment returns on gross market value and the rate allocated in fixing bonuses, updated to include 1995:

* 12% was applied to new benefits secured during the year’

Under ‘Distribution policy’, GAD state:

The society follows a policy aimed at providing each generation of policyholders with a return that reflects earnings on assets during his or her membership of the fund, whilst avoiding short term fluctuations. Thus, total bonuses are intended to reflect a smoothed total earned rate. Part is allocated in the form of non-cancellable reversionary bonuses and the rest is in the form of final bonus.

GAD make no reference to the effect of Equitable’s bonus policy on policyholders’ reasonable expectations.

(11) Reinsurance

GAD state that Equitable make little use of reinsurance.

(12) Compliance

Under ‘DTI compliance problems’, GAD state:

The Equitable is a highly ethical institution and likes to think of itself as being beyond reproach, although it has recently given ground in relation to mortality assumptions in relation to annuity liabilities.

I am unconvinced of the value of its gross premium bonus reserve valuation, and would be happier to see a clearer exposition of its ability to react to possible falls in the value of assets — bearing in mind its exceptionally large exposure to unitised with profit type liabilities. It would be helpful to learn what scenario testing it undertakes.

No serious reporting omissions are noted, although the Actuary continues to rely on the comments made about derivatives under 4(2)(a) rather than include a specific response to 4(2)(c). (Usage of real derivatives is minimal, with the majority of entries in Form 13A relating to quasi-derivatives, i.e. convertible bonds, warrants and partly paid shares.)

Under ‘PIA and other compliance problems’, GAD state:

Although the Equitable might be expected to be beyond reproach, we understand that an over-estimation of pension liabilities of £50m has been incorporated into its reserves as a provision against possible costs arising from pensions mis-selling.

No other problems are known.

GAD’s scrutiny report runs to 16 pages. Line Supervisor B copies the report to the Head of Life Insurance and to Line Manager B.

Every insurance company is sent by DTI’s Director of Insurance a letter requesting state of play  information on money laundering, close matching of linked benefits, counterparty exposure on derivatives and controls on investments of linked funds.

DTI write to Equitable to set out three matters to discuss under ‘Any Other Business’ at the visit now planned for 08/11/1996:

1. Details of the continued fall in the company’s actual overhead expense levels, and its potential ability to continue on this creditable path.

2. How the company views the sustainability of its present contract structures — largely based on accumulating funds to which regular bonuses are added. What scenario tests has it performed in relation to possible falls in asset values, and how would it react to sustained unfavourable market movements?

3. The increased investment in non-insurance companies — £75.4m in shares and £18.7m in debt (previously, £49.3m and £2.8m respectively).

DTI (Line Manager B and Line Supervisor B) and GAD (Chief Actuary D and Scrutinising Actuary E) meet Equitable’s Appointed Actuary/Chief Executive, Company Secretary and another employee. DTI prepare a note of the meeting, which is amended by GAD. Although DTI had suggested a series of meetings (see 15/10/1996), only one meeting takes place.

DTI and GAD record discussion under six main areas:

Reports to Equitable’s Board

Equitable’s Appointed Actuary explains the cycle of reports presented on a monthly and quarterly basis and provides figures on Equitable’s premium growth, expenses, turnover, profits of administration and marketing departments and expense ratios (the latter presently running at 4.8%, compared with 7.5% in early 1995). These show also that, over the past year, there had been 25% more new business on annual premiums and 30% more on single premiums. DTI and GAD note that recurrent single premiums are classed as annual.

In response to a question from Scrutinising Actuary E, the Appointed Actuary agrees that Equitable’s falling expenses are partly the result of high software expenditure several years ago.

The note records: ‘There was some discussion on the “financial condition” report. On the concept of dynamic solvency testing, [Equitable’s Appointed Actuary] said that you needed dynamic management – there was a need to manage the business actively’.

Bonuses

Scrutinising Actuary E asks if the company built up a terminal bonus reserve. In reply ‘[the Appointed Actuary] said not — terminal bonuses were “instantaneous”! Declared rates were always broadly linked to the gilt rate for guaranteed benefits. Final bonuses were paid out of what was left. He noted that a “lively” life company would have smaller free assets than a moribund one!’.

The Scrutinising Actuary comments that he was not clear what Equitable’s bonus declarations said. In relation to accumulated with-profits business, the Appointed Actuary explains ‘that all bonus statements showed a build-up of guaranteed benefits — then also showed the non-guaranteed benefits. In the DTI returns, the terminal non-guaranteed bonus was not shown as a liability — not in the reserves’.

DTI and GAD record Equitable’s Appointed Actuary as noting that:

… every actuary valued as weakly as possible, to make the business look stronger. [Scrutinising Actuary E] suggested that gross premium reserving was not really any stronger than a standard net premium valuation method. [The Appointed Actuary] agreed — but said the Board was used to this method and happy with it. At the AGM, someone had asked about the “orphan estate”, and was told that it was all paid out! [The Appointed Actuary] explained that they never guaranteed a surrender value on any business. [Scrutinising Actuary E] noted that they had to be very careful with their bonus statements — to ensure that customers were not misled about the benefits.

Future plans/Permanent Insurance

Equitable’s Appointed Actuary sets out the Society’s plans to grow its health and sickness products. He explains that business in the Republic of Ireland is buoyant. DTI’s Line Manager B notes:

… that the Department’s lawyers were not happy about [Equitable’s] sales force selling another company’s products — section 16 implications. He was relaxed about this issue. [The Appointed Actuary] said he hadn’t thought about section 16 … [Line Manager B] said that it would be no problem if [Equitable] owned the whole of Permanent [Insurance].

The Appointed Actuary explains that the Society’s German branch was losing about £2m per annum at present and that Equitable would be deciding whether or not to pull out in the next few weeks. He explains that Equitable were thinking of doing business in Italy, Austria and Malta. Line Manager B suggests Gibraltar.

Equitable’s 1995 returns

GAD’s Chief Actuary D queries Equitable’s investments in a non-insurance subsidiary. The Appointed Actuary explains that the companies involved are not subsidiaries in a real sense, as Equitable have majority holdings in them for investment purposes. These are carefully controlled through the investment committee.

The Appointed Actuary explains that the Society ‘had sold all its software to its consulting company and had lent the company £10m to pay for the software! They had also lent £6m to the unit trust subsidiary. He promised to provide more detail’.

Equitable’s Appointed Actuary explains that the Society had put £50m in technical reserves for personal pensions mis-selling. The Appointed Actuary says that he thinks that:

… about £10-15m would be needed. This didn’t include staff costs. All policyholders had been written to. 35,000 cases to review, of which 10,000 were priority. 6,000 cases had been done. Very little evidence of real mis-selling. Some policyholders were “mis-remembering” details! About £449K had been paid on 28 cases so far. Where possible, [the Society] was enhancing benefits. 50 staff were progressing cases — at a cost of about £1.5m. In August, the PIA enforcement team came — 4 people for a week. [The Appointed Actuary] thought they had misunderstood the issues, and had sent them away! It was hoped that all cases would be settled by Autumn 97.

Selling

The Appointed Actuary explains that Equitable would begin telephone sales.

Business plans

The Appointed Actuary explains that Equitable have no new business targets or plans to increase their sales force.

Under Any other business, the Appointed Actuary explains that Equitable might apply for a section 68 Order for a subordinated loan. He also explains, as regards his retirement, that he would stay ‘until all the changes had been consolidated’.

A copy of the note is passed to Chief Actuary C. He underlines the Appointed Actuary’s statements that a lively life company would have smaller assets than a moribund one, and that every actuary valued as weakly as possible. He also underlines Scrutinising Actuary E’s comment that Equitable had to be very careful not to mislead customers with their bonus statements.

Equitable write to DTI seeking their views on a subordinated loan. The Society says it could raise finance from the market but was interested in the possibility of raising finance by the sale of bonds to Equitable’s own policyholders. Equitable say that this would be cheaper and would provide benefits to policyholders. Equitable ask DTI to indicate if, in principle, they would agree to the necessary application for a section 68 Order. 

At around this time, GAD prepare an update to their 1994 annual report on the life insurance industry using information disclosed in companies’ 1995 returns. (Note: GAD did not produce a full report for this year due to ‘particular resource constraints within GAD during 1996’. The bodies under investigation have been unable to provide me with a copy of this update. However, as for the 1994 report (see 03/11/1995), I have seen GAD’s detailed analysis of the parts of the report which were updated.)

GAD update their comparison of maturity payouts against their own estimates of the theoretical asset shares. For endowment policies (based on contributions of £50 per month for 25 years), GAD calculate that the with-profits industry median payout is £97,496. GAD calculate this to be 113% of the theoretical asset share. For Equitable, GAD calculate that they are paying £86,739. GAD show this to be 101% of the theoretical asset share.

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 £10,004. GAD show this to be 125% of the theoretical asset share. For Equitable, GAD calculate that they are paying £10,221. GAD show this to be 127% of the theoretical asset share.

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 £126,199. GAD show this to be 132% of the theoretical asset share. For Equitable, GAD calculate that they are paying £131,239. GAD show this to be 137% of the theoretical asset share.

GAD update their analysis of the strength of companies’ valuation bases. GAD use the same method as that used in the 1993 dummy report (see 30/08/1995). Their analysis again shows that Equitable’s net premium valuation basis is the weakest across the industry, with a figure of 89.9% (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 that GAD looked back and assessed the strength of Equitable’s net premium valuation basis for 1990. GAD’s analysis produces a figure of 93.2% for that year.