1997

DTI send Equitable the section 68 Order applied for on 05/12/1996 and revoke the section 68 Order issued on 14/10/1986.

GAD advise DTI on Equitable’s letter of 27/11/1996 about a subordinated loan. GAD question if the bonds Equitable have in mind fall within the concept of members accounts envisaged by the Third Life Directive. GAD warn that DTI and Equitable would ‘find themselves in difficulty over a very short term if the concept were ever to fail’. GAD say that they would be troubled if such a pool of bonds were treated as perpetual. GAD also advise that:

… we would always feel uncomfortable that the Society could “market” such a product, even if the risks were clearly explained, and then treat the proceeds as free capital and not be obliged to hold full reserves within the long term fund to cover the repayment liability.

GAD conclude:

Despite our general misgivings as expressed … above, we believe that it might be possible within the terms of the [Third Life] Directive for Equitable to issue a tranche of “term subordinated loans” to its members — but the DTI would need to be satisfied that early redemptions were strictly limited or that bonds surrendered would be taken up under an agreement with an underwriting bank or that some similar arrangement was in place to ensure that solvency cover could not suddenly evaporate. Such term debt could, of course, only count for up to 25% of the Required Margin of Solvency.

You should of course ascertain the views of your legal advisers on this proposition.

With reference to the letter from [Equitable’s Appointed Actuary] of 14 March … and the question raised regarding the need to establish a subsidiary company for the purposes of issuing subordinated debt, it is my understanding that this arose from a DTI view that it would not be possible to satisfactorily issue such debt from within the Long Term Fund.

GAD continue:

If an insurance company issued subordinated debt through a Long Term Fund, the view is that it is not possible to achieve a proper degree of subordination to protect the interests of the Long Term policyholders. Issuance by a subsidiary company seems to have been the most satisfactory way of overcoming the problem of achieving acceptable subordination.

Equitable’s Appointed Actuary asks DTI for advice as to how recurrent single premiums should be analysed between ‘annual’ and ‘single’ premiums for the purposes of the statutory returns. The Appointed Actuary explains:

As I think you will know, we capture policyholders’ intentions regarding premium maintenance at the new business stage and that analysis is used, in part, as the basis for remunerating our field force. Our published new business figures reflect that same analysis.

It is, therefore, straightforward for us to prepare Form 47 using that same analysis. That will give a helpful consistency with the analysis shown in our statutory accounts.

We are, however, finding it extremely difficult to arrive at a meaningful “in-force” annual premium on recurrent single premium business for the purpose of Form 46. There are really two main difficulties:

(i) Our internal definition of “annual” and “single” is based on an expression of client intention and is held on an entirely separate system, which is primarily used for field force remuneration, from our main data system. That system has a variety of internal rules, including grouping of similar contracts (e.g. retirement annuities and personal pensions) and limitations on what can be treated as “annual”, which would make translation of that information back to interpret the premium records on the main data system from which the in-force data needs to be drawn extremely complex.

(ii) Even if the problems in (i) could be overcome the data would be subject to significant distortion because our internal rules operate on a policy year rather than calendar year basis. Thus a policyholder paying (in our terms) a level premium each year but varying the timing within the policy year could create a sequence of “ons” and “offs” in the DTI data.

Equitable’s Appointed Actuary continues:

We have investigated this matter in depth but can see no practical solution. If, therefore, we are to adopt a realistic presentation in Form 47, which I think we would all agree to be highly desirable, we shall need to request a modification of Instruction 3 to Form 46.

I should, therefore, like to request that a section 68 order be granted allowing us not to include recurrent single premiums within the “annual premium” figures in Form 46 of the Returns.

A DTI legal adviser provides comments on Equitable’s proposed subordinated loan. The legal adviser points out that PGN 1994/1 makes clear that responsibility for achieving effective subordination rests with the company and their legal advisers. He advises that the paperwork Equitable have provided shows that they have had regard to PGN 1994/1 and that they ‘have indeed achieved the necessary degree of subordination’. He advises DTI to draw Equitable’s attention to one part of PGN 1994/1 (on ensuring that the documentation secures that the note holders’ (i.e. bondholders’) claims on the assets of the company were subordinated to the liabilities assessed in respect of all long term business policies) and suggests that they have explicit regard to this in their documentation. He adds that, in principle, it does not seem necessary to issue the loan through a subsidiary company; this is not required in PGN 1994/1. He notes GAD’s concern that there are no assets held outside the long term fund. If that were the case:

… we should put that point to the company and see what response it elicits. If in that context we are able to say that the usual practice is for the issue to be by a subsidiary company and to identify adequate reasons for that (I am bound to say that from the papers which I have seen no clear rationale for that proposition emerges) I see no harm in doing so.

GAD write to DTI about Equitable’s proposed subordinated loan, having seen the legal advice received (see 25/04/1997). GAD express their uncertainty about how the proposals would operate, ‘bearing in mind the requirement that the loan (capital and interest) should not constitute a liability attributable to the long term fund’. GAD query how Equitable would make interest payments and eventual capital repayment if they hold no assets outside the long term fund. GAD advise that others have used a subsidiary to achieve the necessary subordination. GAD suggest DTI raise these points with Equitable. GAD conclude:

It should be appreciated by the DTI that the potential sums involved in these proposed issues are substantial … ie a possible total of £325m, and this amount of gearing could cause problems to the Society unless the terms are reasonable and proper subordination to policyholder rights is achieved.

GAD inform Equitable that they agree to the requested section 68 Order allowing Equitable to treat recurrent single premiums in Form 46 of the returns in the way they propose (see 08/04/1997). GAD say:

… I understand that [Chief Actuary D] has agreed that we would recommend to the DTI that they should accept your request for a Section 68 Order in this regard – on a temporary basis. (The volume of pensions business sold by the Society subject to variable premiums is so large that it would be unreasonable to allow it a permanent exemption from disclosure in Form 46 [of the returns, on summary of changes in ordinary long term business].

An exemption from the inclusion of recurrent single premium pensions business in Form 46 for the 1996, 1997 and 1998 Returns has been suggested – with the expectation that the Society will be able to provide meaningful data in Form 46 from 1999.

GAD copy their letter to DTI. In an accompanying note, GAD inform DTI that:

… on the telephone [Equitable] have agreed that it should be possible to have in place appropriate record systems by the end of 1998 — to generate an acceptable presentation for the Returns at the end of 1999.

We therefore recommend that you grant a Section 68 Order … for three years only.

(Note: GAD’s compliance issues on the scrutiny report had included the failure by Equitable to produce meaningful in-force premium figures for renewable single premium business. Against this, Line Supervisor B had written ‘wouldn’t call this a compliance problem’ – see 16/12/1997.)

A DTI official writes to Line Manager C and another official about subordinated loans issued by mutuals. The official notes that a subordinated loan taken out by a mutual was likely to constitute a liability on the long term fund. However, DTI had already issued section 68 concessions to mutuals ‘despite the apparent lacking of the safeguard that would be in place in a proprietary company’. The official suggests that DTI:

… should not change what has become our policy, namely that we are prepared to consider offering section 68 concessions to enable mutuals to count subordinated loan capital toward their [required minimum margin], subject to considering each individual proposal and satisfying ourselves that the proposal is reasonable, particularly in relation to there being adequate subordination …

The official also suggests that DTI should not insist on the issue being effected through a subsidiary.

The official says that, if DTI were to adopt this approach, it would be necessary for him to amend PGN 1994/1 to reflect this.

GAD write to DTI about Equitable’s proposed subordinated loan. GAD note the inability of a  mutual to satisfy PGN 1994/1 but add:

Since other mutual offices have already by-passed [PGN 1994/1] successfully (even though the advance from a subsidiary must still have actually become a liability of the Long-Term Fund), and it seems to be accepted in principle that mutual offices should be able to benefit from the issuance of Hybrid Capital, it would seem that the DTI needs to review the application to mutual offices of [PGN 1994/1]. We would, however, emphasise the desirability of retaining this Paragraph to apply to proprietary offices.)

GAD explain that they have discussed this problem with a DTI official who is expecting a meeting to clarify DTI’s approach. GAD also raise concerns about the proposed taxation clause on the grounds that it ‘introduces the possibility of generating interest strains that are greater than it may be reasonable to accept as falling within the permitted guidelines’. GAD add:

… to the best of my knowledge, this is the first UK insurance company to consider raising capital in this way. It is therefore a new problem, and we would wish to be assured that such a clause did not introduce an unacceptable level of volatility to the obligation undertaken by the company. If the DTI were to be convinced that these clauses are indeed “of academic interest only” as suggested by [Equitable’s solicitors] then it might decide not to make the existence of such a clause a reason for refusing to grant a Section 68 Order.

DTI’s Company Law Directorate write to DTI’s Inspector of Companies, with a copy to Line  Supervisor B. DTI set out the procedure that they follow when companies repeatedly breach Part VI of the Companies Act 1985 (which deals with disclosure of interest in shares), including sending progressively stronger letters, warning that the Department might take action for non- compliance. DTI explain that a first letter is usually sufficient to prevent further breaches. However:

… there are some investors who have become multiple offenders and we have now reached a position with the Equitable Life Assurance Society where it has committed its fourth offence within a period of twelve months, and, indeed, its third offence since the beginning of the year. The Equitable Life Assurance Society does not seem to take its responsibilities under part VI sufficiently serious enough.

DTI seek views, especially from Line Supervisor B, as to what further action should be taken.

DTI’s Line Manager C writes to a DTI official in response to his note about subordinated loans (see 09/05/1997). The Line Manager agrees ‘that we should not change our policy on mutuals’ access to [subordinated loan capital]. I also share your view that there would appear to be no clear reason why we should insist on this taking place through a subsidiary’.

On the same day, Line Manager C writes to Equitable’s solicitors. The Line Manager explains that, while the revised wording in Equitable’s letter of 30/04/1997 is more appropriate, it still did not address the issue of how the rights of a note holder could be met from assets outside the long term fund. The Line Manager also repeats concerns about the taxation clause, in the light of the comments by GAD on 12/05/1997.

Equitable’s solicitors write to DTI in response to their letter of 16/05/1997. The Society’s solicitors explain:

I do not think it is helpful, in the descriptive wording which is to be included in the term sheet, to specify that the rights of the Noteholders will be met from assets outside the long term fund. As I have said, that will be the effect of the actual subordination wording contained in the bond, but to insert that wording as part of the description in the term sheet would, in my view, arguably be misleading because it may give rise to the notion that there are indeed assets held outside the long term fund of the Society which are available to meet the rights of the Noteholders. In the case of a mutual there are of course unlikely to be any such funds.

The solicitors also explain that they do not consider that there is any foreseeable exposure for Equitable from the taxation clause.

GAD advise DTI on the letter of 28/05/1997 from Equitable’s solicitors. They note that the solicitors still believe the proposal satisfies PGN 1994/1, even though they acknowledged that there were unlikely to be any assets of a mutual company outside the long term fund. GAD say:

… it is only honest that all parties should acknowledge that the Long Term Fund is involved — and the DTI has already accepted the reality of the situation. We think that the adoption of clever legal wording to try to avoid the issue should be discouraged.

GAD set out the advice that they have given in respect of another mutual pursuing a subordinated loan as to how to show the loan in their returns. GAD also explain that they have reviewed the information Equitable’s solicitors have provided on the taxation clause. GAD suggest that there are now only concerns in relation to the Deutschmarks issue. GAD also suggest that DTI seek guidance from other sources as to whether there would be any major additional liability falling on Equitable, while noting that Chief Actuary D ‘remains somewhat uncomfortable about this proposed issue’.

DTI’s Head of Life Insurance provides briefing to a Minister for a visit to Equitable. The Head of Life Insurance writes:

The Equitable Life is one of the leading UK life insurance companies, with particular strength in pensions business. Generally speaking, it has a well deserved reputation for giving good returns to policyholders, and has so far escaped the worst of the criticism aimed at the life insurance sector in recent years. However, its heavy involvement in pensions business means that it is not immune from the problems of the [Securities and Investments Board]/PIA Pensions Review.

DTI’s Head of Life Insurance expresses no concerns in relation to matters relevant to the prudential regulation of the Society.

DTI advise Equitable that the Secretary of State had no objection to the appointment of their new Managing Director.

DTI send Equitable the section 68 Order requested on 30/04/1997, exempting Equitable’s auditors from auditing statements in the directors’ certificate on money laundering and the operation of the internal linked fund.

DTI’s Line Supervisor B writes to DTI’s Company Law Directorate in response to their note of 12/05/1997. She says ‘we do not think that the matter warrants action under the Insurance Companies Act Schedule 2A under the criteria of “sound and prudent management”’. The Line Supervisor suggests that the matter is pursued through the Companies Act legislation. The Line Supervisor goes on to suggest ‘that the issue is taken up by your head of section who could contact the company’s Compliance Officer … and find out if they have proper systems in place to comply with the notifications procedure. (We know that Equitable Life have very sophisticated computer systems – we have had a tour of their “paperless office” – which should easily be able to cope with this)’.

DTI’s Line Supervisor B sends Equitable the section 68 Order allowing Equitable not to include the recurrent single premiums within the ‘annual premium’ figures in Form 46 of the 1996, 1997 and 1998 returns. The Order requires the Society to include a note in its returns saying:

The Secretary of State has issued an Order dated 13 June 1997 under section 68 of the Act to the effect that figures in Form 46 exclude recurrent single premiums from the annual premium figures as the Company cannot at present calculate a meaningful figure.

DTI’s Company Law Directorate write to Equitable regarding Equitable’s breach of Part VI of the Companies Act 1985. DTI state that:

… having considered the circumstances explained in your letter [of 28 April 1997] and having noted your investigation of the matter, has decided not to take any further action on this occasion.

However, the Department is not prepared to tolerate a further breach of the provisions of Part VI by The Equitable Life Assurance Society. Accordingly, in the event of any future contravention, I will have no other option but to refer the matter to the Department’s Investigations and Enforcement Directorate in order that consideration be given to the taking of prosecution action …

DTI copy Equitable’s letter of 25/06/1997 to DTI’s Head of Legal Services.