Submission of the 1999 regulatory returns

Equitable submit their 1999 regulatory returns to FSA. Accompanying those returns arecopies of the annual report and accounts for 1999, prepared in accordance with the Companies Act 1985 and dated 22 March 2000.

These documents include the following information about Equitable’s business and theirfinancial position as at 31 December 1999.

Companies Act annual report and accounts

The ‘President’s Statement’ says that:

1999 was a challenging year for The Equitable and I am pleased to say that it was a year of considerable achievement.We cannot, however, escape from the fact that the yearwas overshadowed by adverse publicity surrounding a single issue – guaranteed annuityrates. This is a complex matter and it is important that our members have a full andaccurate explanation of the central points.We have therefore devoted a special section … in this report to explaining this issue and the background to the recent court actions…

The ‘President’s Statement’ also says that a disciplined approach had been taken to the setting of reversionary bonus in recent years, which allowed Equitable to maintain reversionary bonus in 1999 at the 1998 level. Investment returns during 1999 had been relatively high and so the growth allocated to total policy funds had been increased to 12%. The Society’s bonus policy provided competitive payouts over a wide range of products and durations as indicated by its standing in surveys by financial publications. This was due in large part to Equitable’s approach to mutuality and the fair and full distribution of profits. The statement also considered that the 1999 bonus statements were accompanied by a more extensive and improved explanation of the Society’s bonus system.

The ‘Management Report’ in the 1999 Companies Act report says that Equitable were able to provide an unbeatable range of benefits to their members, due to their approach to mutuality.This approach is described as (a) the provision of services to members at cost, (b) the full distribution of profits to each generation of policyholders, and (c) the fairest possible allocation of bonuses between all classes and durations of policies.

The report comments that arguments for demutualisation focused on the need for capital to fund growth and to access new distribution channels. Financial inducements were normally provided to existing members to enable this. However, the Society felt that, in its case, these arguments do not apply.

It was said that capital requirements had not placed any restrictions on Equitable’s growth plans as demonstrated by the impressive growth in recent years. Substantial investments had beenmade to make Equitable the most efficient life office in the industry and they did not need the assistance of other companies in distributing their products.

Equitable’s policy of full distribution of profits to each generation of policyholders meant that they had traditionally operated with a lower free asset ratio than other offices but this had not placed any restriction on the operation of their businesses. Equitable considered that, compared to other offices, their approach offered greater fairness and better returns to their members who recognised and valued the Society’s mutuality. It followed that Equitable had no intention of surrendering their mutual status.

Under expense control, the report said that Equitable had steadily driven down their operating costs over the last decade, even though Equitable had grown considerably. These savings hadbeen passed back to policyholders via reduced charges and increased benefits.

It was recognised that the adverse publicity surrounding the annuity guarantees issue had hit Equitable’s sales, but it was said that these had still held up well, decreasing by only 7.9% compared to 1998. It was also noted that the industry in general had been affected by further adverse publicity surrounding pensions mis-selling. Equitable explained that pension sales werealso affected throughout the industry, as potential policyholders deferred purchasing pensions in anticipation of the new Stakeholder Pensions.

In the section on guaranteed annuity rates, under the heading ‘What effect do the guarantees have on other policies?’ the Society reported:

… in some cases the guaranteed annuity will provide a higher pension than would otherwise be available.Where that happens, as with any other policy guarantee, the cost of the additional benefits provided by the guarantee falls on the fund generally.We have projected that the cost of these additional benefits is unlikely to exceed £50 million in total over the coming years, and the experience in 1998 and 1999 was well within our expectations. However, for accounting purposes we have established a provision of £200 million in our balance sheet, to provide an allowance for more extreme future changes in financial conditions and mortality experience which could lead to more policyholders taking benefits in the guaranteed annuity form. These amounts are modest in the context of the Society’s total assets and would have no material effect on the level of benefits under other policies.

The Society also said that the Hyman case was expected to be heard by the House of Lords in June 2000 and Equitable expected a ruling soon afterwards. Equitable had established that this case was not the kind to be taken up by the European Court and so the House of Lords’ decision would be final.

The returns

Equitable’s returns are submitted in one part covering Schedules 1, 3, 4 and 6 to the ICAS Regulations 1996.

GAD’s copy of the 1999 returns includes various annotations. I am satisfied that these were made by GAD during the scrutiny programme. Some of the annotations contained in GAD’s copy of the returns were made by a GAD trainee actuary on or around 28/07/2000, at the time he completed the A1 Initial Scrutiny key checks. The trainee actuary’s annotations are largely the addition of certain corresponding figures from the previous returns. The other annotations were added by Scrutinising Actuary F on or around 14/08/2000, at the time he completed the A2 Initial Scrutiny key checks. However, for ease of reference mention is made here of these annotations.

Schedule 1 (Balance sheet and profit and loss account)

Schedule 1 of Equitable’s returns consists of Forms 9, 10, 13, 14, 15 and 17. Form 9 summarises the Society’s financial position at 31 December 1999 as follows:



In Form 13, Equitable set out their admissible assets.

In Form 14, Equitable set out their long term business liabilities and margins.

(Note: as in the previous year, the returns did not include a note on contingent liabilities regarding the risk of a successful challenge to Equitable’s bonus practices.)

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

As in previous years, Schedule 3 consists of Forms 40 to 45.

In Form 40, Equitable provide a revenue account.

In Form 41, Equitable provide an analysis of premiums and expenses.

Schedule 4 (Abstract of valuation report prepared by the appointed actuary)

As in previous years, Equitable present two valuations of their long term liabilities. 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 23 of Schedule 4 to the ICAS Regulations 1996 and includes Forms 46 to 49, 51 to 58, 60 and 61.

Equitable state that this valuation is made in conformity with Regulation 64 of ICR 1994.

In response to paragraph 4, Equitable provide 11 pages of information about their non-linked contracts. Most of the description provided is identical to that supplied in the previous returns.

Paragraph 4(1)(a)(i) requires a description of the circumstances in which – and the methods by which – adjustments could be made to surrender payments. In response, Equitable state, in relation to all accumulating with-profits contracts, that:

The Society reserves the right to pay less than the full identifiable current benefit attributable to a policy where the contract is terminated by the policyholder at a time other than one at which the policy benefits can be contractually withdrawn. It is the Society’s current practice only to make an adjustment to the full identifiable current benefit in circumstances where the policyholder is exercising a financial option against the Society, for example by requesting a transfer to another provider, and the full policy value exceeds the underlying share of assets. The current method of adjustment is to pay only a proportion of the full final bonus in such circumstances but there is no guarantee that the amount of the adjustment cannot exceed the full amount of final bonus.

In response to paragraph 5, Equitable provide 70 pages of information about their linked contracts. GAD note the additional description relating to new types of contracts.

In paragraph 6, Equitable set out the general principles and methods adopted in their main valuation.

For retirement annuity contracts, like in previous years, Equitable state that:

… benefits have been valued on the basis that the benefits will be taken at age 60 or, if that age has been attained, at the valuation date.

For personal pension plan contracts, unlike in the previous year, Equitable state that:

… benefits have been valued on the basis that the benefits will be taken at age 55 or, if that age has been attained, at the valuation date.

GAD mark this sentence as ‘new’.

As in previous years, Equitable disclose:

The valuation method makes specific allowance for rates of future reversionary bonus additions, the levels of which are consistent with the valuation interest rates employed having regard to the Society’s established practices for the determination of declared bonus rates. The balance of the total policy proceeds, consistent with policyholders’ reasonable expectations, will be met by final bonus additions at the time of claim. Such additions are not explicitly reserved for in advance but are implicitly covered by the excess of admissible assets over mathematical reserves.

GAD note that the rates of future bonuses used in the valuation are unchanged from the previous returns.

Equitable again state that they have made an explicit provision for their liability for tax on unrealised capital gains (in relation to business other than that linked to their internal funds), which they now estimate as not exceeding £143.6m. The provision made is £150m, which they say is shown in the Appointed Actuary’s certificate in Schedule 6 of the returns.

GAD note that provision of £100m was made in the 1998 returns.

In paragraph 6(1)(g) relating to investment performance guarantees, as in previous years Equitable state that they do not consider it necessary, in current conditions, to hold a reserve for the guarantee they offer on a unit-linked annuity.

In paragraph 6(1)(h), Equitable disclose that they had set up reserves for the annuity guarantees on their ‘Pension contracts – old series’ business. They explain the assumptions used in establishing these reserves relating to assumed take-up rate of the annuity at a guaranteed rate and cash commutations. Equitable state that the ‘combined effect of the allowancesmade is that of these policies which survive to retirement date … the gross reserves are reduced by less than 5%’.

GAD note the changes to the mortality assumptions from those used in the previous year. Scrutinising Actuary F notes what the ‘GAD [standard]’ mortality tables are and that the assumptions used by Equitable are therefore ‘ok’.

Equitable also disclose the interest rate basis used to value the guaranteed annuities, stating that:

Annuity benefits have been valued at an average interest rate based on 5¾% for annuities taken out during 2000 with lower rates of interest assumed for future years to take account of 69(9)(a) of the Insurance Companies Regulations.

GAD note the change in interest rate from that used in the previous year, which was 5%.

As in previous years, Equitable disclose that, for certain non-profit deferred annuities, the valuation rates of interest used were those assumed in the premium basis. Equitable, again, do not elsewhere disclose the rates used in the premium basis.

As in previous years, in paragraph 6(2) Equitable state that, in determining the provision needed for resilience reserves, they have taken account of the fact that the long term fund has been valued at book value.

In paragraph 7(5), Equitable again explain that they consider the reserves for future bonus within the valuation to be fully able to withstand any future strains which would arise if there were significant changes in mortality or morbidity experience. They say that, accordingly, the Society does not consider it necessary to establish any additional reserves in this respect.

In paragraph 7(6), Equitable disclose that they have tested the need for resilience reserves against the three scenarios contained in DAA6, as amended by DAA10. They state that the most onerous scenario tested is scenario c (a rise in fixed interest yields of 3%, a 25% fall in equity values, a 20% fall in property values and a 25% increase in index-linked yields).

Equitable disclose that a resilience reserve of £1,350m was provided for. Against this, GAD note that the resilience reserve in the previous returns was £600m and have written: ‘weakened basis?’.

In paragraph 7(8)(a), Equitable disclose the changes made to valuation assumptions and methods in the resilience scenarios. They explain that, in the resilience scenarios, they had used the appendix (net premium) valuation method rather than the main (gross premium) valuation method, but with some changes to the valuation described in the returns. As in previous years, Equitable disclose that the changes include:

… for all accumulating with profits business, an annual loading of 0.25‰increasing by 4% per annum compound of the basic benefit was reserved which is considered to be a prudent allowance for ongoing expenses: for accumulating with profits pensions business, ½% pa of the benefit value has been deducted for each year up to the date it is assumed that benefits will be taken as a charge for expenses.

Equitable also disclose that, in the resilience scenario, they had reduced the reserve for their potential liability for tax on capital gains to £53.2m. GAD note that the provision was reduced to £20m in the previous returns.

In response to paragraph 8(b) of Schedule 4, Equitable’s description includes that: ‘For accumulating with profit business, the valuation rates of interest shown in Form 52 are net of a 0.25% interest rate reduction as a reserve for future expenses’.

In paragraph 8(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 61 of this report.

GAD sideline this paragraph.

In paragraph 9, Equitable provide information on the valuation of their linked contracts. GAD note where certain assumed rates are unchanged from the previous year.

In paragraph 12(2)(viii), Equitable describe the IRECO reinsurance treaty. The description provided is the same as in the 1998 returns, except for an additional statement that the contract also covers certain group business and a change in the premium payable since the last returns to £875,000 (previously £150,000). GAD note both of these changes.

In paragraph 13, 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’.

In paragraph 14, Equitable set out a statement of their aims with regard to bonus distribution and of how they maintained equity between different generations of policyholders. The information provided is the same as for the 1998 returns. GAD underline the words ‘absolute discretion’ in the statement that:

The Society’s Articles of Association give the Society’s Directors absolute discretion as to the timing and nature of bonus distributions.

In paragraph 15, Equitable disclose that they had set reversionary bonus for the main policy classes at 1.5%. As in previous years, Equitable disclose that they offered loans under a ‘loanback’ arrangement to some retirement annuity, individual and group pension policyholders.

In paragraph 16, Equitable set out final bonus rates. The returns contain the same description of Equitable’s differential terminal bonus policy as that provided in the previous returns.

In paragraph 21, Equitable explain that they used risk-adjusted yields on assets other than land and equity shares by restricting them to 6.75%, which is that available on the highest yielding risk-free security held by Equitable. Equitable also explain that, where they considered this appropriate, they risk-adjusted yields on land and equity shares.

Schedule 4 – main valuation (forms)

In Form 46, Equitable provide information on changes to their ordinary long term business.

In Form 47, Equitable provide an analysis of their new ordinary long term business.

Form 48 shows that 58% of Equitable’s non-linked assets are invested in equities, 7% in land, 32% in fixed and variable interest securities and the remaining 3% in a variety of other assets.

In Form 51, Equitable set out the mathematical reserves held for various types of non-linked contracts (excluding accumulating with-profits contracts) along with information on the number of contracts in force, the benefits valued, and rates of interest and mortality assumptions used.

In Form 52, Equitable set out the mathematical reserves held for accumulating with-profits policies, 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. The Form 52 for ‘Pension business’ discloses that the gross total reserve for ‘Options and guarantees other than investment performance guarantees’ (i.e. the reserve for annuity guarantees) is £1,663m. The Form also shows that this reserve has been reduced by reinsurance of £1,098m to a net total reserve of £565m.

Unlike in previous years, the mathematical reserves are not discounted from the current benefit value.

In Form 53, Equitable set out the mathematical reserves held for the various types of property-linked contracts along with information on the number of contracts in force, the value of current benefits, the level of benefits guaranteed on death, and the rates of interest and mortality assumptions used in valuing them. They again disclose that they hold reserves for non-investment options and other guarantees for many of their unit-linked policies.

In Form 54, Equitable set out the mathematical reserves held for the various types of index-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.

In Form 57, Equitable provide matching rectangles illustrating the notional allocation of assets to each category of liabilities, showing the valuation rates of interest supported and the ability of the matching assets to cover the reserves in the resilience scenarios. The returns show that some of the risk-adjusted yields of the assets allocated are higher than the 6.75% maximum risk-free rate assumption that, in response to paragraph 21 of Schedule 4 to the ICAS Regulations 1996, the Society says it has used.

In Form 58, Equitable set out the valuation result and 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, 6 to 8, 10, 11, 20 and 22. The Society states that the information required by the other paragraphs of the ICAS Regulations 1996 is the same as that provided in the main valuation (apart from paragraph 23 – 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).

In paragraph 6, Equitable set out the general principles and methods used in the appendix valuation.

As in the main valuation, Equitable disclose that, for personal pensions plan contracts, the assumed retirement age is 55 (previously 60 (see 30/03/1999)).

In paragraph 6(1)(b), Equitable state:

In determining the valuation interest rates due regard has been taken of the reasonable expectations of policyholders concerning the rate of future reversionary bonus additions having regard to the Society’s established practices for the determination of declared bonus rates. The balance of the total policy proceeds, consistent with policyholders’ reasonable expectations, will be met by final bonus additions at the time of claim. Such additions are not explicitly reserved for in advance but are implicitly covered by the excess of admissible assets over mathematical reserves.

As in the main valuation, Equitable state in paragraph 6(1)(g) that they do not consider it necessary, in current conditions, to hold a reserve for the guarantee they offer on a unit-linked annuity.

In paragraph 6(1)(h), like in the main valuation, Equitable disclose that they had set up reserves for the annuity guarantees on their ‘Pension contracts – old series’ business. They explain theassumptions used in establishing these reserves relating to assumed take-up rate of the annuity at a guaranteed rate and cash commutations.

In paragraph 7, Equitable state that a resilience reserve of £2,142m was provided for.

As in their main valuation and the previous returns, Equitable disclose in paragraph 7(8)(a) the changes made to valuation assumptions and methods in the resilience scenarios, including that:

… for all accumulating with profits business, an annual loading of 0.25‰increasing by 4% per annum compound of the basic benefit was reserved which is considered to be a prudent allowance for ongoing expenses: for accumulating with profits pension business, ½% per annum of the benefit value has been deducted for each year up to the date it is assumed that benefits will be taken as a charge for expenses.

As in the main valuation, Equitable explain that they risk-adjusted the yields on assets other than land and equity shares by restricting them to 6.75%, which is that available on the highest yielding risk-free security held by them. Equitable also explain that where they considered this appropriate, they risk-adjusted yields on land and equity shares.

Schedule 4 – appendix valuation (forms)

In the appendix version of Form 51, Equitable set out the mathematical reserves held on the appendix valuation basis for various types of non-linked contracts (excluding accumulating with profit), along with information on the rates of interest and mortality assumptions used in valuing them.

In the appendix version of Form 52, Equitable set out the mathematical reserves held on the appendix valuation basis for accumulating with-profits 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.

The Form covering ‘Pension business’ discloses that the gross total reserve for ‘Options and guarantees other than investment performance guarantees’ (i.e. the reserve for annuity guarantees) is £1,630m. The Form also shows that this reserve has been reduced by reinsurance of £1,079m to a net total reserve of £551m.

This Form also discloses that the valuation of this pensions business has assumed a discounted liability of current benefits of £13,961,655,000 (against the current benefit value of £14,659,684,000).

The Form 52 summarising the totals for all of Equitable’s accumulating with-profits business discloses that the valuation has assumed a discounted liability of current benefits of £16,455,227,000 (against the current benefit value of £17,340,835,000). This is a discount of just over £885m.

In the appendix version of Form 53, Equitable set out the mathematical reserves held on the appendix valuation basis for the various types of property-linked contracts along with information on the number of contracts in force, the value of current benefits, the level of benefits guaranteed on death, and the rates of interest and mortality assumptions used in valuing them. They also disclose that they hold reserves for non-investment options and other guarantees for many of their unit-linked policies.

In the appendix version of Form 54, Equitable set out the mathematical reserves held on the appendix valuation basis for the various types of index-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.

Like in the main valuation, Equitable provide appendix versions of Form 57 giving the notional allocation of assets to each category of liabilities on the appendix valuation basis, showing the valuation rates of interest and the ability of the matching assets to cover the reserves in the resilience scenarios.

Supplementary notes to the returns

In the notes to the returns, disclosed at the end of Schedule 4, Equitable disclose that they have been granted a section 68 Order which permits them to include in aggregate form details of their ‘Personalised Funds’ in Forms 43, 45 and 55.

Equitable disclose that they have been granted a section 68 Order, which permits them to take into account a future profits implicit item. The Society states that it has included an item of £925m and that this is within the maximum amount permitted by the Order.

Equitable disclose that they have also been granted a section 68 Order enabling them to disregard amounts owing under the subordinated loan up to an amount not exceeding 50% of the required solvency margin.

In relation to Form 46, Equitable disclose:

Under the Society’s recurrent single premium contracts, the amount and frequency of contributions can be changed at any time without penalty, including ceasing future contributions completely. Most policyholders take advantage of this flexibility and there is consequently no precisely identifiable annual premium on recurrent single premium contracts. On Form 46 the annual premiums shown for recurrent single premium contracts are those which are not specifically identified as single premiums.

Schedule 6 (Certificates by directors, actuary and auditors)

Three Equitable Directors provide the certification required by Regulation 28(a) of the ICAS Regulations 1996. Equitable’s Appointed Actuary provides the certification required by Regulation 28(b) of the ICAS Regulations 1996. Equitable’s Auditors provide their opinion that Schedules 1, 3 and 6 of the returns have been properly prepared.

FSA’s Managing Director telephones Equitable, explaining that FSA are anxious to ensure  continuity among executives at Equitable, and that decisions to resign could be taken in such a  way as to permit that. The Managing Director also explains that, while it would depend on what  was in the judgment, ‘on what we know so far it was unlikely that the FSA would be throwing  brickbats at Equitable Life’.

Line Manager D notes that the Head of Life Insurance agrees with these comments.

GAD recommend to FSA that they should grant Equitable’s request for a section 68 Order for a  future profits implicit item of £1.1bn. GAD explain:

We have reviewed the Actuary’s calculations in the light of the 1999 returns and are  satisfied that they are consistent with the relevant Regulations and Guidance Note.  Although the disclosure seems a little sparse in places there is a significant margin  between the £1.1 bn applied for and the £3.3 bn the company could apply for based on the  assumptions given.

GAD note:

The Actuary’s certificate also confirms that he has taken into account the effect of the GAO [reinsurance] treaty in determining the present value of future profits.

FSA and GAD meet Equitable to discuss the possible scenarios that Equitable have identified from the expected House of Lords’ decision.

According to a note made by FSA, Equitable outline three possible scenarios – Equitable winning, the Court of Appeal judgment being upheld, or Equitable not being allowed to alter the rate of bonus for policies containing annuity guarantees. Equitable comment that this third scenario would be at odds with recent FSA guidance. It had not previously been considered a possibility, but had become one, following submissions during the hearing on behalf of the representative policyholder. Equitable consider it was an unlikely outcome, but, should it arise, it would have a profound effect on solvency and the reinsurance treaty would no longer be valid.

Equitable explain that the scenario has been discussed with the Board, who have agreed that, in those circumstances, Equitable should be put up for sale. Equitable say that they do not thinkthat they would be insolvent, but were carrying out further scenario modelling.

Equitable explain that they are:

… keen to avoid any precipitous action from the FSA in the light of this adverse judgement. Mainly because this could have a detrimental effect on the value of the business, for example stopping the company writing business could lead to losses in the field force and this was a valuable asset for the society. Similarly, a need to rush into gilts could also have detrimental effects.

FSA reassure Equitable:

… that we would not rush to take remedial action in these circumstances and understood the importance of maintaining the value of the society.We would, however, need to be convinced that a suitable buyer for the Society was likely to be found quickly.

FSA note that Equitable think that they would be able to begin substantive sales negotiations with a number of potential partners in August, with a view to completing a sale before the end of the year.

Equitable explain that, if the House of Lords were to uphold the Court of Appeal’s judgment, Equitable would have the right to offer a reduced rate of bonuses for all GAR policies, regardless of how the benefits were taken.

(1) That Equitable win, with or without critical comment on the way they had explained their approach to policyholders.

The Line Manager notes that this would have no direct financial implications for Equitable. FSA would need to consider if Equitable had had due regard to PRE.

(2) That Equitable lose, in that different levels of terminal bonus may not be paid according to whether or not a policyholder chooses to take advantage of an annuity guarantee, but that a GAR policyholder need not receive the same level of bonus as a non-GAR policyholder.

The Line Manager notes that this would allow Equitable to ‘ring fence’ the costs of meeting guaranteed annuities amongst policyholders who have GARs. It would allow Equitable to declare one terminal bonus at the lower of the two levels currently available. FSA would need to consider whether the decision had implications for three or four other insurers who had adopted a similar bonus policy to that of Equitable, and whether the guidance issued on 18/12/1998 had been consistent with the judgment.

(3) That Equitable lose ‘very badly’, in that different levels of terminal bonus may not be paid, as in the second scenario, but that, in addition, the existence of GARs in a class of contract should not influence the level of bonuses paid to that class.

Line Manager D draws attention to the third scenario, which is ‘not something that has been considered previously’ and would involve the court opining on the apportionment of bonuses between different classes of policyholders, rather than just in respect of GAR policyholders.

The Line Manager explains that previous court hearings had focused on the narrow issue of the rights of GAR policyholders; however, ‘the hearings in the House of Lords suggest they may consider the issue in its broader context’.

Line Manager D notes that the financial implications for Equitable would be ‘very serious’. The Line Manager says that Equitable would have to declare one terminal bonus at the higher of the two levels currently available, and that, in view of the impact on market confidence, Equitable would seek a partner. The Line Manager notes that it was expected that there would be noshortage of potential partners. FSA would need to liaise with Equitable over their current and projected financial position and keep in touch with plans for the sale of the business. The Line Manager states that, even if Equitable’s solvency margin were breached, it is ‘unlikely FSA would need to take any public regulatory action since the company would already be taking steps to ensure its financial position was repaired’.

Line Manager D notes that FSA would also need to consider the wider implications of such a judgment. She notes that it would be likely that the guidance issued on 18/12/1998 would be inconsistent with the judgment, that up to 20-25 other companies who sold policies with annuity guarantees might be affected, and that there might be implications for other companies with contracts containing unrelated guarantees.

The House of Lords dismiss Equitable’s appeal against the Court of Appeal’s decision of 21/01/2000. Their ruling makes clear that Equitable cannot ring fence the problem by opting to reduce bonuses for all GAR policyholders, irrespective of how the benefits are taken. Equitable announce their intention to seek a buyer for the business. The Society sets 20 November 2000 as the formal deadline for bids.

FSA’s Chief Counsel A prepares an immediate summary of the judgment. She says that, while it is ‘the worst outcome for Equitable’, the wider implications for other companies who have written policies containing annuity guarantees are unclear. She concludes that the judgment rests ‘on the particular terms of the Equitable policy and the particular circumstances giving rise [to] an expectation that those terms would be met’. Chief Counsel A acknowledges that HMT’s guidance on annuity guarantees (see 18/12/1998) would have to be revised ‘to make its tone less positive’, although they are not clear if substantial amendment would be needed.

FSA advise GAD that Equitable have promised to provide a note on their solvency position within a couple of days. FSA note that Equitable intend to reduce policy values immediately by 5% across the board. FSA hold out the prospect that, once Equitable have been sold, policyholders whose policies have matured in the intervening period would be eligible for a top up.

GAD agree that FSA should write to all companies with annuity guarantees on the implications of the judgment. GAD suggest that, in respect of ‘ring fencing’, the implications may go beyond annuity guarantees.

FSA produce in-house briefing notes in anticipation of questions they might receive. In response to the possible query: ‘What action will the FSA take to make sure policyholders with similar contracts with other companies are properly protected?’, FSA say:

Other companies will need to consider the implications of the judgement for their payment practices.We will be discussing their conclusions with them and the basis on which these have been reached.

In response to the possible query: ‘Doesn’t this show that the FSA failed to act to protect policyholders.Why was it necessary for policyholders to go to court?’, FSA state:

FSA did not fail to protect the interests of policyholders. The Equitable itself chose to bring this test case, and has been commended for doing so. The key issue raised in this case was the interpretation of the detail of contracts issued by the company and the way discretionary powers were exercised by the directors. Once before the court it was right for the FSA to step back and await the outcome, while ensuring adequate reserves were in place.

In response to the possible query: ‘Suggested that Equitable Life’s practice had been “approved” by HM Treasury. Is this true?’, FSA repeat the answer provided to a similar question at the time of the Court of Appeal judgment (21/01/2000), but state that FSA were now reviewing that guidance in the light of the judgment (having previously said they would consider doing so).

HMT ask FSA to consider a number of possible questions that may now be raised. These include:

Guaranteed Annuities

Timing: how long to sort this out (will regulator be pressing for immediate increases in reserves or has that already been done?) …

Did the regulator get it right?

FSA’s Q and A suggests companies will need to consider their position and FSA will be in dialogue: but should that already have happened?

Was the reserving guidance fairer to the companies than it was to the policyholders, appearing to suggest that there was damage limitation through looking to the letter of the contracts. (Newspapers suggest that the Law Lords decision did not turn on the letter of the policy, but on whether a discretion could be exercised in a way that appeared to nullify a provision of a contract.)

Equitable allowed the case to be brought, but should the regulator have been seen to be pushing them to do the decent thing?

Policyholders’ reasonable expectations

How has our understanding changed, if at all?

In response to the request of the previous day for information about regulatory activity in relation to Equitable, PIA inform FSA (as Equitable’s ‘Lead Supervisor’) that they have completed a debrief concerning the Society following a supervision visit in June 2000. PIA say there are no issues from the visit that they expect to lead to disciplinary action. PIA also inform FSA that they are to conduct quarterly visits to Equitable from now on.

On FSA’s ‘Lead Supervisor’ file next to this email and marked with the date ‘21/07/00’ is a copy of PIA’s ‘Debrief Decision Document’, dated 21 March 2000, and attached ‘Visit Synopsis’.

FSA prepare an action plan following the House of Lords’ ruling. This includes establishing Equitable’s current and projected solvency position; asking companies for their assessment of the implications of the ruling for their business; reviewing the guidance of 18/12/1998, and meeting Equitable within the next two weeks to discuss the sale. On the last point, FSA state:

We aim to keep in close touch throughout the process in order to ensure that we can identify at an early stage any regulatory concerns arising from any of the proposed purchasers or the structure of the sale.

In commenting on the action plan, the Director of Insurance suggests that FSA advise companies that they are reviewing the guidance, and that, until the review is completed, companies should not rely on it.

PIA write to FSA’s Line Manager D seeking her views on various aspects of the House of Lords’ ruling, insofar as it affects their review on pensions mis-selling. PIA understand that Equitable would be reducing the value of their with-profits policies. PIA suggest that the immediate implication of this for the review is that the losses experienced by those who have been missold an Equitable policy would increase. PIA presume that Equitable were aware that their reserves would need ‘beefing-up’. PIA ask the Line Manager to bear in mind that there were pension review issues, and that they and colleagues dealing with the review needed to be kept abreast of what was happening. PIA also ask whether a sale of the Equitable business was 100% certain.

In response, Line Manager D confirms that Equitable would need to increase their provision forpension mis-selling but says that she does not think the increase would be significant. The Line Manager says that, while she could not say that a sale was 100% certain, ‘it must be close to 99.9%’. The Line Manager adds: ‘The company see a sale as the only option and as far as I can see the only reason it would not go ahead would be if there was no suitable buyer and that appears unlikely’.