Closure of the Society to new business

Equitable announce that they will stop writing new business with immediate effect. Equitable say that they remain solvent and would continue to pay out benefits and accept premiums on existing policies. Equitable announce that they have increased the market value adjustment made on surrenders or transfers of with-profits policies from 5% to 10%.

FSA receive a copy of Equitable’s ‘Media Q&As’, which sets out answers to questions that might be asked by the press. The document includes this answer to the question: ‘Why couldn’t you find a buyer for Equitable’:

We believe that a combination of the size of Equitable, the intractable nature of the differences in the interests of GAR and non-GAR policyholders, uncertainty over the value of Equitable’s client base given what has happened to the Society and general concern from buyers as to the scope to earn adequate returns on pension business as the UK moves into a stakeholder pension world, all made a full acquisition ultimately too difficult.

In answer to the question: ‘Can Equitable afford to pay [the] redundancy terms [of their employees]?’, Equitable’s response is:

Yes, statutory reserves always have to cover the cost of possible closure of new business. No immediate redundancies are planned.

Equitable send FSA a copy of notes Equitable had given to their representatives following the House of Lords’ ruling and Equitable’s announcement that they were up for sale, to assist those representatives in dealing with questions from policyholders. Equitable apologise for the delay in locating and forwarding this document (the content of which, Equitable say, had been overtaken by events by the time it was sent to FSA). The first section of the notes deals with ‘sale issues and addressing client concerns’. Under the heading ‘Concerns’, and subheading ‘Security’, Equitable state:

Concern: Is the Equitable secure?

Response: If the client is sincerely concerned that the Society “might go broke” and be unable to meet a claim the following simple statement may suffice:

“All UK insurance companies are subject to strict supervision by the regulatory authorities. They would not allow any company to continue accepting new business if they were not satisfied that it could meet its liabilities.”

The response adds that, in the last resort, the Policyholders Protection Act 1975 protects policyholders.

An unsigned note sets out the ‘line to take’ in response to possible questions to HMT about the closure. This includes the following statements:

• FSA maintains a watching brief and will not hesitate to step in if need be; and
• FSA do not believe Equitable Life’s problems go right across the insurance industry.

The underlying cause is specific to Equitable’s own circumstances.

FSA prepare a more detailed note for internal use when briefing journalists. This sets out some of the background to Equitable’s present position. FSA’s note deals specifically with ‘Regulatory Issues’, setting out possible questions and suggested responses.

In response to the question: ‘Why didn’t the FSA take action sooner—how could you let them keep taking new business?’, FSA answer:

The Company remained solvent and there was a realistic prospect of a sale which would have been in the long term interests of policyholders. So there was no clear reason or basis for taking action.

In response to the question: ‘How do you judge policyholders’ reasonable expectations (PRE)?

How can Equitable have been meeting them in recent months?’, FSA answer:

PRE can not be precisely defined but it is important to remember that this company is owned by its members andWith Profit policyholders share in the fortunes of mutuals for good or ill. Generally speaking policyholders have received benefits from this arrangement either through improved investment returns or windfall benefits after demutualisations but it is a two way street.

In response to the question: ‘On what grounds would someone launch a legal action against FSA for its action or inaction, or are you just a law unto yourself?’, FSA answer:

Not clear to us that a person could have grounds to bring a case. FSA has acted in good faith and with integrity throughout. No statutory immunity for those functions of the FSA delegated by the Treasury under the Insurance Companies Act 1982. But FSA does have the protection of the common law which would make successful challenge very unlikely.

In response to the question: ‘Why didn’t you at least require Equitable to explain to prospective policyholders its precarious position?’, FSA say:

We understand that prior to the House of Lords judgement the position as reported to potential policyholders would have been in line with the current understanding of the law—where a differential approach to GARs was justified. Post the [House of Lords] judgement it is our understanding that potential policyholders were advised about the circumstances surrounding the proposed sale of the company.

In response to the question: ‘Would you like to have more or different powers over insurers?’, FSA say:

It is not clear that there is any deficiency in the regulatory powers available.

FSA write to GAD. FSA note that, in their ‘Media Q&As’, Equitable state that they have reserved to cover closure costs. FSA ask if this is correct.

In response, GAD explain that Schedule 4 of Equitable’s 1999 returns shows that their reserves for expenses included costs for redundancy payments and rent due on properties, but no additional sum for costs arising from a closure to new business. GAD note that, generally, Equitable’s reserving basis for expenses is strong, but also that a significant part of this was released in the resilience scenario (note: this was a point taken up in GAD’s letter of 04/12/2000).

GAD conclude:

We need to be sure that they are indeed covering closure costs in both the main valuation and in the resilience scenario.

FSA’s Chief Counsel Investment Business (Chief Counsel B) advises the Director of GCD on the position of policyholders who bought policies after the House of Lords’ ruling on 20/07/2000.

Chief Counsel B sets out the responsibility of those selling Equitable’s policies to advise potential policyholders of relevant information. The Chief Counsel considers that there is ‘a very strong argument to say that the Equitable was under a duty’ to explain that, as a result of the House of Lords’ ruling, there was a risk that Equitable could not sustain their investment returns and performance. In the event of a failure to explain this risk, a policyholder would have the right to take action against Equitable. If Equitable became aware of such a failure, they had a duty to remedy the failure and provide appropriate redress.

Chief Counsel B considers whether FSA could have stipulated to Equitable that it should only sell policies in circumstances where the risk has been explained. He comments:

In one sense this would have been unnecessary since, if I am correct, that obligation already existed. It would clearly, however, have been open to the regulators to have pointed out to the Equitable the obligations to which they were subject and to say that action would be taken to prevent further sales unless those obligations were complied with.

FSA’s Line Supervisor C writes to the Director of Insurance and others. The Line Supervisor refers to complaints from a consulting actuary (see 01/11/2000 [entry 2] and 23/11/2000 [entry 2]) and one other person about Equitable’s recent advertising campaign. The Line Supervisor explains that the complaints had been directed at PIA, who had felt that they did not fall to be investigated by them and so had passed the complaints to FSA. The Line Supervisor explains that FSA’s standard response was that Equitable were authorised and solvent, and so should not be stopped from advertising.

Line Supervisor C notes that the advertisements had been placed at a time when there had been a reasonable expectation of a sale, and that they had served as ‘hooks’ to prompt a subsequent dialogue with sales staff. The Line Supervisor explains that he was asking Equitable for details of the ‘crib sheet’ sales staff had used after 20 July 2000, which would disclose what had been said at this stage.

Line Supervisor C copies his note to PIA. In response, PIA say that the complaints had gone beyond issues of advertising and raised questions about Equitable’s right to write new business and what the Society was doing with its with-profits fund. PIA say that they had understood that FSA could provide a ‘party line’. PIA explain that they had no final view on the post-20 July 2000 advertisements, but that, if they needed to assess them, ‘we would have to consider whether it was fair to promote the Society’s wonderful history and past performance without tempering that with information about the current position. That is a specific point of detail and will need an assessment of the actual words and presentation’.

FSA’s Head of Life Insurance writes to Managing Director A and others about the possible cancellation of policies bought after 20 July 2000. The Head of Life Insurance says Equitable have concluded they should not offer this to policyholders for two reasons. First, the pension contract was governed by pensions legislation which did not entitle a policyholder to any money back, other than at death or the vesting date. Secondly, if a concession were given for policies taken out after 20 July 2000, there would be pressure for this to extend to policiestaken out after the Court of Appeal judgment or earlier.

The Head of Life Insurance concludes that ‘the first of these arguments in particular is a powerful one against the FSA seeking to require that the Equitable should make a concession of this kind’.

Further to discussions on 8 December 2000, Equitable’s solicitors send FSA (ahead of their conference with Counsel on 11/12/2000 [16:00]) the current version of a note on the various legal issues discussed recently, in particular regarding the application of the Policyholders Protection Act 1975 to Equitable in the light of Article 4 of Equitable’s Articles of Association.

Equitable’s solicitors’ note reads:

In the course of our recent discussions with the FSA and, in particular, in the context of our discontinued discussions with [Prospective Bidder A], three specific legal issues have arisen:

(a) the propriety of the Society’s Board of Directors irrevocably approving significant disposals of the Society’s business or assets without the sanction of a resolution of its members;

(b) the legal significance of Regulation 4 of the Society’s Articles of Association (“Regulation 4”); and

(c) the application to the Society of the Policyholders Protection Act 1975 (the “PPA”) in the light of the interpretation of Regulation 4.

FSA thank Equitable’s solicitors for their note and say that, unless they had any immediate questions, they would get back to them after their conference with Counsel.

[17:54] FSA’s Chief Counsel A asks Legal Adviser A to forward the note to Counsel.

FSA’s Director of Insurance says to Line Manager E that the press coverage that he had seen was ‘no worse than we might have expected – and perhaps in some respects not as bad’. However, the Director of Insurance adds that there were three points which caused him some concern, those being:

a) it is suggested that mortgage endowment type policies may not be made paid up but must either be continued in payment or surrendered. Is this really true? Could you check with the company as a matter of urgency please?

b) a number of advisers are quoted as saying that policyholders are likely to be better off surrendering their policies (and accepting the 10% hit) rather than leaving funds locked in. The argument appears to be that moving funds to another company to avert the effect of the projected ½% to 1% fall in bonus rates consequent on adjustments to the investment mix will pay off for all except those close to maturity. Have we any feel for whether this is reasonable (particularly allowing for commission payments)? It seems inconsistent with the view we have been taking (although quite consistent with the “Don’t panic” message which is all we have said publicly).

c) some are suggesting (as expected) that policies sold after the [House of Lords] judgment have necessarily been “missold”. Can we put any sort of figure on the inflow of funds during this period and the likely net cost of returning premiums + interest and cancelling the relevant liabilities.

The Director of Insurance says that FSA should give some thought as to how they could assess ‘what could we have done better?’ to ensure the relevant lessons are learned.

FSA’s Director of GCD advises the Head of Life Insurance that FSA: ‘need to be clear whether early cancellation of a pension cannot be done, because of tax legislation, or whether it canbe done, at the cost of losing the tax relief. If it can be, this might be the right course for some policyholders’.

The Director of GCD also says that FSA: ‘should explore whether the [Inland Revenue] would be prepared to grant an extra-statutory concession allowing transfers to another provider. There seems no reason why they should not, if the investor remains unable to access the funds’.

[13:14] The Head of Life Insurance agrees to follow up both points. He says that Equitable’s preliminary view was that, subject to the Inland Revenue being agreeable, cancellation shouldnot be impossible, although they thought this would be very complex.

The Head of Life Insurance says: ‘Even if it is do-able, we need to be clear that it is justifiable to give such an option to policyholders who took out their policy after 20 July, but not to others’.

[15:46] The Director says that, if transfers were possible, such transfers could in principle be open to all annuitants, not just those who had taken their annuity after 20 July 2000.

[16:05] Chief Counsel B asks the Head of Life Insurance whether a cost-free transfer to another pension provider should be the alternative, if cancellation were not possible.

FSA’s Chief Counsel B provides advice to Managing Director A on PIA’s regulatory approach to advertising. The advice is also sent to other FSA officials. Chief Counsel B advises:

(a) Correct, the regulators have never operated pre-vetting, although the monitoring staff may, and in practice on occasions do, offer views on draft material prior to issue but on the basis that this is without prejudice to the ability of the regulator subsequently to take action.

(b) For others to say, but my experience is that the PIA does engage in active monitoring of advertising. It does so through responding to complaints and allegations from the public and regulated firms and by some more systematic surveys of what is published (for example, at one stage Lautro/PIA subscribed to a service by which it was provided with samples of most direct-mail advertisements sent by postal mail-shot). In practice those “monitoring” advertising may, if the case appears to be sufficiently serious, engage with the regulated firm with a view to (i) the withdrawal or amendment of an advertisement (ii) contacting clients who have purchased. So in practice I do not think (historically) we have merely relied on the rules as a ground for compensation (your point (c)).

Equitable send FSA a copy of a letter that is to be sent to policyholders about closure to new business. The letter includes a copy of Equitable’s press notice (of 08/12/2000) about the decision to close to new business and their ‘Most Frequently Asked Questions and Answers’.

FSA send the letter to PIA, having discussed it first, saying that Equitable would like any comments on it as soon as possible, as they hoped to send the letter to their printers that day.

FSA’s Line Supervisor C replies to the Director of Insurance’s questions of 10/12/2000 [19:18] that:

a) [Equitable’s Appointed Actuary] has confirmed that mortgage endowments can be made “paid up” and he will send something to us confirming this. Although this possibly contradicts part of the crib notes to staff that we received on [08/12/2000] so we need to double check this.

b) Could not really pin him down on this but the surrender rate is being closely monitored. [The Appointed Actuary] said [the] penalty could increase further if required. A colleague of [the Appointed Actuary’s] I spoke to said that many other providers have a to 1% reduction in investment return likely to be experienced at [Equitable].

c) [Further information] to come from [Equitable as soon as possible] but the 15,000 policies referred to post 20 July contain both [with profits] and non profit policies.

The Line Supervisor adds: ‘It is worth noting that PIA have their wish list of matters they wish to discuss with [Equitable], they have held off for the time being but if we are to meet the Society soon perhaps they could also attend the meeting?’.

Line Supervisor C later [16:16] provides an update, having spoken again to Equitable. The Line Supervisor says that Equitable have confirmed that the particular endowments that Equitable sell could not be made paid up. He says that a written explanation is to follow.

[16:27] FSA’s Director of Insurance thanks the Line Supervisor and says ‘I hope the explanation will follow quickly!’. The Director of Insurance also asks:

Do we have/could you put together a very quick outline chronology covering:

a) when did [Equitable] start including GARs in their policies

b) when did they stop

c) when did we/GAD first look at the issue of reserving for GARs

d) when did we issue guidance on this

Do we have/could we get more information on what instructions the sales force were given post [House of Lords] judgment on the risks implicit in [Equitable] policies given the inevitable shift in investment strategy that would be needed if no sale could be negotiated.

The Director of Insurance sends a copy of his note to PIA and, on the last point, says that any information or advice that PIA could provide would be welcome.

FSA meet Counsel to discuss the meaning of Article 4 of Equitable’s Articles of Association.

FSA’s note (which was subsequently approved by Counsel) records:

Counsel said that he had considered whether it was possible in law for a company to limit its liabilities to the amount of its assets. However, he had not found any authority for saying that it was not possible so was advising on the basis that such provision would not be inherently illegal.

Counsel was of the view that there were three possible constructions to be placed on the example article (a relatively common provision in the articles of association of mutuals) which is reproduced in the insurance contracts.

The first meaning was that the company’s liabilities were reduced to the amount of the available assets in the way mentioned in paragraph 3.8 of the instructions. If this was the correct interpretation then the [Policyholders Protection Act 1975] compensation scheme could not apply as there would be no liabilities on which it could bite. The liability of the company was restricted to its assets so if the company was bankrupt there were no legal rights on which the policyholder could claim.

The second meaning was the one put forward in the instructions, namely that the article dealt with the limitation of the liability of members and did not affect the liability of the company.

The third meaning depended on how “assets” should be construed: construing assets as gross assets rather than net assets.

Counsel advises that the first interpretation is ‘alarming and novel’ and takes the view that a court would be unlikely to accept it.

FSA note:

The Second Meaning

Counsel advised that this interpretation made sense in its context. The section in which the article was located was headed “Members”. It also made sense in the context of section 74 of the Insolvency Act 1986 which provides:

Nothing in the Companies Act or this Act invalidates any provision contained in any policy of insurance or other contract whereby the liability of individual members on the policy or contract is restricted, or whereby the funds of the company are alone made liable in respect of the policy or contract.

Counsel, however, had a linguistic difficulty with this interpretation because the construction did not appear to give effect to the first three lines which clearly limited the liability of the Society, and not the liability of the Members.

The Third Meaning

Counsel stated that the article referred to “assets and property from time to time existing”. It had been assumed that “assets” referred to net assets but it could reasonably be argued that the reference to “assets” here was a reference to “gross” assets. So in the case of a company having gross assets of £100 million and liabilities of £150 million the liability of the company would be restricted to the assets of £100 million.

In Counsel’s view this interpretation made sense of the first three lines of the article and would probably not expunge any (or at least all) liability so as to present a problem with the Policyholders Protection Act.

Counsel said that the third meaning was his preferred construction. However, both the second and third meaning could be argued as alternatives so we were not driven to choosing between them. He could not say that the first meaning was not arguable on the wording but that he considered it the least likely construction.