January 2001

FSA and PIA meet to discuss Equitable. FSA’s note of the meeting records the conclusions and action points agreed on the issues related to ‘Media’, ‘MVA’ and ‘Policyholder Information’.

In relation to the market value adjuster, the note records that:

No information about OFT timetable available; FSA wrote to OFT [week ending] 22/12 and OFT requested information from Equitable – Equitable have not responded to date.

[FSA’s Director of Insurance] wrote to [Equitable’s solicitors] on 19 December about any possible legal implications of the application of the MVA that would reduce the amount paid on a surrender (or other non-contractual termination) to an amount that would be “lower than the accumulated guaranteed fund that would be available on contractual termination” and in particular whether any such move might in some way be contrary to the House of Lords’ decision. Equitable’s response appeared robust but required further work on presentation.

FSA’s note continues, stating that:

Attendees were concerned about potential implications of any further increase in MVA. [The Director of Insurance] explained FSA’s responsibilities and powers in this area and the complications caused by the competing interests of different groups of policyholders. FSA’s powers were separate to any consideration under Unfair Contract Terms (currently within OFT’s responsibility but soon to move to FSA).

It is agreed that Managing Director A would draft a letter to Equitable’s Appointed Actuary, informing him that FSA would be concerned if the market value adjuster were increased fromits current level without ‘significant justification’.

FSA’s note goes on to record that FSA’s Chairman has requested more information to verify that the market value adjuster was in line with other insurers. Attendees confirm that GAD had provided an oral briefing to FSA, which had said that Equitable’s application of the market value adjuster was more transparent than others in the industry.

It is agreed that Line Manager E would request a briefing note from GAD on industry comparisons.

[15:50] Line Manager E requests the briefing note from GAD, comparing Equitable’s surrender values with the rest of the industry.

The Government Actuary writes to an Equitable policyholder in response to a complaint about the regulation of Equitable. After noting that GAD had never been responsible for insurance regulation, the Government Actuary says:

The Government Actuary’s Department has provided actuarial advice to each of these regulatory bodies but it would not be appropriate for us to disclose details of the professional advice given to our clients.

The Government Actuary continues:

I would emphasise that ELAS has always met the statutory solvency margin requirements, which are substantially more stringent than a normal test of insolvency. UK insurance legislation, based on the requirements of EU directives, but in common with insurance legislation in many countries, envisages intervention by the supervisory authorities if and only if the solvency margins are breached.

ELAS has prudently decided … that they should cease to accept new business. However, they expect to be able to meet all their liabilities as they fall due.

The Government Actuary had sought advice from Chief Actuary C on a draft of the letter, asking whether the draft was appropriate or ‘should I be even less forthcoming’. The following drafting was removed from the final sentence quoted above: ‘so there is no question of insolvency, the approach of which would have triggered regulatory intervention’.

Reference to the continuing ability of Equitable to meet their solvency requirements was also omitted.

(Note: I am told that the statement was omitted from the final version in line with established policy and practice at GAD not to say anything about a company’s solvency position that was not in the public domain.)

GAD’s Directing Actuary B writes to Scrutinising Actuary F about Equitable’s letter on their 1999 returns (see 21/12/2001 [entry 1]). The Directing Actuary says that the Scrutinising Actuary needed to suggest to FSA that they should take legal advice on the interpretation of Regulation 72(3). The Directing Actuary gives his view that the regulation did require that the actuary should look at whether the payment could be covered by existing resources, should the option be exercised, and that there was no indication that the actuary would be allowed to assume that only a small percentage of clients would exercise that option. He believes that the relevant paragraph of a draft revision to Guidance Note 8, which was currently being consulted on, relates to Regulation 72(1), not to Regulation 72(3) directly – and that GAD’s interpretation was in line with the recommendations in the professional working party paper. The Directing Actuary concludes that, if GAD’s interpretation were not correct:

… actuaries would be able to circumvent their basic premise that the reserve should be at least equal to the PRE surrender value on mass discontinuance (the reference here to “mass” being largely at the insistence of Equitable!)

FSA’s Head of Press Office informs senior officials and Equitable’s supervisors that Equitable’s press office were stressing that the market value adjuster applied to the projected final bonus as well as to the guaranteed element, and had said that they were only being criticised about this as other insurance companies were less transparent about the final benefits of their policies. The Head of Press Office gives, as an example of Equitable’s more transparent approach, the fact that ‘Equitable send a statement each year identifying the guaranteed bonuses and a projection of the final bonus’.

The Head of Press Office also reports that Equitable have also conducted an analysis of final surrender values which had confirmed that, even with the adjuster, they compared ‘pretty well’ with the market. However, he says that ‘that is not a message they are keen to peddle at this stage since their main priority is to encourage people to stay rather than leave’.

The Head of Press Office concludes by saying that: ‘The main focus for [Equitable] … is the OFT and getting a powerful response to them on the MVA’.

FSA meet Equitable and their advisers to discuss progress on the sale of the business.

Equitable’s advisers provide an overview of the position of discussions with the key interested parties (‘Prospective Bidder D’, ‘Prospective Bidder E’, ‘Prospective Bidder F’ and Halifax) and say that they expect to receive indicative proposals the following week. The advisers say that each party was working on slightly different proposals, with Prospective Bidder E’s bid appearing to be the most comprehensive. This envisaged acquisition of Equitable’s infrastructure first, and later looking to achieve an ‘accommodation’ with GAR policyholders, followed by a transfer of the ongoing business pursuant to Schedule 2C of ICA 1982. The bidder hoped to continue both with-profit and unit-linked business.

Equitable’s advisers say that discussions with Prospective Bidder B were facing difficulties, as the bidder desired exclusive negotiations. The advisers confirm that, nevertheless, all the other bidders:

… were looking to buy the infrastructure and leave a closed Equitable fund. However, they were also looking at ways of enabling the existing policyholders to transfer from Equitable into new funds within the purchaser’s group on favourable terms. He thought that none were looking to inject large amounts of shareholders funds but all the proposals involved some form of capital support to the ongoing fund.

FSA’s Chairman says that FSA’s interest in the discussions was to ascertain what input potential bidders might seek from them, and:

[FSA’s Chairman] noted that it was likely that if there was to be a transfer or accommodation subject to court approval, the court could place considerable reliance on any views expressed by us. He noted that we were willing to be involved and would make ourselves available when required … [The Director of Insurance] said that there was a limit to how far we could commit ourselves in advance, but we would do our best to give an indicative view. He added that it would be useful to have early discussions so we could better understand the proposals, and that not all the regulatory hurdles would necessarily be easy to overcome.

After discussion about the effects of various sale scenarios on the sales force, FSA’s Chairman asks whether the market value adjuster had been raised. In response:

[Equitable’s adviser] said he believed most were expecting it to remain. There were essentially three options under all the proposals: a policyholder could stay in the closed fund, leave the fund and suffer the mva, or they could transfer to the acquirer, who would look to enhance the value of the transferred funds (eg on the basis of low acquisition costs).

Equitable’s advisers continue: ‘The level of surrenders had remained fairly stable, running at about four times the usual rate’.

Equitable’s Appointed Actuary says that there were no plans to increase the level ‘which continued to operate marginally in favour of those remaining in the fund, but [he] noted that the current value of shares meant the margin was very thin’. Equitable say that they were yet to respond to the OFT, who had asked about the justification for the adjuster.

Equitable’s President informs FSA that Equitable had sold a substantial quantity of equities and that their equities to fixed interest ratio was now 55:45 (from 60:40).

The potential benefits of some form of compromise between the different policyholder groups are discussed. FSA’s note records that:

… even in isolation there were potential benefits … whether by a s.425 scheme, a Schedule 2C transfer or even a contractual buying out of GAR rights. The latter would not be a complete solution, compared with a court solution, as some GAR policyholders would almost certainly not sign up. It was not, however, ruled out.

FSA ask about whether Equitable’s sales force might stop giving advice. FSA later receive revised proposals, which clarify to staff the extent to which they could provide advice and when those staff should refer policyholders to an independent financial adviser.

Under the heading ‘Post 20 July sales’, FSA’s note records: ‘[FSA’s Managing Director A] asked if there had been any developments on the post 20 July 2000 sales. [Equitable’s Appointed Actuary] said that there had not, since there was no real indication from the behaviour of policyholders that there was a particular issue about the most recent sales. [The Director of Insurance] said that it would be useful to develop a general approach to complaints handling, and that it might be helpful to discuss that at an early stage with the [Financial Ombudsman]’.

Following the meeting, FSA’s Chairman talks to Equitable’s President about Equitable’s Board and, in particular, about the position of their Appointed Actuary. The President explains that the charges being incurred, as part of the search for ‘headhunters’ to assist with finding new non-executives, were, in his view, ‘hugely inflated’. FSA’s Chairman says that he had advised Equitable’s President:

… to point out to them that, in present circumstances, the costs of the assignment would be highly likely to become known, and they would need to watch out for their reputation if it looked as if they were picking over a corpse too extravagantly.

FSA’s Chairman records that he had expressed surprise when informed that Equitable’s Appointed Actuary would sit on Equitable’s Nomination Committee that would vet applications for non-executives, as it was ‘highly unusual for executives to be involved in choosing the non-executives on the Board’.

(Note: it has been explained to me that, historically, Equitable’s Nominations Committee had been comprised wholly of non-executive directors. In the unusual situation of early 2001, when all the non-executive directors had announced their intention of resigning as soon as replacements could be found, those non-executive directors had felt that it would be inappropriate for them alone to decide on new director appointments and had asked the Society’s Chief Executive to join the Committee to provide some continuity.When FSA’s Chairman raised his concern, Equitable’s Chief Executive had relinquished his membership of the Committee and the Society had reverted to the historical norm.)

FSA’s Chairman says that FSA did not want the individual to remain in the Chief Executive and Appointed Actuary roles concurrently for any longer than was necessary, to which Equitable’s President agreed. The Chairman also says that ‘[the Appointed Actuary] had been associated with some propositions in relation to reserving for GARs which were particularly extreme, and any review of regulation in the past would be bound to draw attention to that’. Equitable’s President again apologises for the position that the Society had got itself into, adding that he did not know what it could have done in the last two or three years to avoid it. FSA’s Chairman suggests that ‘[there] were policy holders, of course, who thought they should have [attempted] to do a deal earlier, rather than take the case all the way to the Lords’ to which the President replied that Equitable: ‘had thought about that, but had been strongly advised that the only way to get certainty was to take a case. But that was now all water under the bridge’.

On the following day, FSA’s Chairman informs the Director of Insurance, Managing Director A, the Head of Life Insurance and Line Manager E of this discussion.

FSA’s Director of Insurance writes to Managing Director A about a meeting with the action group planned for 5 February 2001. The Director of Insurance suggests that, while the exact nature of any statement depended on the outcome of the meeting, a possible public line to take might be:

FSA is keeping closely in touch with all interested parties. Much of our effort has been directed to ensuring that policyholders are given the fullest possible information (both by the Company and via our helpline/website etc). Moreover policyholders, both as policyholders and owners of the company, are likely to have an important role to play in future developments – particularly in any which might involve some resolution of conflicting interests between different categories of policyholders. It is therefore right that we should [hear] what policyholders think both of the adequacy of the information etc which has been made available and on possible future developments.

FSA meet Halifax’s Chief Executive, who wanted to inform Equitable of the possibility that they might make an offer for parts of Equitable. The Chief Executive explains that Halifax had been interested in acquiring Equitable prior to closure to new business ‘but had not pursued it previously because they were concerned about the balance sheet implications for the group and were not sure that they would be in a position to support the business going forward’.

The Chief Executive says that they had revisited this in the light of Equitable’s closure to new business. The Chief Executive outlines their two stage proposition where they, first, buy Equitable’s infrastructure (with Equitable then contracting out those services to Halifax) and, secondly, seek to reach an accommodation between different groups of policyholders. He explains that the second stage was key to realising the value of their investment in the sales force. He says that Halifax were also looking at the possibility of buying Equitable’s unit-linked business.

FSA’s Managing Director A notes that:

… the FSA was not there to be involved in the commercial considerations behind a possible deal. However, he said that we would be willing to help to deal quickly with regulatory issues. He also noted the FSA’s potential involvement in any court based procedures, where [the case of another company] had demonstrated that a judge might attach considerable weight to any evidence submitted by the FSA. [FSA’s Director of Insurance] added that a court based procedure would be necessary both for a section 425 reconstruction or a Schedule 2C transfer. [The Managing Director] also pointed out that it was important not to overlook any banking regulatory issues.

FSA’s note records:

[Halifax’s Chief Executive] said that the condition of the closed fund was a matter of concern. Part of the problem was the GARs, which was widely acknowledged, but he thought also that the general inadequacy of capital in the fund was a real problem. He asked about our position on the concessions that had already been granted to Equitable, to which we replied that we saw no reason for our attitude to change following any deal. [Halifax’s Chief Executive] also asked our view if the statutory solvency requirements were breached. Halifax were concerned that if they were, they would wish to be able to continue to make bonus allocations while working on a longer term plan for the restoration of the financial position. If bonuses could not be paid in such circumstances until after the solvency position had been corrected, that could seriously damage the goodwill of the customers they were seeking to attract. [FSA’s Director of Insurance] expressed sympathy over the problem but said it would be difficult to give assurances on this point since it might depend on wider market conditions that could not be predicted with certainty.

Halifax’s Chief Executive also asks: ‘if it was consistent with the closure to new business for Equitable to continue to take on further funds and premiums.We confirmed that this was acceptable where the policies, or rights to a further policy, existed before the closure announcement’.

FSA write to Equitable, following discussions ‘on a number of occasions’ about the market value adjuster. FSA explain that they had sought to make clear that:

• the level of the MVA for any insurance company is of legitimate concern for the FSA because of its implications for policyholders’ reasonable expectations and for directors responsibilities under the “criterion of sound and prudent management”.
• in the circumstances in which the Equitable currently finds itself, there are particular prudential risks of any further rise in your present MVA – namely that it might cause the obverse of what is intended, by leading people to panic into early surrender.

FSA say that they had indicated that FSA expected to be consulted on any plans to raise the market value adjuster applied to policies, and that consulting would:

… reduce the risk that might otherwise arise (and which would be of no benefit to either the Society or to policyholders) that if you were to raise MVAs the FSA might then find it appropriate to take formal action, on PRE or “sound or prudent management” grounds to secure a reduction in them.

FSA continue:

I understand the point you have made to me in response, namely that there are circumstances in which you might wish to move very quickly – most obviously in the event of a sharp sudden fall in asset prices. In such an event, the FSA recognises that adjustment of the MVA can be one way of seeking to ensure a balance between the legitimate interests of policy-holders that stay with the company and those that wish to terminate their policies. Let us hope that such circumstances do not arise. If, however, they do I should be grateful if we could discuss the issue urgently before any decision is taken.

FSA note:

Obviously, while the circumstances currently facing the Equitable are specific to your Society, MVAs are a topic of general interest to the life assurance industry. Recent circumstances suggest that there may be a case for the FSA to consider providing general guidance on how it views this topic and the main circumstances it would take into account in deciding at any point in time whether to exercise its powers.

FSA’s Director of Insurance writes to Line Manager E about restrictions on distributions by a holding company with an insurance subsidiary with a life fund in deficit. The Director sets out his understanding of the issue with discussion of the relevant sections of ICA 1982, as well as FSMA 2000. The Director of Insurance notes that:

• section 29(7) of ICA 1982 would prevent any company from declaring a dividend where the long term fund or funds of a subsidiary insurance company were in deficit on the regulatory basis;
• a section 68 Order could in theory disapply section 29(7), but only where the company was an insurance company – it was ‘not immediately clear that it is available in respect of non-insurance companies’; and
• the position would change when FSMA 2000 and associated rules and regulations came into effect.
• In the light of the above, the Director of Insurance sets out the following options:
• It was arguable that, due to Article 4 of Equitable’s constitution, their long term fund could never be in deficit. FSA were sceptical of this view and it was inconsistent with initial advice received from Counsel.
• It might be that HMT could make a section 68 Order to disapply section 29(7), which could raise policy problems said to be ‘difficult’ but ‘in the circumstances probably not insuperable’ for FSA. The Order would have limited use, as such an order would have no effect once ICA 1982 was replaced by FSMA 2000.
• There was no provision within FSMA 2000 similar to section 68 in ICA 1982 which would allow HMT to waive any requirement under the regulations due to come into force. A ‘generic, but suitably restricted’ draft of the regulation was suggested, so as to prevent other companies in a similar position to Equitable exploiting a possible loophole which could be created by that regulation. It was said, however, that this option ‘looks fraught with difficulty’.
• HMT regulations could not be waived but an exemption could be provided in respect of the FSA rule. If granted, no breach would occur and the HMT regulation would not be triggered. The Director of Insurance says:

This seems a much more promising way forward – not least because it would keep the issue under our own control and would not be subject to the vagaries of HMT drafting and Parliamentary process. To be acceptable it might well be necessary to accompany the exemption by a bespoke requirement on the Equitable (perhaps restraining the Equitable from moving assets out of the long term fund except in certain defined circumstances).

FSA’s Director of Insurance concludes that the last option appeared to be the only ‘serious contender’.

[12:59] Line Manager E says:

I think there is a fundamental policy issue we need to address here before we can work out the detail. However, it does seem that even if there are short term difficulties, there may be scope for overcoming them from N2 – it really depends what restrictions we think are necessary across the board.

The Line Manager notes further that:

The provisions in section 142 [of FSMA 2000] were included because of an (ie my) understanding at the Treasury that the general prohibitions on making distributions or charges would be continued in FSA rules.

Your account of the proposals for funds in deficit suggest that the de facto prohibition on paying dividends will not apply (although a dim view will presumably be taken in the event a company whose fund is in deficit makes distributions at a time that it can ill afford to do so). However, this change of approach is significant, and not something I had appreciated. The power of the Treasury was intended to back onto the requirements that would be imposed on the insurance companies themselves. However, if the primary requirements are not to be imposed on the insurance companies themselves, I am not sure I (if I were still in my previous [incarnation]) would see the grounds for imposing secondary restrictions on the parents of insurance companies. It is even arguable whether the lack of corresponding “asset identification rules” might even have the effect of narrowing the Treasury’s discretion to make the Regulations we had talked about.

Before we can produce an analysis of the future impact of the regime, I think we need to work out quite what the restrictions are that we would be looking to impose on parent companies, and then explain our position to the Treasury …

Perhaps [the Insurance Division’s Head of Policy (the Head of Insurance Policy)] and I could discuss?

[13:22] FSA’s Director of Insurance thanks him for his comments and asks Line Manager E to discuss this urgently with the Head of Insurance Policy.

[14:08] The Head of Insurance Policy writes:

Happy to discuss. But you might like to note that [the Director of Insurance’s] memo is not quite right in one important respect which I think might be the key driver of the concern you express.

FSA rules, not HMT [Regulations], prohibit the insurer from paying a dividend when its long-term insurance fund is in deficit – see rule 3.2(6) in Consultation Paper 41a. The HMT [Regulations] (will, when drafted) merely reinforce this by also prohibiting the holding company from paying a dividend.

[15:50] The Director of GCD gives some comments, following ‘useful discussions’, including:

Under the existing law, the legal position would be straightforward, I believe, if the company wishing to pay the dividend were a UK authorised insurer. In that case, a section 68 order could in my view lift the section 29(7) requirement from it both as an insurer and as a holding company. Since the section 68 powers are for HMT to exercise, it would need to be HMT lawyers who advise on this, but it is in my view the correct position.

However, the position under the existing law would be more difficult if the holding company were not an insurer. This is because section 68 powers allows us to lift requirements only for insurers. I have not yet found a way to resolve this issue. (I have not researched the idea that section 29(7) applies only to holding companies within the UK jurisdiction, but this seems to me pretty improbable.)

I am, however, more optimistic about the prospect for dealing with the problem under the new legislation …

As I understand it, the existing outright ban on distribution by holding companies creates many anomalies. We could therefore modify the rules we have currently proposed, not only to extend them to holding companies who are authorised, but also to avoid these anomalies, for example, by creating a group derogation. This could allow distribution by a holding company where the assets of the group are such that the group could have made the distribution if it had been a single insurer, or where the insurer with the life fund has been required by a group on terms designed to ringfence its funds (and their liabilities).

[17:44] Legal Adviser A notes that:

… the starting point is Article 21(2). In general, we cannot restrict the free disposal of assets. I agree with your comment on Article 24(3) which is reflected in section 32 and 45(2) and 37(3)(d). The only obligation to restrict seems to be in [the] second paragraph of Article 26. I can find nothing to suggest that we must impose a restriction on the holding company.

[18:05] The Director of GCD asks: ‘does this mean that the existing s29(7) is inconsistent with the directive and could be repealed under [the European Communities Act 1972] S 2(2)?’.

GAD’s note reproduces the results of a Money Management survey carried out in February 2000 (and published in April 2000). GAD explain that the survey showed that Equitable’s maturity payouts were slightly below average in February 2000 ‘(and indeed they have been in the third quartile on their 20 and 25 year policies since around 1990)’, but that their surrender values at most durations (and original terms) were above average in February 2000 (except for policies approaching maturity).

GAD go on to explain that the application of a 10% market value adjuster would reduce these payments on surrender but that they would still be close to the average for endowment policies at most terms and durations, and indeed higher than average for short duration policies.

GAD also point out that other companies were also likely to have reduced their surrender values to reflect the negative investment returns of around -2% to -7% that most companies were likely to have experienced on their with-profits funds during the year 2000. Accordingly, ‘we would expect to find that surrender values on with-profit endowments offered by Equitable Life are still likely to be fairly close to the average for all companies, even after the application of the 10% MVA factor’.

GAD explain that Equitable had only a relatively small portfolio of with-profits endowment policies (which was the main type of contract on which published surrender value surveys were carried out) and that: ‘We do not have any corresponding survey figures for the transfer values available on accumulating with-profit pension policies (the Equitable’s main product line) but we would expect the pattern to be similar ie close to average surrender values. (Maturity values on pension policies were though shown to be around 5 to 10% below the market average in a March 2000 survey.)’

FSA’s Director of GCD queries how the market value adjuster was deducted from the guaranteed amount of a policy (see 02/01/2001 [15:38]). The Director of GCD asks: ‘Does this mean that if a policy has a guaranteed value of £10,000, and a projected final bonus of £5,000, the MVA is £1,500 and this is deducted from the £15,000 so that the policyholder gets back £13,500?’.

Line Manager E confirms that FSA’s understanding was that this was done on that basis, clarifying that the final bonus would ‘only be the share of the terminal bonus earned after x years, not the amount that would have been earned had the policy run its course’.

An FSA Legal Adviser writes to the Director of GCD about restriction on dividends and makes the following observations regarding whether section 29(7) is inconsistent with the First Life Directive:

I … conclude that the inconsistency exists. The payment of a dividend is a form of disposal of assets. The existence of a deficit on the long term business does not justify restricting, under the Life Insurance Directives, the payment of a dividend. Section 29(7) could therefore be repealed under section 2(2) of the [European Communities Act 1972], since in effecting the repeal we would be implementing a Community obligation not to restrict the free disposal of free assets.

I should imagine that if we were to remove the inconsistency we would wish (how urgently I can only speculate) to do so by replacing it with a provision that goes at least some way towards achieving the same policy objective (for instance requiring the insurance company to notify FSA if a dividend were declared where the deficit existed). That would then raise the question whether the replacement provision itself could be effected under section 2(2) and whether, if not, we could make use of other powers.

[14:32] The Director of GCD agrees with this view, saying:

… we will not be in a position to replicate such a provision in our rules, as currently proposed …

This does not necessarily provide a complete answer before N2. Assuming HMT agree with our view, they could repeal the existing current Insurance Companies Act requirement by regulations under the European Communities Act. We will need to give further thought to whether the [provision] has any legal effect in the interim.

Equitable send FSA a draft briefing note that they planned to send to their representatives, which included information sheets for issuing to clients. Equitable ask for FSA’s and PIA’s comments.

Equitable also send FSA two communications that have ‘come my way’ which showed the advice being given to policyholders by two Independent Financial Advisers. In one of the two Independent Financial Adviser communications, it says, in response to the question, ‘Is our money safe?’:

Yes – the Society has closed to new business. It remains solvent and will continue to meet its contractual obligations under existing policies. Should this position alter 90% of investors’ funds will be met under the Policyholder’s Protection Act.

The advice given also states:

• l that future returns were likely to be poor;
• l that, as a closed fund, the Society was forced to be more cautious by investing in gilts rather than equities. This would also impact on future returns;
• l that Equitable were likely to increase future charges;
• l that anyone with unit trusts was advised to sell and reinvest, as these funds had historically under-performed and there would be no penalty for selling;
• l that investors with with-profit bonds should surrender at the first penalty-free opportunity;
• l that those with endowment plans should generally surrender their plan if they were still in the early years. Otherwise, they should continue with the premium but arrange to fund any shortfalls from the Equitable Life plan. It was recommended that investors ‘Please seek our advice before surrendering your plan, as there may be tax implications’;
• l that holders of with-profits pensions were most affected. Those with less than five years to normal retirement should remain invested, as Equitable would impose an exit penalty. Those with more than five years to retirement should consider transferring, as the exit penalty would be made up by better growth elsewhere. Investors who had GAR policies should seek individual advice as: ‘The value of the “guarantee” lost on transfer needs to be weighed against the inevitable loss of growth in remaining invested. We would strongly recommend that anyone with this type of plan bring us their policy document in order that we can fully assess the implications’.

The advice also noted that the exit penalty was currently 10%, but that this might change. It concluded by informing policyholders that:

It is essential that all Equitable Policyholders review their contract in light of the current circumstances and we would suggest that you contact one of our advisers as soon as possible.

FSA’s Line Manager E notes that Equitable had planned not to make a public comment about this type of advice. However, he says that Equitable ‘were considering if they could privately raise it with the media as a way of alerting policyholders to the need for care when taking independent advice, and to rubbish scare stories’.

FSA’s Chief Counsel B informs the Director of GCD that he had had a ‘satisfactory [conference]’ with Counsel that morning in relation to advice on the operation of the Policyholders Protection Act 1975, in the light of Article 4 of Equitable’s Articles of Association. Chief Counsel B reports:

[Counsel] has firmed up on his advice as to the preferred meaning which is the “Third meaning” identified at the previous [conference] that the reference to “assets” in [Article] 4 should be taken as referring to the gross assets of the Society – this means that a policyholders rights under a policy would only fall to be scaled down (by the operation of the Article) where the liabilities under that policy exceeded the total gross assets of the Society – what you don’t do is net off all policy liabilities and then assess whether there is a deficiency and if so scale down.

FSA’s Director of GCD provides Managing Director A with advice on how to deal with concerns that had been expressed about FSA’s regulatory approach to Equitable’s advertising in the period after the House of Lords’ ruling. The Director of GCD suggests that the following questions might need to be addressed by FSA and should be considered:

Was it in fact your view, after the House of Lords judgement, that failure to sell the company would lead to closure to new business?

along with the following ‘other’ questions:

a) whether, short of acquiring a disclosure along these lines, we were concerned about the scale of advertising on the part of the Equitable in this period, whether we took any action to express that concern to the company, or ask it to reduce the scale of that advertising;

b) whether we formed any view on the accuracy of the statements made in that advertising or of the company’s ability to meet the policyholder expectations it was creating;

c) whether we believe that the scale of the advertising during that period was normal for the company concerned, or whether we believe that it was specifically designed with a view to a possible sale;

d) whether we are happy with the response which we gave when concern was expressed to us about the Equitable’s ongoing advertising or whether, with the benefit of hindsight, we believe that that could have been better handled;

e) whether we undertook any particular enhanced monitoring of Equitable’s advertising during the period concerned;

f) how far we think that the split accountability for prudential regulation, to HMT, and conduct of business regulation, to PIA, may have affected our response;

g) how the move to the new regulatory structure might make a difference, either in strengthening or reducing our powers.

The Director of GCD suggests producing a briefing regarding FSA’s approach to investment advertising in the context of consideration of the European Directive on misleading advertising.

FSA (Head of Life Insurance and Line Supervisor C) and IMRO meet Equitable to discuss new business issues for Equitable Investment Fund Managers Limited, following Equitable’s closure to new business. According to FSA’s note of the meeting, the following points are considered:

• l that Equitable Investment Fund Managers Limited had not actively marketed themselves or sought business since Equitable’s closure to new business;
• l that Individual Savings Account (ISA) business would roll forward into the following tax year, unless an investor wished to cancel. Equitable Investment Fund Managers Limited wished to continue offering ISAs to existing clients; and
• l that Equitable Investment Fund Managers Limited also sought clarification on whether it would be appropriate for them to invest money in, for example, an Open Ended Investment Company, if approached by a client to do so.

FSA and IMRO confirm that the continuation by Equitable Investment Fund Managers Limited of business in this passive manner should not pose problems in the light of the current situation, but that this would need to be revisited should there be a sale and/or restructuring, as ‘there could be an issue regarding viability of [Equitable Investment Fund Managers Limited] on a stand alone basis’.

It is noted that IMRO had seen the financial information provided by Equitable Investment Fund Managers Limited prior to the meeting and that it had been thought that any potential problems would be human resource-based rather than financial.

FSA’s note records that Equitable Investment Fund Managers Limited had provided IMRO with some financial information prior to the meeting. FSA record that in this information, Equitable Investment Fund Managers Limited acknowledged that they faced a heavy administrative workload, having to deal with queries and surrenders. The information noted that there appeared to be a fair amount of uncertainty in investors’ minds, however, those investors did not appreciate that Equitable Investment Fund Managers Limited investors were not affected by the GAR uncertainty which affected the Society’s with-profits fund. Equitable Investment Fund Managers Limited were considering writing to investors to clarify the difference between an investment between Equitable Investment Fund Managers Limited and the Society.

In response to Chief Counsel B’s note of the clarification from Counsel (see 05/01/2001 [17:54]), the Director of Insurance says:

This advice is clearly helpful. I am concerned however about the possibility that [Equitable] may take a contrary view – particularly if this leads them to take action which might be unhelpful to policyholders and which (a fortiori) we would consider unnecessary. That said I am not [clear] what that action might be. But, if for example they came to the view that the [Equitable] couldn’t become insolvent in [Policyholders Protection Act 1975] terms they might [feel] it appropriate to warn policyholders about this. It would clearly be relevant to any policyholder in deciding whether to surrender a policy. But such a warning, if inaccurate, could produce the “wrong” decision. If we do end up taking different views we will presumably need to provide rather clearer guidance to policyholders and to the Equitable on the availability of compensation in the event of insolvency. Are we comfortable that unequivocal guidance be given?

Against this background I have been one of those who have thought ([in] my simple non-lawyer sort of way) that it might be a good idea if we and the [Equitable] could contrive to get the best, most reliable and most consistent advice so that we could ensure that policyholders are, in turn, best advised and protected. Happy to discuss. [There] are clearly issues here which I do not understand!

[10:58] The Director of GCD comments:

I would be concerned in this event that the [Policyholders Protection Board] might take the narrower view, or at least be reluctant to agree [with] the advice we have received, because of concern to protect their fund. We need to guard against this – hence my desire to get support from [government] lawyers. [Chief Counsel B] has suggested that this needs to be done on the back of scenario planning as to how the issue might arise. Could [Legal Adviser A] prepare this, discussing with [Chief Counsel B] what he has in mind?

[16:41] Chief Counsel B replies that he had discussed the matter with Legal Adviser A and they had agreed to start work on the scenario planning.

GAD write to Equitable in response to their letter of 21/12/2000 about their 1999 returns. GAD:

• l note that Equitable were considering what reserving basis for GARs was appropriate following the House of Lords’ decision;
• l note that Equitable intend to strengthen their assumptions in respect of payments of future GAR premiums;
• l note the comments made on the assumed retirement age for personal pension business. However, GAD ‘take the view at present that Regulation 72 (3) overrides Regulation 72 (1) and requires the actuary to set up a liability sufficient to cover the cash payments that would result from an exercising of the vesting option, at any time that that option may be exercised. In our opinion, the revised GN8, in paragraph 3.8.2, is referring to Regulation 72 (1), and not Regulation 72 (3)’;
• l in relation to the quasi-zillmer adjustment used in the resilience test, assume that Equitable have accepted GAD’s interpretation of the Regulations and note that Equitable would be applying a more sophisticated hypothecation of assets; and
• l note that Equitable were reviewing the level of provision required for expenses in the resilience scenario.

GAD send a copy of their letter to FSA, explaining that there remained disagreement over the retirement age assumptions used (that is, over the interpretation of Regulation 72) and suggest that the matter is referred to FSA’s lawyers for a definitive view.

By way of background, GAD explain:

… that in his valuation, [Equitable’s Appointed Actuary] assumes that benefits are taken at age 60 on retirement annuities, and at age 55 on personal pension contracts. On the retirement annuities, benefits may in practice be taken at full value (i.e. without applying an MVA) at any time between the ages 60 and 75. In his letter of 29 November, [the Appointed Actuary] said that the actual average age of retirement is closer to 65 [than 60] on these contracts, but a reasonable proportion of clients retire at 60 or shortly thereafter, and so age 60 was chosen as a prudent assumption in the valuation. Indeed, this is the strongest age assumption he could be expected to make.

On the personal pensions, benefits may be taken at any time after age 50 at full value. [The Appointed Actuary] told us in his 29 November letter that the average retirement age on these contracts is still well over 60, but since retirement in the late 50’s is more popular than previously, [he] felt it appropriate to “introduce an extra degree of prudence into the valuation” by using an assumed retirement age of 55. (In previous valuations, he assumed a retirement age of 60 on this business also.)

Because the valuation discounts the guaranteed retirement benefits from the assumed retirement age to the valuation date, the sooner the benefits are assumed to be taken, the stronger the reserving basis becomes. Indeed, the strongest reserving basis would be to assume that all personal pensions policyholders take their benefits at age 50. We advised [the Appointed Actuary] in our letter of 04 December 2000 that the Regulations required this.

[Equitable’s Appointed Actuary] appears to be arguing that Regulation 72(1) requires a prudent assumption to be made on when the vesting option may be exercised. He cites the actuarial guidance GN8 in support of this (presumably referring to 3.8.1 and 3.8.2 – attached.) He then considers that Regulation 72(3) allows him to take account of the assumed vesting dates when assessing the liability, i.e. he considers that the words in the Regulations “if the assumptions adopted for the valuation of the contract are fulfilled in practice” includes the assumption as to the date when the option will be exercised.

However, we take the view that Regulation 72(3) overrides that Regulation 72(1) and requires the actuary to set up a liability sufficient to cover the cash payment that would result from an exercising of the vesting option, at anytime that that option may be exercised.

Regulation 64(3)(c) requires the amount of the long term liabilities to take into account “all options available to the policyholder under the terms of the contract”.

Prospective Bidder B sends FSA a copy of a letter to Equitable dated 8 January 2001, which stated, in the light of events, a revised interest in purchasing parts of the business. This was on a revised basis from that prior to closure, due to:

… the need to restructure our initial first round proposal in order to limit the risk of deteriorating investment markets as well as a fall in interest rates. We also concluded that it would not be possible to pay a bonus in 2000 and that by not paying bonuses, persistency and new business could suffer significantly. Finally, we felt that we could not write new with-profits pensions business in the long term fund of Equitable without a capital commitment far larger than we could economically justify.

The four key components of the revised proposals were:

a) a deferred purchase of the non-with-profits value of insurance in force;

b) contingent loan financing of the with-profits fund;

c) reduced payment for goodwill; and

d) an offer to transfer non-with-profits business to a ‘New Equitable’ at a reduced market value adjuster.

FSA’s Director of GCD provides a note to the Director of Insurance confirming the advice that the Director of GCD had given at a meeting on 8 January 2001 on the issue of the restriction on dividends. The Director of GCD advises:

There is more than one view about the extent of the impact of Community Law on this situation. But all are agreed about one point. This is that it would in our view be contrary to Community Law for the restriction on declaration of dividends by a holding company to be applied to a holding company which was itself an insurer which was home state regulated in another member state.

… It is not necessarily a complete answer to the issue. This would depend on HMT taking the same view.

This is for two reasons. The first is that HMT will need to decide whether to continue the existing restrictions in their current form, or in a modified form, when the Insurance Companies Act provisions are repealed. It will be desirable to ensure that HMT do not continue the existing restrictions. Second, in the interim, if action were required to bring UK legislation in line with Community Law, it would need to be HMT which took this action.

There is also a wider, policy question, about whether it makes sense to apply controls on holding companies to insurers, but not to other firms we regulate.

FSA’s Director of Insurance provides the Financial Services Compensation Scheme with a briefing paper about Equitable and arranges to attend a briefing for the Scheme’s Board on

20 February 2001. The briefing note provides background about the Society and its closure to new business. It also deals with a number of current issues, including:

• l Solvency and compensation arrangements.
• l Review of FSA regulation.
• l Future performance.
• l Help for policyholders.
• l Other FSA activity.
• l Adjustments to policy values.

In relation to solvency, FSA say that ‘the Equitable continues to be solvent in Companies Act terms, as well as satisfying the more onerous requirements under the Insurance Companies Act 1982. The compensation arrangements under the Policyholders Protection Act 1975 and in future under the Financial Services and Markets Act 2000 are not, therefore, of immediate relevance’.

FSA meet with Prospective Bidder D. The purpose of the meeting was to keep FSA informed so that any regulatory issues could be spotted in advance. The Bidder outlines its proposals and gives FSA a copy of a letter, dated 8 January 2001, to Equitable setting out those proposals. These are summarised as follows:

• l Prospective Bidder D strongly supports Equitable’s approach to business. The bidder intends to build a company which mirrored the characteristics of Equitable’s strategy and infrastructure.
• l The bidder intends to make a substantial payment into Equitable’s closed fund in consideration for all of Equitable’s ongoing business.
• l Part of the consideration would be deferred to reflect the success of the ongoing business.
• l Equitable’s closed fund would be managed by a service company operated by Prospective Bidder D.

The proposals note that the potential buyer ‘intends to enter into immediate discussions regarding partial demutualisation of The Equitable to achieve a substantive resolution of its current capitalisation problems. This is expected to provide significant benefits for existing policyholders of The Equitable’.

FSA’s note of the meeting states that the potential buyer:

… thought that a resolution of the problem between GAR and non GAR policyholders was required for the [Prospective Bidder D] proposal to work. Some thought had been given as to what the form of compromise could be and this largely appeared to be some form of cash settlement to all GAR policyholders, but this needed further work. The final settlement of this issue would lead to a c£1bn “estate” from the release of regulatory capital which could then be used to buy the GAR policyholders out.

At the next stage policyholders of both camps would have the option of transferring to an [Prospective Bidder D] company (possibly a dormant subsidiary of [an insurance company]) this would be recapitalised with a further £1bn from [Prospective Bidder D]. This should help maintain investment freedom.

An FSA official distributes a revised version of FSA’s lines to take, which had received plain language comments. In response to a question, which asked whether Equitable were justified/legally entitled to withhold seven months’ bonus/interest, it is stated that:

Life Insurance companies can only pay bonuses to their with-profits policyholders when they have surplus assets. Most of the Equitable’s surplus funds have had to be earmarked to cover the costs of correcting the position of certain policyholders in line with the recent House of Lords judgment. It had been hoped that the sale of the business would have provided additional capital, so the bonus could be restored. However, as the Equitable were unable to find a buyer, it has announced that it is unlikely now to be able to restore the bonus.

In response to a question, which asked whether ‘previous accounts should have mentioned or taken account of these liabilities even though the legal position was still being considered’, it is stated that: ‘The Companies Acts require a company to prepare its accounts, based on a “true and fair” valuation of its assets and liabilities, and for the auditors to give an opinion as to whether this has been done’.

When asked ‘What advice have you given [Independent Financial Advisers?]’, the FSA line is that: ‘independent financial advisers are required to act in accordance with the rules made by the Personal Investment Authority. The PIA has recently issued a regulatory bulletin to remind [Independent Financial Advisers] of their duties and responsibilities’.

In relation to the degree to which the GAR issue had wider implications, it is said that:

The practice of offering pension plans with guaranteed annuity options was fairly common some years ago. However, the circumstances leading to the Equitable’s decision not to accept new business were specific to the Equitable. This arose from the combination of a number of factors, including the generous terms of the guarantees and the significant proportion of its business which had the benefit of such guarantees.

It is also noted that: ‘Unlike many companies, the Equitable did not maintain large levels of unallocated assets, often referred to as “orphan” or “inherited estates”. Instead, the Equitable preferred to distribute surpluses to its fund to policyholders as and when they arose’.

FSA meet Equitable and their advisers to discuss their thinking on the indicative bids received. FSA’s note records:

[Equitable’s adviser for the sale] said that since [indicative] bids had been received, [they] had been trying to analyse them on a consistent basis (eg some attributed value to assets but on the basis that future intra-group charges would be on a cost or profit basis while others maintained existing charges but offered no consideration). They also needed to consider whether the bids carried any risks (in terms of delivery or price), the number of conditions and the timetables. He expressed some disappointment that the submissions were thin on detail and would need considerable further investigation.

[The advisers] first outlined the [Prospective Bidder E’s] proposition. They were looking at a two stage process. First they would acquire the parts of the company relevant to new business acquisition. The second stage was dependent on an accommodation between policyholders and would involve a Schedule 2C transfer of the business to a company in the [Prospective Bidder E] group. The administration platform would only be taken over at that stage.

The offer included £100 million by way of consideration, £100m for goodwill and up to a further £300 million which was contingent on certain factors. Further capital would be generated on restructuring the fund and buying out the in-force business. They would be looking to transfer existing business into an open fund. The bid made certain assumptions about the adequacy of funds to maintain equity ratios, the sales force not leaving and litigation and publicity being under control. [Equitable’s advisers] thought the key issues were whether the numbers would work generally and in particular whether the assumptions on the GAR/non-GAR were realistic.

On Halifax, [the advisers] noted the similarities to other bids, but also the philosophical differences. In particular, Halifax were clear that they wished to leave the old closed fund as a self-standing entity for which they would have no responsibility. The offer was for £100m, with a further £400m (made up as a number of components) as a carrot for resolution of the GAR issues. They would also offer a further £250m by way of a loan, which would help demonstrate confidence. Equitable wanted to find out more about their “not-for-profit” proposals, to compensate policyholders for the mva when transferring from Equitable to a Halifax company with-profits fund. There could however be implications for the closed fund that would need to be considered. Fuller details are recorded on file in a draft proposal given to us by Halifax before it was submitted.

[Equitable’s advisers] noted that the [Prospective Bidder D] proposal was also broadly similar to the others although parts of it were unclear through lack of detail. Equitable would need to explore this further to understand it better. Again, fuller details of the proposal are on file (copy of the submission from [Prospective Bidder D] and a note of a meeting on 10 January 2001). [The advisers] said he was particularly unclear about what would happen with in-force business – was it to transfer to [a Prospective Bidder D] company or remain mutual. [FSA’s Line Manager E] explained what he had understood from the discussion with [them] that morning, and summarised in that meeting note. Broadly, the plan appeared to be to seek a resolution to Equitable’s problems within the company, but then to propose a Schedule 2C transfer to [a Prospective Bidder D] group company, with policyholders having the option to remain in a closed Equitable fund.

[Equitable’s advisers] said that the [Prospective Bidder F] bid was disappointing. A simple cash offer of £50m and a contingent loan of £I billion. They had no interest in resolving the issues surrounding the closed fund.

[The advisers] said at this stage, they were not minded to proceed with the bid from [Prospective Bidder F]. Of the rest, they all had attractions but it was too early to say which would be the most favourable. They hoped to be in a position to select a preferred bidder before an Equitable board meeting on 17 January. [FSA’s Director of Insurance] said we would make ourselves available if bidders wished to discuss any regulatory issues with us.

An FSA official asks Legal Adviser A whether the Policyholders Protection Act 1975 applied to group policies such as a company’s Group Money Purchase Pension Plan.

[11:03] Legal Adviser A says that he would look into it. The Legal Adviser also highlights that FSA’s frequently asked questions stated categorically that the Policyholders Protection Act 1975 did not apply in respect of policies sold through Equitable’s Guernsey branch. He says that he did not ‘think it is that easy’ and would advise further.

On 15 January 2001 [09:42], the Director of GCD asks Legal Adviser A to ensure that their answer was amended and that ‘no answer is given’ until Legal Adviser A had reviewed it.

Equitable send FSA a copy of the policyholder update that they had issued that day, by way of a press notice, which started by saying that ‘the sale process is going well’.

FSA send the Personal Investment Authority Ombudsman a copy of Equitable’s policyholder update ‘as it covers some of the issues we discussed the other day’.

FSA’s Line Manager E writes to GAD about an article in a national newspaper that day which concerned the reinsurance treaty. Line Manager E says: ‘As I understand it, … the journalist was trying to imply that there was something fishy about a reinsurance with an offshore company etc, perhaps that it was not really worth very much etc’.

[10:56] GAD’s Directing Actuary B replies that GAD were looking back through their file for more information. The Directing Actuary says he believed that there were ‘a number of inaccuracies’ in the article and states:

1) Irish European is currently AAA rated ([Standard & Poor’s]) reinsurer.

2) Equitable Life is fully reserved to cover all guaranteed benefits including [GAOs] up to the threshold, and held reserves of close to £1 billion (including a resilience provision for adverse experience) as at 31 December 1999 for this purpose.

3) We accept though that bonuses would be reduced to meet GAO costs. This is a direct result of the House of Lords judgment last year which required these costs to be spread across all policyholders.

[12:20] GAD’s Scrutinising Actuary F sends Line Manager E a copy of his report of 19/12/2000 [17:43] and directs him to what he had said there.

FSA’s Company Secretary writes to the Director of GCD about the latest position regarding any potential conflicts of interest among FSA’s Board. Information is provided on personal Board conflicts, detailing the Equitable policies held by Board members or their partners. Four of the twelve members declared that they held an Equitable policy (all of which were for not insignificant sums), one member declared that their partner held a policy (again, for a not insignificant sum) and one member had not made a declaration, as they were currently abroad.

The Company Secretary states that two members (who did not hold Equitable policies) have indicated that they would be conflicted if their company were interested in acquiring the sales force or other parts of Equitable’s business. The Company Secretary goes on to say:

I have discussed the conflicts issue with [FSA’s Chairman] and he agreed that this represents part of the study of risks faced by the Board in achieving its function, which I believe [FSA’s Director of Internal Audit] is undertaking. In the meantime, the Articles currently provide for a materiality test, but I believe we need some advice on exactly how we can interpret this, whether we need to change the relevant Article for the future, and if so, how.

FSA and GAD meet Prospective Bidder E to discuss their indicative bid. Equitable and their advisers for the sale, their actuarial consultants and solicitors, also attend the meeting.

Prospective Bidder E explain that they had been looking to expand their distribution and product range and had been interested in Equitable at an earlier stage but: ‘at that time it was difficult to come up with a scheme that would work. He noted that in the changed circumstances, there was more scope to conduct a realistic deal which would enable them to restore confidence among Equitable policyholders’. Prospective Bidder E explain their proposals and several issues are discussed. On regulatory issues, they say that one concern to them was the continuing availability of Equitable’s implicit items and subordinated loan. GAD say that they had considered the implicit items and saw no reason in principle why this could not continue. On the subordinated loan, FSA say that they would not intend to apply a different test to those normally adopted.

Equitable leave the meeting and Prospective Bidder E ask about FSA’s approach to Equitable’s reserving basis, noting that they had seen correspondence on the issue. Prospective Bidder E seeks comfort that FSA were not expecting to raise any new issues. GAD confirm that there had been a recent exchange on reserving but say that the disputed issues had largely been resolved.

FSA and GAD meet Prospective Bidder D to discuss their indicative bid. Equitable and their advisers for the sale, their actuarial consultants and solicitors, also attend the meeting.

Prospective Bidder D takes FSA through a paper that they had prepared, setting out how their proposals would work – and several issues are discussed.

Equitable write to FSA about Equitable Investment Fund Managers Limited to confirm the points that had been agreed at the meeting of 08/01/2001.

On 16 January 2001, FSA’s Head of Life Insurance notes to Line Manager E that he believed the letter reflected the points agreed.

FSA’s Director of GCD asks Chief Counsel B (copied to FSA’s Chairman and Company Secretary) to advise the Company Secretary on any conflicts regarding members of FSA’s Board (see 12/01/2001 [entry 3]). The Director of GCD says:

At the last Board, I among others disclosed conflicts re [Equitable]. Those do not generally inhibit me advising on [Equitable], given the disclosure, but should inhibit me taking responsibility for advice on how conflicts themselves should be handled – or at least make it desirable that someone else should be involved.

HMT write to FSA asking for information on Equitable’s ‘key numbers … ie an official take on all the [figures] that are in the press’.

[10:36] FSA’s Line Manager E asks Line Supervisor C to deal with the request.

A Bank of England official writes to FSA’s Managing Director A following a ‘[Managing Director A]/[the Bank of England’s Executive Director of Financial Stability] dinner’, at which the issue had arisen as to whether the Financial Law Panel should be asked to assist with the ‘uncertainty’ following the House of Lords’ decision. The official asks if FSA had followed up the issue.

FSA’s Managing Director A suggests to the Director of GCD:

… my own feeling about this is that the [Financial Law Panel] is something of a red herring (though [the Bank of England official] would argue it does allow subjects to be raised informally with “the right people”).

We have 2 main options it seems to me:

a) we understand Equitable itself is seeking legal advice and we should not pre-empt that. Absent developments there, it might be worth the [Financial Law Panel] being involved but it would make much more sense for the [Association of British Insurers] or the Equitable or another firm to approach them rather than us, as so much seems to rest upon particular circumstances (about which we by definition are not best placed to speak).

b) The other route is … for us (or for us to ask [the Bank of England] to raise it for us) to raise the issue with the [Financial Law Panel] and see what bright ideas [the Financial Law Panel] come up with for going forward.

The Director of GCD replies: ‘A supervisory matter, but not sure what help this would be at this stage’.

FSA’s Director of GCD replies to the FSA official about FSA’s lines to take (see 12/01/2001 [12:45]). The Director of GCD says:

… the essence of the [House of Lords’] judgment is that GAR liabilities are binding liabilities of the company. All company assets are available to satisfy them. Given this, [it is] not clear how the FSA “keeping a very close watch” could help.

The answer to the second and third questions says that “there is no obvious statutory basis” for the regulators organising an accommodation among the different classes of policyholders/a rescue. This need not inhibit action of this kind. Organising rescues without public money falls to us under the Tripartite [Memorandum of Understanding].

We could surely require the company to call an EGM under usual intervention powers – eg to secure PRE/sound and prudent management.

[17:21] Line Manager E queries whether the use of section 45 of ICA 1982 to order an extraordinary general meeting would be an appropriate use of that power.

[18:13] Legal Adviser A advises further on this question.

FSA and GAD meet Equitable. Equitable’s handling of customer enquiries is discussed, along with the level of requests from individuals for policy surrenders and transfers. Equitable say that cash reserves had already been built up to meet the demand of these withdrawals and no assets had to be sold for this specific purpose. FSA record that the position on withdrawals for group schemes was unclear, because moving such schemes took time to process and employers needed to research the alternatives. Equitable confirm that the market value adjuster for group schemes was negotiated with them. FSA’s note also records that there had been a higher level of surrenders in the Republic of Ireland ‘where there was less of an MVA because of a separate hypothecation of Irish assets’.

Equitable report that they expected to show in the 2000 returns around £500m of free assets above their required minimum margin, subject to work by their new appointed actuary ‘and to confirmation by [FSA] of some technical waivers to the valuation rules as intimated to us last year (and as given recently to some other companies)’. Equitable say that this valuation included the various changes agreed in recent correspondence ‘(other than the possible additional £250 million for personal pension policies on which we await legal advice), but does not include a contingent liability for any possible redress for pension fund withdrawal contracts that might be imposed by PIA (estimated by the PIA as £40m on a worse case scenario)’.

FSA note that Equitable were expecting to fail to declare any bonus that year, as they did not have sufficient emerging surplus, and that they were currently reviewing the interim bonus of 9% that was applied to maturing policies, or on death. FSA note that Equitable would also need to review the bonus rate applied to with-profits annuities in payment that were held by ‘a particularly sensitive group of policyholders (who have no ability to transfer their policies to another company)’.

FSA record that Equitable:

… explained that the present 10% MVA is [needed] to cover the additional cost of [guaranteed annuity options] arising following the [House of Lords’] judgment (probably around 5%), along with the relatively poor investment return last year (around 2.5%), and the need to recover all initial expenses incurred (around 2.5%). They have made a robust response to the OFT on this topic.

The MVA is applied of course to the full policy value which was increased on an interim basis by around 4% last year, as compared with an actual investment return on the fund of around 2-2.5%. Meanwhile, they are not keen to draw any further attention to the MVA and its link to investment conditions in view of the possible adverse publicity. They stressed to us that the MVA is not intended to act as a penalty; rather the objective is that payments on non-contractual termination should be fair to both outgoing and remaining policyholders.

FSA’s note of the meeting records the actions to be taken:

• l FSA ‘owed’ Equitable a note on new business issues.
• l Equitable were to submit formal notification of their new Appointed Actuary.
• l FSA were to liaise with Equitable on the treatment of the section 68 Order for the calculation of the valuation rates of interest for fixed interest securities.
• l FSA were to consider whether they wished to see Equitable’s submission to the OFT.
• l FSA were to consider how Permanent Insurance should be valued in Equitable’s 2000 returns, noting that Equitable would need to apply for a section 68 Order.

FSA’s Director of GCD suggests to the Head of Life Insurance that FSA should formulate ‘criteria for judging’ the proposals for purchasing Equitable’s assets.

[11:31] Managing Director A says that he was ‘not in favour of this’ as the ‘commercial decision is for Equitable’ not FSA. The Managing Director says that FSA’s role was to ensure that the offer Equitable decided to proceed with was sound in regulatory terms: ‘(bidder can afford it, Equitable policy-holders fairly treated etc)’.

FSA hold an ‘Equitable Life Lawyers Group’ meeting. The minutes of that meeting include:

l Chief Counsel A informs the group that: ‘a breach of PRE investigation had been on hold since the judgement of the Court of Appeal. The evidence gathered was consequently incomplete and the likely outcome of the investigation could now only be a matter of speculation’.

l Legal Adviser A explains that, if Equitable were to have a deficit on the long term fund, then any holding company would be prevented by section 29(7) of ICA 1982 from paying a dividend.

l The group note: ‘The internal view on the market value adjuster (MVA) was that the Insurance Regulations do not bite on MVAs … A brief discussion on intervention powers (in relation to MVAs) was held. It was noted that judging when it was appropriate to intervene should MVAs be increased would be a difficult task. It was agreed that [Line Manager E] would be contacted to see what public statements had been made by Equitable on MVAs’.

l The issues of compromising GAR rights and winding up are discussed and the group note that the Policyholders Protection Board would be involved where policyholders’ rights were to be compromised, stating: ‘[The case of a named company] was a good comparison for Equitable on this point as it slipped from solvency to insolvency during run-off. A scheme of Arrangement or analogous measures under a Schedule 2C Scheme may be more appropriate in circumstances where solvency was likely, and as it would cap all the uncapped GAR liabilities its relevance is unlikely to be limited to insolvency alone.’

It is agreed that the minutes of the group’s meetings should be sent to Line Manager E, the Head of Life Insurance and the Director of Insurance and PIA.

GAD’s Directing Actuary B sends FSA (Managing Director A, the Head of Life Insurance, Line Manager E and Line Supervisor C) and Scrutinising Actuary F his conclusions on the present financial position of Equitable, following their meeting with them that morning. Directing Actuary B reports:

At a meeting today with Equitable, they outlined to us their draft financial result for the year 2000. They expect to be able to show free reserves of some £500 million in excess of the required margin of solvency, subject of course to further work by the newly appointed actuary in examining the methodology and assumptions, and to confirmation by [FSA] of some technical waivers to the valuation rules as intimated to us last year (and as given recently to some other companies).

This result includes a provision of around £1.8 billion net of reinsurance for Guaranteed Annuity Options, and the various changes to the valuation basis as agreed in recent correspondence (other than the possible additional £250 million for personal pension policies on which we await legal advice), but does not include a contingent liability for any possible redress for pension fund withdrawal contracts that might be imposed by PIA.

The net provision for [guaranteed annuity options] has therefore increased over the year by around £1.2 billion (in addition to a £200 million provision for redress to already retired policyholders), mainly as a result of the changes to the reinsurance cover (following the [House of Lords’] judgment), the lower interest rates assumed (both as a result of changing market conditions and the more conservative approach required by the changes to the regulations), and an increased allowance (following the [House of Lords’] judgment) for the payment of future premiums on GAO policies.

Directing Actuary B’s note continues:

They are not expecting to make any bonus declaration this year (as they do not have sufficient emerging surplus), and are reviewing the present 9% p.a interim bonus that is added for claims on maturity (or death). They will also need to review the bonus rate applied to the with-profit annuities in payment that are held by a particularly sensitive group of policyholders (who have no ability at present to transfer their policies to another company).

They explained that the present 10% MVA is need to cover the additional cost of [guaranteed annuity options] arising following the [House of Lords’] judgment (probably around 5%), along with the relatively poor investment return last year (around 2.5%), and the need to recover all initial expenses incurred (around 2.5%). They have made a robust response to the OFT on this topic.

The MVA is applied of course to the full policy value which was increased on an interim basis by around 4% last year, as compared with an actual investment return on the fund of around 2-2.5%. Meanwhile, they are not keen to draw any further attention to the MVA and its link to investment conditions in view of the possible adverse publicity. They stressed to us that the MVA is not intended to act as a penalty; rather the objective is that payments on non-contractual termination should be fair to both outgoing and remaining policyholders.

The Directing Actuary’s note continues:

They sold around £740 million overseas equities last December, along with £530 million UK equities, and then held most of this in cash. In January, they have sold so far a further £375 million equities and £50 million investment trusts and are planning some further sales to reduce the equity proportion from around 72% last autumn to possibly 60%, depending of course also on the progress on the potential sale of the society. They have invested around £400 million this month in fixed-interest securities but are also mindful of the need to maintain liquidity.

They are estimating at present cash outflow of up to £3 billion this year, based on an outflow of around £200 million over the last month (and a fairly steady rate of requests for surrender continuing at around 1,000 policies per day). Their investment manager is somewhat nervous though about the capacity of the market to absorb possible sales at this continuing level. They are not looking actively to sell properties at this stage but will take advantage of any such opportunities that may arise.

Directing Actuary B concludes:

Generally, they remain of course quite vulnerable to adverse investment conditions, and meanwhile, the equity market will be aware that further significant sales by the society can be expected to continue. Their best prospect is a link to one of the potential bidders that allows a less defensive investment strategy to be implemented.

FSA’s Head of Life Insurance informs Managing Director A of the ‘considerations’ which FSA ‘are taking into account in discussing with the Equitable and various interested parties the proposals to purchase some or all of the business’. The Head of Life Insurance’s note says:

Our basic approach is that it is for the directors of Equitable Life to decide which proposal, if any, to choose to put to policyholders. The FSA’s primary aim is to ensure that any regulatory issues arising from these proposals are exposed in good time, so they can be either resolved or taken into account before decisions are taken. We are also offering our good offices to facilitate discussions between the parties to assist the prospect of a satisfactory agreement being reached.

As regards to the proposals themselves, and the various bidders, we are taking the following factors into account:

• l The fairness of the proposal to policyholders in general, and to each of the main classes of policyholder (GAR and non-GAR);
• l Financial factors, notably the impact of the proposal on the strength of the Equitable fund or any replacement to it and the wider group of which Equitable may become a part;
• l The commitment of the bidder to the deal, and to the longer term interests of the Equitable policyholders in the way the deal is followed through;
• l How convincing the proposal is, in terms both of how well the proposal fits the strategic objectives of the bidder, and how attractive it is likely to be to policyholders;
• l The strength of the management, and its ability to carry through the proposal;
• l The regulatory standing of the bidder, both in the UK and (in the case of overseas bidders) in its own jurisdiction;
• l Whether the bid is likely to produce a better outcome overall compared with a continuation of the closed fund.

Equitable send FSA a copy of a letter from them to the OFT, dated 8 January 2001, about their use of a market value adjuster. The letter contains information on the financial adjuster, as requested by the OFT. Equitable’s letter concludes:

It will be worth your bearing in mind one overriding fact – a contract without a financial adjustment mechanism could not be fair to all with profits policyholders since it could at any point in time place on the fund and hence on continuing policyholders an unfair burden to finance continuing with profits policyholders. The timing of surrender is entirely at the discretion of the policyholders in question and therefore creates considerable scope for them to act to the disadvantage of other with profits policyholders.

FSA’s Head of Life Insurance seeks advice from Legal Adviser A on FSA’s powers under ICA 1982 to object to or to approve the proposed appointment of a new Managing Director of Equitable. The Head of Life Insurance says:

From a policy point of view, we may not be happy with [the person] as [Managing Director] on a long term basis; but there are strong practical grounds for not objecting to him performing this role during the interim period while the future of the company is in doubt, and they are negotiating with third parties over a possible sale. The new owners (if any) may well have views on the future of the existing Equitable management.

… I would like you to consider … whether it would be possible to give, in effect, a qualified or conditional approval, for example giving approval for a limited period of say 6 months …

Whatever the legal position, we shall probably want to discuss the issue with [the proposed Managing Director] and [Equitable’s President] (or his successor, if appointed), before giving a formal response to the application. But before we do so, it would be helpful to be clear whether there is any flexibility in the statutory position.

GAD provide FSA with further information that had been requested by Managing Director A at the meeting on 16/01/2001 about Equitable’s future profits implicit item. GAD say:

Under the present rules and guidance, this has to be substantiated both by a historical test against actual profits achieved, and also by a certificate from the actuary relating to the sustainability of these profits.

The application, accompanied by such a certificate, for an amount of £1.1 Bn for the year ending 31/12/00 was made by Equitable in June 2000, and I believe has now following perusal by GAD and FSA been granted by FSA/HMT.

The information provided with this application indicated that the formal historical test (as required by the EU Directives) would be satisfied even if all policies were assumed to run off over the next 3 years.

The actuary has not provided us with details of the calculations made for the purpose of his certification that future profits of the required amount will emerge. However, if we assume that they need to generate profits of around £450 million for the next 5 years in order to cover both the reinsurance offset of £800 million and the future profits item of £1100 million, then we believe that they would need to earn an average investment rate of return on their with-profit fund of around 5.5% each year.

The figure of 5.5% is circled by FSA’s Chairman.

GAD explain that, if the market value adjuster remained in place, solvency should continue to be covered:

However, if the MVA has to be removed while the FTSE Index remains at present levels, then they will incur a loss on all their surrenders. This would not only invalidate the implicit item for future profits but would also mean that additional provisions would almost certainly need to be established in the balance sheet for potential surrenders. This would be likely to mean that the society would be declared technically insolvent.

GAD suggest that FSA should ask the new Appointed Actuary to recertify the item and provide details of his key assumptions before the 2000 returns were submitted.

GAD also provide figures for the increased cost of annuity guarantees. These provide an analysis of the increase in the reserve for annuity guarantees between 31 December 1999 and 31 December 2000 (based on the draft year-end 2000 figures so far available from Equitable). GAD highlight that the main sensitivities of this reserve were the interest rates and future premiums that might be payable. They explain:

The potential variability in this reserve is then one of the main reasons that Equitable are hoping to arrange some deal between the GAR and non-GAR policyholders that would buy out these GAOs.

Equitable send FSA some policies data, which is presented as follows:

Data at 31/12/2001 With profit Unit linked Total

(see notes)

Number of policies in force 720,000 189,000 909,000

Number of Group Schemes

(excluding [group pension

plan policies] but including AVCs) 5,400 2,500 7,900

Number of members within

Group Schemes 656,000 132,000 788,000

Number of individual GAR

policies 110,000 N/A 110,000

Please note the following points:

• l ULAS policies are included.
• l Non Profit policies are excluded from the number of policies/schemes in force.
• l [Equitable Investment Fund Managers Limited] business is excluded.
• l Where a policy/scheme has both unit linked and with profit investments, they will be counted in both sets of data.
• l For information, please note that the GAR figure of 90,000 which is frequently quoted relates to the approximate number of clients with an interest in GAR policies at the time of the court case.

In response to a query from the press as to whether FSA would be providing more specific advice to policyholders, FSA’s Line Manager E notes that he is:

… sure that we should not be giving information of that kind to policyholders. We have made it clear – and should continue to do so – that everyone’s circumstances are different and people should take proper advice before taking action. It is all very well making generic assumptions about people’s circumstances, but while that may be right for the majority, it will not be right for everyone. Eg someone in their late 20s or early 30s who has taken out an endowment with their home loan and a couple of years later is found to be suffering from a terminal illness should not surrender if they want their families to be protected.

Other FSA officials agree with this ‘cautious view’.

FSA’s Chairman informs officials of a telephone conversation that he had had with Prospective Bidder A on 16 January 2001. The Chairman reports:

I first wanted to confirm with him that the message we had sent, via the [Association of British Insurers], about our willingness to discuss a collective package for the Equitable had got through. He confirmed it had done so, and thought it had been reasonable of us to ask. But there was no interest among his colleagues in discussing a collective rescue. They were concerned about the moral hazard point, since they believed that Equitable had run with too little capital for a long time. And they could not see how the economics could be made to work. If there was any value in the Equitable which might justify an additional contribution to the with profits fund, then that depended on the goodwill and the access to the Equitable’s customer base. It was hard to see how that value could be realised for the benefit of a group of firms, rather than one. So he simply did not think that any industry-wide deal was a runner.

FSA’s Chairman’s note continues:

As for the position of the Society itself, he confirmed his view that [Equitable] was simply short of capital, and had been for some time. There had apparently been some discussions with the Society a few years back about the possibility of a conversion and acquisition, at a time when it would have been possible to reconstruct the fund on a viable long term basis. But the management had not been interested. And he thought that, once the court case had begun, the die was cast. In his view, half the problem lay in the approach to reserving which the government actuary had taken in the past. Although he agreed that, for many insurance policyholders, had the Society been required to have larger reserves in the past, their current position would not be materially different from what it is now, since they would have had lower distributions along the way.

FSA meet with PIA to discuss enforcement issues. FSA record the discussion under the following headings.

Pension Fund Withdrawals

PIA say that Equitable had ‘agreed to do a past business review’ (note: said to be around 20,000 cases), although ‘It was currently thought that the scope of the review was not fully acceptable to [Enforcement], but Equitable were moving in the right direction’. It is noted that Equitable did not accept that their sales process had been flawed. FSA record: ‘It was thought that typically a mis-selling case of this nature might attract a fine of about £500,000. It was thought that on a worse case scenario the total cost of this to the Equitable could be £40m including compensation and expenses’.

Pensions review

PIA say that the ‘remedial action’ required from Equitable for failings with regard to PIA’s Pension Review had been signed off by Enforcement. However: ‘the issues that arose from this case following a June 2nd visit would normally lead to some form of penalty from [Enforcement]. A possible fine of £300,000-£500,000. It was not thought that there were any remaining additional costs to the Society in respect of the review’.

Discipline

FSA record:

[FSA’s Head of Life Insurance] was concerned that any disciplinary action could harm the delicate sales process and any goodwill payment which would be in the overall interest of policyholders. [The Head of Life Insurance] outlined the sensitivities and the proposed sales timetable.

[One of PIA’s Enforcement Heads of Department] was sympathetic to [FSA’s] concerns and agreed to talk to the Chairman of the disciplinary committee that day to outline these. He thought that the committee should be able to take a decision in principle on this issue. But it was important not to sacrifice the principle that those that have lost out should be compensated – on this both [FSA] and [PIA Enforcement] were agreed.

FSA’s supervisory file includes a letter from PIA to Equitable, dated 18 January 2001, about their pension fund withdrawal contracts enforcement investigation. PIA seek clarification of a number of points concerning Equitable’s proposed review.

FSA’s Director of GCD says that Chief Counsel A’s suggestion of requiring Equitable to provide accelerated returns: ‘Sounds sensible to me!’.

[09:59] The Head of Life Insurance comments:

We are in communication with the company on their current financial position. I am inclined to think that asking for returns as at end 2000 will not add to our knowledge; and since they won’t be in the normal publishable form, they won’t assist public disclosure either (which would be the strongest argument for early submission, but is outweighed by the need to avoid imposing distractions on the management from getting a deal).

[13:44] The Director of GCD replies ‘ok’.

FSA send HMT the information about Equitable that FSA had received the previous day (see 17/01/2001 [17:13]).

[20:20] HMT ask FSA to contact the Department of Social Security, who were seeking some similar general information about Equitable.

PIA write to FSA about the situations in which Equitable were writing new policies for existing group schemes and about the ability of personal pension policyholders aged over 50 to avoid the application of a market value adjuster by transferring to income drawdown policies and then transferring to another provider.

FSA later (on 19 January 2001) confirm the situation in which new policies were being written and, on 22 January 2001, that they were aware of, and had spoken to Equitable about, policyholders being able to transfer out while avoiding the market value adjuster.

Further to Line Manager E’s comments about giving advice to policyholders (see 17/01/2001 [16:29]), the Director of GCD says:

I believe it would be possible to give generic advice of the kind [suggested] without any risk that we would be giving authorisable investment advice.

This would be similar to the decision trees we are working on for a stakeholder pensions. But I can understand reluctance to give advice on these issues in the immediate future particularly if its effect could be destabilising on the Equitable and/or its sale prospects. This is a difficult balancing judgement.

FSA’s Head of Life Insurance forwards GAD’s note of 17/01/2001 [13:28] to Managing Director A, commenting that, at first sight, this might seem alarming but that it was a ‘hypothetical worst case scenario’. The Head of Life Insurance says that if the market value adjuster did disappear, the effect on solvency would be severe, but this: ‘is a highly unlikely scenario, and if it did arise, we as prudential regulator would have to consider intervention to protect policyholders (which might take the form of preventing the company from making any payouts on policies except those which were contractually required – ie even more severe in its effect than the MVA?’. The Head of Life Insurance also writes: ‘As regards the reserve for GAOs, the figure has increased partly as a result of discussions which we and GAD have had with the company over recent months about the appropriate prudent level’.

[13:03] The Managing Director sends GAD’s note and the Head of Life Insurance’s comments to FSA’s Chairman, who later replies on 23 January 2001, saying: ‘My worry (if I understand all this, which is not guaranteed!) is that the “future profits” figure appears to assume fund growth of 5.5% p.a., whereas I understand their Friday announcement as saying that the figure for last year was 2.7%’.

FSA’s Legal Adviser A provides the Head of Life Insurance with advice on whether FSA’s powers under ICA 1982 allowed them to give qualified conditional approval of a new managing director. The Legal Adviser advises that it was legally permissible for FSA to impose the condition that the appointment is limited to six months. This advice was based on the use of the sound and prudent management criteria set out in Schedule 2A of ICA 1982. The Legal Adviser says:

Paragraph 3 of Schedule 2D to the Act gives some flexibility. The position is as follows. If we are entitled to serve a notice of objection (effectively because we consider that the criteria of sound and prudent management may not be fulfilled or continue to be fulfilled in respect of the company if the appointment is made) but we consider the criteria will be fulfilled if certain conditions are complied with, we can impose conditions instead of objecting outright. Conditions can be imposed on the company or the managing director.

Before serving such a notice, we have to go through a similar procedure to that involved in serving a notice of objection. That is, we have to serve a preliminary notice and allow one month for the making of written and oral representations.

The preliminary notice will have to state the conditions we propose to impose and the criteria of sound and prudent management which we consider will not be fulfilled if we neither serve such a notice nor a notice of objection.

It is necessary, therefore, to first identify the criteria of sound and prudent management that will not be fulfilled if the appointment is made. In this case, because we consider that “a controller” ([the Managing Director]) is not fit and proper to hold the position (the second criteria). We would then have to “consider” that if a condition was imposed the criteria would be fulfilled.

The suggested condition is that the company should make the appointment only for a limited period of time. It seems to me legally permissible to form the view that a person is fit and proper to be managing director of a company, particularly one having difficulties, as an interim measure but not in the long term.

Legal Adviser A concludes by stating that his advice ‘pre-supposes that you have good grounds for considering [the Managing Director] not to be fit and proper in the first place’.

FSA’s Head of Life Insurance informs the Director of GCD and Chief Counsel A that he has told Equitable that, in considering proposals for compromising GAR rights as part of a sale, one factor on which FSA would need to be satisfied is the ‘fairness of the arrangement to relevant classes of policyholder’. The Head of Life Insurance says that Equitable had agreed to send them a note on possible mechanisms tomorrow and that he planned to send them a note on the considerations against which FSA would judge the acceptability of any such proposals. The Head of Life Insurance also notes that Equitable’s advisers would send a note regarding the Society’s constitution.

[20:41] The Director of GCD thanks the Head of Life Insurance and says that FSA should put the notes, when they received them, to Counsel.

FSA’s Managing Director A presents to the FSA Board his ‘Managing Director’s Report: Financial Supervision’. The report includes recent developments on Equitable. The report states:

Discussions continue between the Equitable and other parties interested in a variety of possible transactions. At the time of writing, the Equitable has sold only one subsidiary, Permanent Insurance Group. We are keeping in close touch with the Equitable on these discussions, and are participating in discussions with interested third parties, as almost any deal will require rather more than usual regulatory action. We are also meeting various action groups, and continue to work closely with the Equitable on handling representations from policyholders and members of the public. Dedicated units have been set up to deal with correspondence on this issue, and to prepare material for [the] Treasury Select Committee (TSC) and for the FSA’s internal enquiry.

FSA’s supervisory file contains a note prepared by Line Manager E, entitled ‘Impact of disciplinary and enforcement action’. It is not clear what prompted him to prepare this, whether it was discussed with PIA or what use FSA put it to. A copy of the note is also held on the Head of Life Insurance’s working papers. The note reads:

Following the High Court ruling and the subsequent decisions to seek a buyer for the business and then to close to new business, the prospect of any enforcement action has had the impact [of] damaging the interests of the members of the Equitable and its other non-member policyholders. The impact needs to be looked at in three ways: a fine, public censure or rectification. It is also important that the value of securing a rescue is of benefit to all policyholders of the Equitable since it could restore its investment freedom and give greater confidence over its long term security.

On the impact of imposing a fine, FSA say:

As it is a mutual, any fine imposed on the Society will impact directly on the members and other policyholders. This may well be the right outcome in normal circumstances since the same people could well benefit from the upside to any improper behaviour by the Society. However, given the difficult financial circumstances of the Equitable following the adverse ruling in the House of Lords, any financial penalty would simply erode the already thin cover that the Society has over its solvency margin and could lead it into statutory insolvency. As recent developments have shown, in realistic terms the business already has negative value in simple economic terms, and a further deterioration could destroy any “good will” value that a potential rescuer might see at this late stage and completely jeopardise the prospects of any kind of sale.

On the impact of public censure, FSA say:

A public censure would not of itself cause financial damage, but is not without difficulty. The terms of any statement would be highly material. As noted above, the current positive value of the Society is marginal and anything that would have the impact of further eroding confidence of the Equitable’s client base in the company could tip the balance and scare off the possible rescuers. A statement that had the effect of identifying shortcomings but at the same time confirmed that the issue was a past issue and that it had been rectified already, or an indication that a sale of the business and allied changes in management arrangements address the issues, could mitigate the risk of damage, but the position is extremely sensitive.

On the impact of rectifying Equitable’s mis-selling, FSA state:

Rectification raises some different issues. There can be no suggestion that we should permit a small number of policyholders to suffer disproportionately to the marginal benefit of the majority. However, it is important that proposals for review and appropriate compensation should be properly assessed. Action could have a number of impacts – the direct costs of compensation, the distraction of management from priorities and associated internal costs and the risk of reputational damage. These costs, if significant, could also have the effect of jeopardising a possible sale.

FSA write to Equitable to set out the considerations that they were taking into account in relation to the sale. FSA state:

Our basic approach is that it is for the directors of Equitable Life to decide which proposal, if any, to choose to put to policyholders. The FSA’s primary aim is to ensure that any regulatory issues arising from these proposals are exposed in good time, so they can be either resolved or taken into account before decisions are taken. We are also offering our good offices to facilitate discussions between the parties to assist the prospect of a satisfactory agreement being reached.

The letter continues:

As regards the proposals themselves, and the various bidders, we are taking the following factors into account:

• l The fairness of the proposal to Equitable policyholders in general, and to each relevant class of policyholder;
• l Financial factors, notably the impact of the proposal on the strength of the Equitable fund or any replacement to it and the wider group of which Equitable may become a part;
• l The commitment of the bidder to the deal;
• l How credible the proposal is, in terms both of how well the proposal fits the strategic objectives of the bidder, and how attractive it is likely to be to policyholders;
• l The strength of the on-going management, and its ability to carry through the proposal;
• l The regulatory standing of the bidder, at group and solo level, both in the UK and (in the case of overseas bidders) in its own jurisdiction;
• l Whether the bid is likely to produce a better outcome for the policyholders of the Equitable compared with a continuation of a stand alone fund;
• l Whether the bid might have an adverse effect on the reasonable expectations of any relevant policyholders of a bidder;
• l The fairness and thoroughness of the process by which the Equitable Board make the decision on what structure to propose to policyholders going forward.

FSA copy the letter to Equitable’s advisers for the sale and ask that they should forward copies to interested parties.

FSA’s Director of GCD responds to Legal Adviser A’s advice of 18/01/2001 [17:40], saying that it had produced ‘the right result’, but that he had three doubts about his analysis. These were:

… it looks as though conditions can be imposed where the doubt is about sound and prudent management, but not where it is about whether the individual is fit and proper.

It looks a bit odd to say that someone is fit for six months but ceased to be automatically one day later.

The … conditions look like conditions requiring action by the company – not merely the [effluxion] of time.

The Director concludes by saying that ‘we should consider (if you think it works) allowing him to remain as acting [Chief Executive], but on the basis that we do not for the time being wish to form a view on fitness to be [Chief Executive]’.

FSA’s Director of GCD asks Chief Counsel B to advise on the respective treatment of the rights of GAR and non-GAR policyholders in the event of a winding up.

[11:26] Chief Counsel A says that she would ask Legal Adviser A and another legal adviser to look at this.

FSA’s Line Manager E speaks to an OFT case officer about their work on Equitable’s use of the market value adjuster. The Line Manager records the OFT’s provisional views as being that they accepted the ‘explanation we gave them and the criteria that Equitable apply in calculating a suitable adjustment’, while not being in a position to form a view on whether the 10% level was a reasonable one. The Line Manager says ‘the “bad” news’ is that the OFT took exception to the terms of the policies which said that Equitable had absolute discretion on making such adjustments.

[16:57] The Director of GCD suggests to Line Manager E that ‘This would be understandable, if the conclusion is reached that the unfair contract terms legislation applies’. FSA show the OFT their legal advice, which suggested that the Unfair Terms in Consumer Contracts Regulations 1999 did not apply.

[17:34] Line Manager E queries whether the legal advice had said that the regulations could be said to apply if the policy terms were being used in a way that was not justifiable. The Line Manager records that he had informed the OFT of FSA’s powers to intervene under section 45 of ICA 1982, if FSA considered that the application of a market value adjuster was unfair to a group of policyholders. He notes that the OFT had found this ‘reassuring’.

FSA’s Legal Adviser A writes to Line Manager E in response to his request for advice ‘on the dispute between [Equitable’s previous Appointed Actuary] and GAD relating to the interpretation of regulation 72’. The Legal Adviser says that he could not give any definitive advice unless he received some input from GAD on the nuances of the regulations.

[18:01] Line Manager E thanks Legal Adviser A for his comments and asks GAD for ‘help with the detail … asked for’.

FSA ask GAD to consider Equitable’s proposal that they should apply for a concession ‘so enhanced value can be given to the value of Permanent [Insurance] in the 31/12/00 returns’. FSA note that the sale had been agreed in principle prior to the year-end, but would not be completed ‘until later this year’. FSA say that, therefore, ‘I thought that this could only be treated as a post balance sheet event but you may have some other ideas’.

[10:56] GAD say that they would need to see the sale agreement before they could advise on how the value of Permanent Insurance ought to be treated. GAD suggest that FSA should ask Equitable how their auditors intended to treat Permanent Insurance in their Companies Act accounts.

GAD also ask FSA if they wanted to request early submission of Equitable’s 2000 returns. GAD say: ‘Although we were given comfort about their solvency position at last week’s meeting, the wider world would presumably benefit from such disclosure sooner than 30.06.01?’.

[11:24] FSA say that they will send GAD a copy of the sale agreement.

FSA’s Head of Life Insurance writes to the Head of Consumer Education about:

… whether we could put on to the FSA website some sort of decision tree similar to that published recently in the Financial Times … I remain of the view that the difficulties and risks of the exercise outweigh any benefits. The average Equitable policyholder is fairly sophisticated and articulate, and is looking for quite specific assistance in relation to his or her policy. This is the best given by the company. As you know you have been encouraging the company to improve its own material for policyholders, and their own website now contains a lot of extremely useful material. I think we now need to concentrate on the efforts to find a [compromise] solution to take the company forward.

GAD’s Directing Actuary B advises FSA’s Head of Life Insurance and Director of Insurance:

I am concerned to see that some press reports are seemingly attempting to raise policyholder expectations about higher bonus rates this year. After a 2.7% investment return last year and equity values still close to end-2000 levels, it is very doubtful that the Equitable could afford to increase the 9% interim bonus rate applied last year, and smoothing surely implies that their figure should now be reduced.

Similarly, I believe that it is very unlikely that they have the capacity at present to make any significant reduction in the present 10% MVA.

GAD respond to FSA’s request for help of 19/01/2001, by suggesting a meeting to discuss the issue further.

[10:15] Internally, GAD suggest sending FSA’s Legal Adviser A a copy of the actuarial profession’s Guidance Note 8.

A draft letter to be sent by FSA’s Chairman to the Chancellor of the Exchequer is circulated to officials for comment.

The Director of GCD comments that a proposed statement that FSA were ‘tightening up the reserving requirements for GARs will be taken as acceptance that existing levels of reserving are too low, or defective. We must clearly tighten them up, if that is the case, but we should be wary, in the light of possible future litigation, of seeming to concede that the current approach is inadequate’.

Managing Director A agrees with the Director’s concerns, adding ‘One way to deal with this would be to talk instead about the prospective integrated source book and to say that we will before long be going out with consultation on ways of harmonising insurance and banking regulation’.

GAD write to FSA regarding possible policyholder classes for a compromise scheme. GAD note that:

… there are a number of potential sub-classes that could be identified. For example, among the GAR group, there would be those with an immediate right to retire, those with 3.5% annual bonus guarantees, and those with the right to pay future premiums. There will also be groups with different levels of GAR (ie the actual rate written into the contract), and groups with various levels of availability of GAR.

FSA’s Head of Life Insurance speaks on the telephone with Equitable’s Chief Executive. The Head of Life Insurance’s note of the call records:

… that the results of [the] weekend discussions looked promising on both fronts …

I mentioned our concern that FSA would have sufficient time to consider the bids against our own “hurdles” for acceptability, before the Equitable Board make a decision between the two on Friday. [The Chief Executive] said that, under pressure from both bidders, the Board was now hoping to reach a decision on Wednesday. I said that I thought this would be very difficult for FSA. We had already thought that the Friday deadline would be tight for the work we needed to do. [The Chief Executive] said that he would pass that consideration on to the bidders.

… Meanwhile, we are preparing a short checklist of issues which we will need to consider under the various possible scenarios (e.g. rival bids on different basis; only one bid; or no bid at all).

FSA’s Chairman notes that ‘[clearly] we have to do a thorough job. But equally we don’t want to hold things up if we can avoid it’.

FSA’s Chairman writes to the Chancellor of the Exchequer to set out what FSA were doing in response to Equitable’s closure to new business.

The Chairman says that FSA’s ‘immediate focus is on resolving the future status of the company, and attempting to create a more certain prospect for its policyholders, who continue to face great uncertainty’.

FSA’s Chairman writes:

There is no interest in the insurance industry in a collective rescue, but some individual companies have been interested in acquiring all or part of its operations. These offers would be likely to involve a restructuring of the with-profits fund, to cap the liabilities to policyholders with guaranteed annuities. So any deal in prospect would involve some cost for policyholders, both with and without guaranteed annuities. The upside might be a fund with a large company behind it in the future, and therefore able to hold a larger proportion of equities, and yield a higher return.

Since the reconstruction proposals would depend on support from different groups of policyholders, we have also been in discussions with the associations representing policyholders, who generally understand the need for concessions on all sides.

The Chairman explains that the negotiations with the prospective purchasers ‘are at a delicate stage, and there is no guarantee of success’, and he notes in parentheses that: ‘If no new purchaser is prepared to do a deal, then reconstruction of the fund will still be necessary. But without the associated benefit of strong future backing it would be more difficult to “sell” to policyholders’.

FSA’s Chairman goes on to explain the internal review of their regulation of Equitable in the period from 1 January 1999 to 8 December 2000 that FSA’s Board had commissioned (the Baird Review). He notes that such a review could not address the full history of the case, but FSA aimed to learn what lessons they could from an assessment of their actions as regulator. The Chairman continues by stating:

We had already, in fact, reached one conclusion about the prudential regulation of insurance companies which is that, by comparison with other forms of financial regulation, it has been under-resourced in the past. And part of our reconstruction of the FSA as a single regulator will involve an increase in resources for insurance supervision, within a broadly flat overall total, therefore involving some reallocation of staff from elsewhere. That has been part of our planning for the last year. But there may be other lessons, too.

The Chairman also outlines the longer term actions that FSA were to undertake, being:

• l Setting rules under the new regulatory regime to come into force at 1 December 2001, requiring companies to include more information about their with-profits contracts within their returns.
• l Conducting a review of with-profits policies, which would look particularly at the extent of discretion inherent in policies and at how to improve the transparency of policies.
• l Giving consideration to whether discussions with companies over distribution of inherited estates could be done through a more transparent process.

FSA and GAD meet Equitable’s new Appointed Actuary. The main purpose of the meeting ‘was to exchange views on the society’s current position, and in particular its reserving position’. According to FSA’s note of the meeting:

[The Appointed Actuary] was clearly nervous about his professional responsibilities, especially that of being satisfied at all times that the company was meeting its solvency requirement. He stressed that he had only been in the job seven days, and could not with hand on heart [confirm] that the solvency requirement was currently being met (although he had no reason to suppose that it was not). He also wondered whether the FSA would look to the appointed actuary in place at the year end to certify the year end returns of the Equitable, as we had often done in the past when there was a change of appointed actuary between the year end and the time that the return had to be submitted.

FSA’s note records that they had told Equitable that:

… in this particular case, given the special circumstances of the Equitable, including widespread public concerns about the financial position, we would expect the new appointed actuary to form his own opinion of the financial position, and be prepared to certify to that opinion in the returns. We would regard this as a significant element of comfort, especially as he himself was a highly respected and senior member of the profession, and would be bringing a fresh mind to the position of the Equitable Life.

FSA’s note continues:

[Equitable’s Appointed Actuary] speculated that it could turn out that the Equitable Life was clearly and comfortably solvent in Companies Act terms, but that there might be a period when it would be difficult or impossible to meet the margin of solvency required in the Insurance Companies Act. What would the FSA’s attitude be to that situation? It could be in the interest of policyholders to accept a short period when the margin of solvency was breached, if in the long run that enabled the fund to recover and produce better returns for policyholders than going into insolvency. In the case of a closed fund, the arguments for maintaining the solvency margin were weaker than the case of a fund open to new business, not least because there were no competitive issues.

FSA record that they told Equitable: ‘that we would not wish to enforce the regulations in an unhelpfully restrictive way, if there were good arguments for flexibility; but any departure from the norm would have to be [open] and transparent, and capable of being justified’.

The House of Lords’ judgment is also mentioned, and: ‘[The Appointed Actuary] repeated his well-known views that the judgement had rendered illegal practices which lay at the heart of the management of with-profits funds right across the industry. But he accepted that there was no realistic prospect of a challenge to that judgement’.

The note recorded that no detailed discussion on the sale had taken place ‘as the position was so fluid’. However:

… we discussed possible ways of reaching an accommodation with the GAR and non-GAR policyholders. [The Appointed Actuary] shared my hope that the classes of policyholder who would need to vote separately on any proposal could be restricted to two (GAR and non-GAR); although it would be very easy to identify a number of categories, it was not clear that their interests were so special that they should be given a vote of their own; and the greater the number of policyholder classes, the less likely that any proposal would secure the necessary agreement.

FSA’s note continues that:

In the context of the Treasury Select Committee enquiry, [the Appointed Actuary] was surprised that the Equitable’s position had aroused public consternation. He contrasted this with the actual failure of a large number of other financial institutions which had not aroused the same public dismay; yet the Equitable was still solvent. I said that we had made that point ourselves, but it would not be an easy one to put across in the current climate.

FSA’s note concludes by recording that:

[Equitable’s Appointed Actuary] said that he had got the impression that we had had some difficulties and disagreements with his new colleagues. We said that the Equitable had a reputation in the market place as a company which was confident of the rightness of its position, and that we have found the same in our dealings. But our current relationship was very open and co-operative. [His] own comment was that the company had tended to rely on [home] grown talent for much longer than other life offices; and that the effects of this were still apparent.

FSA receive Counsel’s Opinion on Article 4 of Equitable’s Articles of Association and on the potential impact of the Unfair Terms in Consumer Contracts Regulations 1994 and 1999 on related issues. In relation to the Regulations, the Opinion states that:

On any basis the impact of the Regulations on The Equitable Life’s policies would be limited. These and the predecessor 1994 Regulations would only have potential effect on policies issued after 1st July 1995. This is likely to represent a modest proportion of the total number of policies issued by the Equitable Life.

The Opinion then goes on to offer some ‘tentative’ conclusions. First, it is suggested that, on balance, Equitable’s members and those holding investments who were not members ‘would qualify as consumers’. Secondly:

Taking a broad view of the matter, we would have thought that there was a plainly arguable case for saying that [Article 4] was “unfair”, in that its operation and effect could indeed cause a “significant imbalance in the parties’ rights and obligations … to the detriment of the [policyholder]”.

… it would be open to a policyholder to seek a declaration from the Court to this effect or to deploy the Regulations against The Equitable Life if and to the extent that the company sought to deny liability to the policyholder …

FSA’s Line Supervisor C submits a paper to FSA’s Insurance Supervisory Committee, recommending that they should support Equitable’s application for a section 68 Order on the admissibility limits of certain shares for the year-end 2000. (See 12/01/2001 [entry 2].)

The paper states that the request for the Order followed the guidance that had been issued by the Committee. (See 18/12/2000 [14:30].)

PIA ask FSA for updated figures on Equitable’s new business following the House of Lords’ judgment.

[12:01] Line Manager E asks Line Supervisor C whether this had been covered in the information received ‘the other day’, which they had been ‘told not to disclose’.

An FSA legal adviser writes to Chief Counsel A about the powers of a liquidator to compromise claims. The legal adviser says:

The answer is yes. The power to compromise claims is expressed in very wide terms in Schedule 4 of the Insolvency Act 1986.

… This power is exercised with the sanction of an extraordinary resolution of the company in the case of members voluntary winding up, the sanction of the liquidation committee in the case of creditors’ voluntary winding up and the sanction of the liquidation committee or the court in the case of a compulsory winding up.

Section 55(1) of the Insurance Companies Act 1982 provides that long term insurance companies cannot be voluntarily wound up. Section 366 of [FSMA 2000] will allow such companies to be voluntarily wound up with the consent of FSA.

GAD provide FSA with their comments on Equitable’s paper ‘Buying out GAR options’ (see 19/01/2001 [13:39]). GAD say that they support the objectives of the proposal, although the relative emphasis given to each objective needed fine-tuning. GAD note that ‘the GAR/non-GAR issue is rather more fundamental than the term “incidental” might suggest’.

GAD note that, while ‘Equitable would like to restrict the number of policyholder classes to 2’, there were at least 11 different ways of distinguishing between groups of policyholder. However:

There would seem to be three underlying categories:

1. Those with-profit policyholders who potentially benefit at the expense of others (e.g. the GAR policies);

2. Those with-profits policyholders who provide such benefit (e.g. the non-GAR with-profit policies);

3. Those who neither provide nor receive benefit (e.g. non-profit policyholders), but who ultimately benefit from a stronger solvency position.

GAD continue:

Those in (or potentially in) category 1 are the GAR policyholders, those non-GAR policyholders with a minimum 3.5% bonus rate, and those with-profit policyholders who can terminate without penalty, either now or at some future date.

In category 2 we have the with-profit policyholders without a minimum bonus rate and who can only leave subject to an MVA, and with-profit annuities in payment. Income drawdown may also be in this category, but the policy wording would need to be examined to understand the extent to which any MVA might be applied.

In category 3 we have all the non-profit (including non-profit annuities in payment) and unit-linked policyholders.

GAD continue:

However, the fundamental issue at stake, following the House of Lords judgement, is how to distribute the available funds between GAR and non-GAR policyholders such that both groups are satisfied that their share of the “cake” is in accordance with their expectations. Whilst, for example, some cross subsidy may arise separately between policyholders with a minimum roll-up of 3.5% and those without such a guarantee (indeed, investment returns during 2000, when the with-profits fund secured a growth of, we understand, about 2%, were such that cross subsidy may well have arisen over that year), there is no evidence of any dissatisfaction between these two “classes” of policyholders. However, [Equitable’s solicitors’] note (§2.8) comments that “it may be that policyholders benefiting from a 3½% p.a. investment return guarantee would also need to be treated as a separate class”.

[Equitable’s solicitors] also say (§2.9) that “it is in theory possible … that policyholders with both GAR and non-GAR policies should be placed in a separate class” because of the impossibility of knowing that they might vote otherwise.

GAD state that:

[The] distinction between those retired and those who have not yet retired could be reflected rather better in the terms of the “deal”; to seek to divide these into groups (according to duration to retirement, presumably), would involve some inevitably arbitrary divisions. However, so far as we can tell, there is no “tapering” of the proposed deal, and we think this is unsatisfactory. For example, if the GAR is currently worth 30% more than CAR, and the proposal were to give policyholders a 20% uplift, this does not look equitable to the policyholder 1 year away from retirement, but it may be quite acceptable to a policyholder 15 years away from retirement.

[Also, we] believe that non-profit policyholders are in separate category. As noted above, they would ultimately benefit from a stronger solvency position (and certainty of outcome). [Equitable’s solicitors] do not appear to comment on these, but it seems to us that they constitute a separate “policyholder class”.

GAD conclude that:

We therefore appear to have potentially 5 (or more) policyholder classes. This is unfortunate, since the higher the number, the more likely it is that one of the classes will not vote in favour. These five are:

• l GAR policyholders;
• l Non-GAR with-profit pension policyholders;
• l With-profit life policyholders;
• l Policyholders with policies that fall into more than one class;
• l Non-profit (including unit-linked) policyholders.

… it is for the lawyers to decide on the appropriate number of classes.

FSA and GAD meet Equitable’s Chief Executive and advisers to discuss the latest position on potential bids for Equitable’s business. Counsel for FSA is also present. FSA’s note of the meeting records the current position of all bidders.

Equitable report that Prospective Bidder E had decided to withdraw from the process, but would not make this public knowledge yet. Equitable say that they had had concerns about the implications of the time it would take to transfer the business and had been advised that it would take longer than anticipated. Equitable say that, given that Prospective Bidder D were the only company left, they would continue exclusive negotiations with them for two weeks and attempt to improve on any offer.

FSA’s note records: ‘The latest proposal was disappointing and the chances of securing improve-ments would be better if [Prospective Bidder D] did not know they were the only party left’.

The details of the proposals are discussed. FSA’s Managing Director A expresses concern about the scale of the effective reduction in policy values envisaged by Prospective Bidder D’s requirement that Equitable should establish an estate of £1bn and about the proposed increase in the level of the market value adjuster, pending adoption of a scheme of arrangement between GAR and non-GAR policyholders.

FSA’s Director of Insurance states that it was important to consider realistic alternatives to a deal: ‘For example, thought would need to be given to whether or not a section 425 scheme was likely to be achievable under a bid or closed fund option. The analysis would also need to compare the possible outcomes compared with a winding up of the Society’.

In an ‘aide memoire’ sent by the Director of GCD to Managing Director A in advance of the meeting, the Director notes, among other matters, that ‘the proposal to increase the mva to avoid adverse selection in light of reduction in policy values arising from the offer’ was a ‘critical issue for us, given our commitment to keep this under review and the OFT angle’.

He notes further that all this ‘suggests the deal [is] not [very good] for policyholders’.

FSA’s Head of Life Insurance talks with Prospective Bidder E about the background to their decision to withdraw. Prospective Bidder E says that there had been a combination of factors that had led to their decision, including:

Fund Strength

[Prospective Bidder E] had been keen to achieve an outcome which produced a fund which was both robust and seen to be robust; they attached importance to the realistic possibility of the fund reopening in due course, in a way which would engender policyholder confidence. In this context, he claimed that [Prospective Bidder E] thought this would be difficult to explain convincingly to policyholders, not least because of the impact on the Equitable of the new valuation regulations in respect of unitised with-profits business (these require companies to take more account in their reserving of terminal bonuses, which are not guaranteed). He said that this provision would be particularly hard on the Equitable, because of the unusually explicit reference in their sales material to the use of MVAs.

Other factors noted by FSA were:

… the difficulty of selling any proposal to policyholders, in a way which would reduce the risk of challenge to acceptable proportions. These problems of timing also affected the value of the salesforce, which was a wasting asset.

… a number of issues surrounding the salesforce. Equitable were keen for the salesforce to be able quickly to start selling with-profits policies again; but [Prospective Bidder E] had doubts about this. There were also concerns about problems arising from Equitable’s past sales practices (though no suggestion that these were worse than other companies’); and about the ability to retain the salesforce – they had received a large retention payment already, and had been led to expect large redundancy payments; these factors made it less likely that they would stay on in the longer term.

Prospective Bidder E write to FSA to formally notify FSA of their decision to withdraw from negotiations on the purchase of part of Equitable.

Prospective Bidder E explains: ‘Our decision to withdraw arose not from a single factor but from a combination of emerging concerns over the last few days – particularly on our ability to re-open, successfully, the Equitable Life With Profit Fund (given the required visibility of MVA and associated issues in the light of Equitable Life’s reserving position) and the prospect of the transfer process becoming substantially more complex than we or our lawyers had initially anticipated (with the potential for the process to fail or, at least, the likelihood of there being lengthy delays in implementation)’.

On 26 January 2001, FSA’s Director of Insurance comments:

As expected. A bit thin – they could have reached this decision much more quickly – but we always doubted their commitment.

FSA’s Director of GCD sends the Head of Life Insurance a note of actions that FSA had agreed to take after the meeting with Equitable that morning, which reads:

You will prepare a letter to go to Equitable pretty rapidly asking them for more detail about the deal for policyholders. This is partly to ensure that their own Board has a proper understanding of what this might mean for policyholders, partly to enable us to give our assessment of it from this viewpoint; and partly to put them in a position where they can answer questions regarding this if and when this deal is agreed and announced. This material should compare the deal that is being offered to different classes of policyholders with what they would get without the deal, whether on winding up or otherwise.

This is against the background of advice from [Counsel] that a schedule 2 scheme could not credibly be used to modify the rights of the GAR holders, and that a section 425 scheme would be long and difficult. Policyholders need to be put in a position where they can see an attractive outcome from the start if such a process is to have a chance of success. This meshes in with [FSA’s Managing Director A’s] concern that the action groups should be in a position where they can support the process.

We also noted that part of the possible counter factual might be intervention action by FSA, depending on the financial situation, the safeguards for policyholders expectations, and what intervention could achieve. We should consider this in its own right as well as a counter factual to section 425 scheme.

It concludes by stating:

[Legal Adviser C] is asked to advise rapidly on whether OFT’s view that the width of the discretion is inconsistent with UCTA could call into question the validity of a reasonable MVA imposed under that discretion.

FSA’s Line Manager E seeks advice from GAD’s Scrutinising Actuary F. The Line Manager says:

[Chief Counsel A] just raised with me a question about the reinsurance treaty. Counsel has spotted that there is a provision that terminates the contract on insolvency. (I should point out here that we are not sure whether he was looking at the current treaty.) I know you are familiar with it and so wondered if you could confirm the position.

As I understood it, the treaty simply provides cover for excessive take up of the GARs and so reduces the overall reserving requirements. If there were an insolvency, those people saving under pension plans including the GAR option would not be able to exercise their right to the guarantee – rather they would receive their share of the fund which they would have to switch to another provider with whom they had started a new pension scheme.

If that is right, there would be no basis for a claim under the treaty in the event of actual insolvency in any event, so its automatic termination would not seem to be an issue.

But do you know if the provision features in the existing reinsurance agreement and whether or not “insolvency” in this context means insolvency in the Companies Act sense or in the sense of failing to cover the ICA requirements?

[11:55] Chief Counsel A clarifies to Line Manager E and GAD that: ‘I do not think Counsel was talking about the reinsurance covering GAR take-up, but rather the contract which was replaced after the [House of Lords’] judgment. I would be grateful if GAD would check to see if present contracts can be voided on insolvency and, if any of them can, that does not matter’.

FSA seek comments internally and externally from PIA and GAD on a draft letter to the OFT about Equitable’s use of a market value adjuster. FSA explain:

OFT’s position is that [they] accept our arguments that the mva is necessary for prudential reasons, and given that its effect is to achieve fairness, it is not by definition unfair, in practice. However, they are unhappy about the absolute discretion reserved to the society to decide what if anything should be paid on surrender and are thinking of asking Equitable to change the wording so that it will clarify the circumstances in which adjustments would be made and the criteria that are used in calculating the adjustment.

At the end of the day, we share the same underlying thought – the mva is necessary, but it should be used fairly. Where we differ is that OFT want to use their powers (which we are not clear they have in this context) to modify the terms of the contract. I think (and hope [others] will agree) that we need to be careful that we do not inadvertently prevent the mva being applied in circumstances where it is necessary, just because it is not spelt out in any modified terms. That points to us relying on our general intervention powers under the ICA 1982.

FSA’s Line Manager E suggests sending the draft letter to the OFT, pointing out the common ground between them, and suggests that they meet to ‘explore the best method for achieving our common objective’.

[14:41] GAD’s Directing Actuary B notes the need ‘to be careful that any imposed surrender value term takes reasonable account of the interests of both departing and continuing policyholders’ and suggests: ‘As a possible way forward for further debate, this term might be phrased for example as being the latest “policy value” less an adjustment for any element of unrealised profits within that “policy value”. These unrealised profits would include both profits not fully earned at the last balance sheet date (and the Society could be asked to disclose the relevant proportion publicly) together with any investment or other losses (relative to any interim bonus rate applied) sustained since then (which again could be disclosed at regular intervals)’.

[15:31] FSA’s Director of Insurance says that he is ‘a little nervous’ about leading the OFT to the conclusion that the Unfair Terms in Consumer Contracts Regulations 1999 did not apply.

[19:15] PIA reply to FSA, saying that they agreed with earlier comments, and that:

More generally I do think it looks like (though I’m sure this isn’t actually the case) we are taking [Equitable’s] interpretation/advice pretty much without question and then drawing conclusions from it, which might be dangerous to this particular audience?

My other issue though is that the interpretation itself looks … not to be entirely consistent with that given to us recently by leading counsel in relation to mortgage endowments. [Counsel] has told us that in providing compensation for contractual “product flaws” breaches, we should be looking to firms to compensate people who have surrendered policies (even though the contractual promise is likely only to relate to maturity value), as policies should behave during their life in a way consistent with the eventual outcome, in terms of the relationship between costs and investment returns. That doesn’t seem to me to support the pretty wide management discretion view expressed in the draft OFT letter.

PIA ask that FSA’s General Counsel’s Division consider whether their concern was misplaced. (See 26/02/2001 [11:37])

FSA write to Equitable, following their meeting the previous day. FSA say that they had no major issues regarding the Society’s update on the negotiations for the sale. FSA say that the discussions had highlighted the importance of presenting as clear a picture as possible of the sale proposals and how any accommodation of annuity rate guarantees would work. FSA say that policyholders also needed to know that any accommodation would most likely require a scheme under section 425 of the Companies Act 1985 and that any such scheme ‘stands the best chance of success if the scope and implications … can be explained in broad terms to policyholders at the time the deal is announced’. Given this, FSA ask Equitable to provide more detail as to how they would handle the issue, the key questions being: ‘what classes of policyholders need to be separately identified for the purposes of voting under a Section 425 scheme[?]; and in what terms will the proposition be put to each separate class of policyholder – in other words, what is the selling point?’.

FSA suggest that the minimum number of policyholder classes was two (GAR and non-GAR) and that the scheme was a ‘“graded” proposal which addresses the main differences of interest between policyholders within any one class’. FSA explain:

The FSA will need to assess any “deal” that might be offered to different classes of policyholder taking into account what they would get absent a “deal”, whether on a winding up or otherwise. We should be grateful if, as your discussions with third parties proceed, you could keep us abreast of how the Equitable itself is assessing these alternatives.

This information will assist us in carrying out our responsibility to consider, for example, whether we should object to any proposal which may be put forward (you will recall that an important criterion for us in this regard is the fairness of any deal to relevant groups of policy holder). An important aspect of this is whether we are satisfied that the Equitable Board has itself addressed the issues in a proper and thorough way before reaching its own decision.

FSA’s Line Manager E circulates a further update, summarising the data received from Equitable, as at 23 January 2001, on the levels of surrenders and transfers and on the number of customer enquiries handled. The Line Manager says that the information showed that the situation seemed to have ‘stabilised considerably’.

The Line Manager also explains that FSA’s correspondence unit were receiving around 10-15 enquiries a day from members of the public (down from around 30 a day) and around 15 enquiries a week from Members of Parliament. The Line Manager says that these were normally being responded to within 48 hours of receipt by the correspondence unit, although FSA had discovered that there was a delay of about a week from when letters arrived in the building to when they reached the unit.

FSA’s Chief Counsel B provides comments on FSA’s proposed letter to the OFT, in response to PIA’s request of 25/02/2001 [19:15], including:

… the legal view which we have taken is one which has proceeded from our examination of the policy documents and the Regulations themselves.

It is important to be clear that we have not advised that the Equitable has a complete unfettered discretion to apply whatever MVA it chooses. What we have said is that a Court approaching the policy terms which allow it to apply the MVA would be likely to construe those terms as involving an implied term that it should exercise the MVA on a reasonable basis.

As [Line Manager E] has pointed out, the FSA does have powers under ICA 1982 to intervene should it appear that the Equitable is exercising its powers in an unreasonable way.

Turning to your reference to the work on endowment mortgages, I am unsure about the point you are seeking to make. The fact that someone who surrenders a policy might be entitled to some form of compensation as a result of losses attributable to the original misselling of policy does not it seems to me impact on whether the existence of the MVA clause in the policy is unfair for the purposes of the Regulations. The MVA is a factor which determines how much is paid to the policyholder on surrender.

FSA’s Director of GCD provides comments on the draft letter to Equitable of 25/01/2001, after the final version is sent. The Director of GCD suggests that it would be useful to formally confirm the Director of Insurance’s summing up of FSA’s position at the end of the meeting on 24/01/2001, that being:

l the Board must compare this offer with realistic alternatives;

l it will be necessary for them to be completely transparent about the genuine value of the offer to policyholders: we could not lend our support to anything which misleads them;

l it is highly desirable to segment the section 425 scheme aspects, so that the position can be no worse with them than without them;

l if it is possible to produce an overall package, this might be better than the section 425 scheme on its own, but the section 425 scheme on its own would constitute a benchmark against which an offer would need to be judged;

l it would be difficult for us to be able to conclude that the offer is reasonable and fair to policyholders if it involves the sort of reduction in policy values described in the paper, or the proposed uplift in the MVA.

[13:31] The Head of Life Insurance says that the letter had already been sent and that he had understood that the Director of GCD did not have any comments on the draft.

[13:44] FSA’s Director of Insurance believes that the last point ‘overstates’ FSA’s position and that FSA would need to look very carefully at any proposals that included reductions in policy values or increases to the level of the market value adjuster ‘of the scale envisaged’.

FSA’s Director of GCD queries GAD’s Directing Actuary B’s comments about the meeting with Prospective Bidder E (see 25/01/2001 [11:06]), saying that it was less likely to be the OFT’s role that was the cause, but Prospective Bidder E’s assessment of the impact that the new regulations would have.

[13:58] Directing Actuary B clarifies that:

The new regulations do not refer to terminal bonus (though it is generally recognised within the actuarial profession that they have the effect of requiring a partial provision for possible terminal bonus).

However, the amended regulations do require that insurers should establish adequate provisions to cover the lower of the amount of cash payment that would reasonably be expected on surrender, and the amount of cash payment that would be expected disregarding all discretionary adjustments.

I suppose that there could be some ambiguity in the latter phrase, but we understand that Equitable would interpret this to mean the amount of the contractual liability (on death or maturity), excluding therefore the potential final bonus (which is discretionary). If this interpretation were incorrect and instead the potential final bonus does have to be included, then they would indeed have a major reserving problem at the end of last year.

[A similar point could arise for other insurers though they would be able to say that they had not disclosed the level of potential terminal bonus to policyholders and therefore that any terminal bonus addition must clearly be a discretionary adjustment. Equitable have tried to be more open by showing the potential amount of this bonus in their annual bonus notices].

The Directing Actuary concludes:

Even if Equitable are right in their interpretation, there would also be an increased reserving requirement if the OFT concluded that they had no discretion on surrenders, and had then to pay out 10% more on surrenders than is being paid at present.

GAD provide the following advice to FSA in response to their request of 25/01/2001 [11:42]:

We confirm that the reinsurance treaty includes a provision that terminates the contract on insolvency. This is provided by Article X.2 which states that:

“Each party is entitled to terminate the treaty without giving prior notice if …

2. The other party becomes insolvent or goes into liquidation or a Receiver/Administrator is appointed or has its licence to conduct insurance business revoked as defined in Section 13 of the Insurance Companies Act 1982”.

The treaty goes on to say that “In the event of cancellation under part 2 … of this clause the portfolio at the date of termination will be withdrawn and the Reinsured shall refund to the Reinsurer at the same point in time any Reinsurance Claims Amount and any outstanding cash balance in full, subject to the requirement that in the event of cancellation under part 2 of this clause such refund will be subordinate to the Reinsured’s liabilities in liquidation towards its policyholders under the terms of its long term policies. However, the Reinsurer will retain the right of offset against future Recovery Amounts due.”

The above extracts are as per the original treaty. They were not amended in any of the subsequent Addenda.

We suggest that the lawyers answer the part of your question as to what “type” of insolvency this is.

We would just add that it is not unusual for a financial reinsurance treaty to terminate on insolvency.

FSA’s Head of Life Insurance provides Managing Director A with a paper on the options for FSA on whether or not to give their formal approval to Equitable’s proposed Managing Director. The Head of Life Insurance sets out his view that FSA had three broad options, namely:

1. Seek to arrange that he remains as acting [Managing Director], without the need for us to either approve or object at this stage. To achieve this, we would need to persuade the company voluntarily to withdraw the notice of proposed appointment. Normally we would not wish to do this, as leaving someone as an acting [Managing Director] without submitting a notification can be used by a company as a device to put in place de facto someone whom they suspect we would not approve. But in the special circumstances of this case, it could be justifiable on an interim basis.

2. We could approve the appointment, subject to the condition that the appointment was for a limited time (say 6 months) after which a fresh application would have to be made to us. The Insurance Companies Act provides a mechanism by which this could be done; but we would still need to issue a provisional notice, and we would still need to state the grounds on which we would object, if the conditions were not met. This would boil down to stating that we did not find him a fit and proper person, or that the criteria of sound and prudent management would not be met. This is a high test, and we would have to think very carefully indeed whether we judged it to be met.

3. We could approve the appointment (or simply let the time limit lapse without objection, which would have the same practical effect). Under this option, we would have to accept that in formal terms the appointment was open-ended. But we could nevertheless speak to the Chairman on an informal basis, to say that we saw merit in the appointment being made for a limited period in the first instance, until the situation clarified; and that we would expect to see the Managing Director supported by a particularly strong and independent Board, given his close involvement in the problems of the past.

FSA’s Head of Life Insurance continues:

You may wish to discuss the options further. My view is that the second option would be difficult to justify. The other two options both involve informal persuasion rather than formal use of powers. One disadvantage of the first is that failure to confirm the appointment would eventually become public knowledge, and this could raise fresh public doubts about the soundness of the company. I therefore come down in favour of the third option. Although we take some risk in giving an approval which in formal terms is unconditional, in practice the risk is limited. The company is now in run-off, so that the job of Managing Director is less significant than in the case of a going concern; and if a bid is successful, the new owner of the business will have a major say in the composition of the Equitable’s Board, and indeed the identity of the [Managing Director].

FSA’s Insurance Division’s Policy Department prepare a paper (which is copied to Equitable’s supervisory team) on how current banking regulation and supervision would have dealt with exposures such as Equitable’s GAR issue. The paper includes the following description of how Equitable’s policies work:

Equitable Life issued individual with profits annuity policies with Guaranteed Annuity Rates (“GARs”). (Annuity = pension). The GARs are applied to the pot of money in the policy at the selected retirement age to calculate the pension payable.

These policies also included an option whereby at the selected retirement age, rather than taking an annuity with [Equitable] using the GARs, policyholders could either take an annuity with [Equitable] but without the GAR ie at current annuity rates, or take the fund they had built up with [Equitable] to the market and a different provider the open market option. In practice this is likely to happen (not exercising the GAR) if the market is offering better annuity rates than the GAR written into the GAR policies. Or perhaps if the policyholder wanted to structure their annuity in a way not allowed under the GAR policies eg to include a spouse’s pension. The policyholder makes this decision once at the point of retirement.

PIA produce a paper on a project to review the conduct of Equitable from the Court of Appeal’s decision of 21/01/2000 to the Society’s closure to new business on 08/12/2000. The paper is distributed to FSA. PIA explain:

Throughout the period 21st January to 8th December 2000 the risk profile of the with profits fund was potentially different to that which applied before the [Court of Appeal’s] decision against Equitable. It potentially changed after the [Court of Appeal’s] ruling and again after the [House of Lords’] decision. The project needs to:

1) Analyse whether appropriate disclosure and/or appropriate advice was given to investors by Equitable to fulfil its regulatory obligations under PIA and Adopted Lautro Rules…

In the light of this analysis establish whether Equitable’s post [Court of Appeal] and/or post [House of Lords] with profits investors have been disadvantaged and, if so, what action should be taken if problems are widespread. For example, should a wide scale review be required and redress be paid or would an approach more focused on individual clients be more appropriate?

If a review is required we will establish which groups of clients are affected and what further action needs to be taken.

2) Establish and assess the basis of Equitable’s adjudication of complaints from investors advised into the with profits fund post [Court of Appeal] and/or post [House of Lords’] ruling [this element will extend to the period post closure to new business].

Under the section ‘How will this work be done?’, PIA list the questions they would be asking in order to assess Equitable’s actions, which were as follows:

3) How did Equitable assess its regulatory obligations post [Court of Appeal] judgement? …

4) How did Equitable assess its regulatory obligations post [House of Lords’] decision? …

5) What it did to alter its marketing and advice positions in response to these obligations.

6) Were Equitable’s actions in compliance with their regulatory obligations in its marketing and advice to new with profits fund clients? How many clients were affected?

7) How are Equitable dealing with complaints from clients who say they should have been told of the risks inherent in the potential future for the with profits fund.

8) Should Equitable be undertaking a full or focused review of their sales of with profits business? If so, over what period?

9) Have any clients entered into the with profits fund post closure to new business?

FSA’s Director of GCD sends Managing Director A a copy of GAD’s paper ‘Reserving and related issues’ (see 19/12/2000 [17:43]). The Director of GCD says:

You should see this, if you have not seen it before. It suggests that the basis for taking the view that the Society is in compliance with solvency requirements is tenuous, and depends on various forms of special treatment agreed for the Society.

Halifax’s Chief Executive writes to FSA’s Head of Life Insurance. The Chief Executive says:

You will no doubt recall the very helpful discussions I had with you and your colleagues earlier in the month. A number of your observations were then and still are today, material to the judgement we have had to make on this difficult transaction. Subsequently, on behalf of the FSA, [an FSA official] confirmed that you were comfortable with the way in which we had represented your position in an internal report.

I’d like to give you the opportunity today of reviewing again the relevant parts of the paper (copy attached).

In section 13 of the same paper we refer also to our need for a waiver of the marketing group rules so as to enable us to operate the [Halifax Equitable] and [Halifax] field forces alongside each other but with separate product portfolios. We would only require the waiver for a matter of months but without it we will be unable to put [Equitable’s] field force back into action for months. It is therefore a matter of significant commercial importance and I would like your guidance on the FSA’s position on this point.

Finally, I would ideally like some “off the record” feedback on [Equitable’s] compliance performance and standing. We know from our due diligence that [the Society] is currently reviewing its advice in relation to a substantial number of income drawdown cases. If this is, in the FSA’s opinion, likely to result in a public reprimand it is an issue that would, at the very least, need to be taken very fully in account in our final judgement today.

The relevant sections of the internal Halifax document are:

10. THE FSA

The FSA’s attitude to any proposals we may make is of crucial importance. A preliminary, and necessarily high level discussion on the basis of the proposition outlined in this paper revealed that:–

l in principle (and subject to the detail) they would be likely to approve of the structure;

l should they approve any final proposal they would give public endorsement on announcement;

l they are prepared to commit unambiguously (again publicly) to the fact that in no circumstances will they regard [Halifax] as standing behind the ultimate fortunes of the closed fund;

l they are committed to move with pace, resource and considerable flexibility to help put in place the detail of any proposals that may be agreed (as between all three parties).

In practice we could not pursue any proposition that did not get this sort of response from the FSA;

and:

Resolution of the GAR/non GAR uncertainty will be seen by most audiences to have substantially resolved [Equitable’s] financial problem. Therefore, should the FSA respond to any short term technical insolvency by insisting on draconian action (for example, passing reversionary bonuses) this would bring the closed fund’s financial position back into very sharp focus and damage both our reputation and any equity inherent in the acquisition. We cannot expect the FSA to stand back in all market circumstances (for example a 50% bear market in equities which materially impacted the whole with profits industry). However, we are optimistic that in most circumstances the closed fund would be allowed to pursue a planned recovery over a number of years. Although it would be for the Board of [Equitable] to oversee this process and they might well take a quite different approach.

… the feasibility of transferring our existing bancassurance business on to [Equitable’s] operating infrastructure … we need to review [Equitable’s] administration and systems capability, the timetable for any transfer, and its organisational and financial implications. Almost certainly we will need more help from the FSA as we will need a waiver to operate two product sets and marketing groups under [Halifax Equitable] and [Halifax]; for a period of up to a year.

On 1 February 2001, the Head of Life Insurance passes the papers to Line Manager E, saying: ‘Papers faxed to me at home last weekend + dealt with in subsequent discussion + correspondence’.

FSA’s Director of GCD advises Managing Director A on the legal considerations relevant to a decision on whether or not FSA should require Equitable to call an emergency general meeting or to consult policyholders in some other way. The Director of GCD says that FSA’s relevant power was section 45 of ICA 1982, which ‘is exercisable if the action required appears to be appropriate for the purpose of ensuring that the criteria of sound and prudent management are fulfilled’. The Director of GCD advises:

A company is not to be regarded as conducting its business in a sound and prudent manner if it fails to conduct its business with due regard to the interests of policyholders and potential policyholders.

The Director continues:

So to require consultation we would need to consider that without it the company would be failing to conduct its business with due regard to the interests of policyholders.

The test allows us to form our own view about what is needed to have due regard to the interests of policyholders. We are not in my view limited to considering whether as a matter of process the company has considered the issue + reached a view on it. But to exercise the power we must conclude that the company is acting without due regard to those interests.

In determining whether a company is having due regard to the interests of policyholders, we are entitled to look at the full range of policyholder interests, including both their interest in being consulted + their interest in getting the best deal. The company must pay due regard to the interests of all policyholders, not merely those of a particular group.

The Director of GCD then asks:

Can we conclude that the company is not having due regard to the interests of policyholders if it goes ahead without consultation?

In favour of consulting would be the possibility that the deal is not the best course for all classes of [policyholders]: though there are no other deals around, some may prefer to see the company liquidated: this would allow the GAR policyholders their rights, and probably stop these being increased by further top ups.

This consideration might be less significant if the deal did not prejudice liquidation, or meant a clear net increase in value over that which would be likely to be obtained on a liquidation. This evaluation would need to take into account both the wasting asset of the sales force and the risk of increased liabilities through the top ups.

The Director continues:

We should also bear in mind that consultation is the course favoured by the only director we expect to stay with the company long term.

In favour of the company going ahead with the deal without consultation would be any real reason to believe the deal would not be maintained for the time it would take to consult: this has been suggested so far but not explained. The bidder will presumably have given an indication of its approach and [Equitable’s advisers] should have advised on the prospects in practice.

Consulting may not be as big a risk for the bidder as going ahead without policyholder support, if the value lies in the possibility of repeat business from customers with goodwill. It may be possible to keep the salesforce in position during the consultation phase if they are given the right incentives.

It would be extremely unattractive if any reluctance to consult were based on a view that the policyholders, properly advised, would not agree to the deal. (The need for an increased mva to prevent adverse policyholder selection suggests something of the kind for the s 425 scheme, though not as I understand it for the deal as a whole.) If this were the case it would be a strong reason to require consultation, since it would show disregard of their wishes if not their interests.

10% of policyholders can requisition an [extraordinary general meeting]. If policyholders know all relevant facts this provides an alternative to action by FSA, but would still allow us to take action if it was needed sooner, and we believed their interests were not being paid due regard.

The Director of GCD concludes that:

Possible next steps would be:

• l bring forward analysis of effect of liquidation;
• l ask the [company] for its analysis of policyholders interests;
• l ask to see what the bidder has said and the advice [Equitable’s advisers for the sale] have given;
• l consider whether the action groups should be consulted + if so who by + on what terms.

FSA’s Managing Director A calls for a meeting that morning (at 10:00) to discuss the ‘key issues with the last bidder’. The issues being:

• l enforcement;
• l extraordinary general meeting;
• l whether FSA would be able to support the GAR/non-GAR deal;
• l details of the draft contract;
• l number of classes of policyholder;
• l situation with Prospective Bidder D; and
• l press handling.

The Managing Director distributes a draft letter to be sent to Equitable that he has prepared, which states FSA’s view on whether Equitable had to put the bid to policyholders before the deal was agreed.

Managing Director A also distributes Halifax’s draft bid, which had been received by FSA on 28 January 2001.

FSA’s Director of GCD sends Managing Director A a note summarising advice on whether FSA had the power to require Equitable to consult their policyholders before accepting a bid.

On a copy of this note, the Director of GCD has written: ‘Advised at meeting 29.1 that: entitled to form own view about whether due regard being paid – not merely [company] has considered’.

FSA’s Managing Director A informs the head of Press Office that he had just spoken to Equitable’s Chief Executive, who had said that they were going to keep ‘a low profile’ regarding the withdrawal of Prospective Bidder D from possible purchase negotiations.

The Managing Director also says to FSA’s Chairman and the Director of GCD that: ‘I told him a letter would be on the way from us; it isn’t as urgent as he was thinking yesterday so if it can’t go today it isn’t the end of the world’. (Note: this appears to be regarding the draft letter distributed by the Managing Director earlier that day.)

FSA’s Line Manager E receives details of the amount of correspondence about Equitable that FSA had received since the Society’s closure to new business. The figures supplied show:

Letters Received Completed

Public/Interested Parties 253 150

MPs (House of Commons) 32 11

MPs (Treasury) 1 1

Total 286 162

Emails 180 130

FSA’s Managing Director A informs the Chairman (copied to other senior officials) that he had received a telephone call from an Equitable Director about progress on finding a President.

Managing Director A also records that: ‘we discussed the need for an [emergency general meeting]. [The Equitable Director] has backed off a bit. If the legal advice is unquestionably that they have powers and if it really would be a deal breaker then he is prepared to back down and go ahead without calling an [emergency general meeting]. I outlined the kind of letter we were likely to be able to send to [Equitable] and he said that would be very helpful’.

In response to FSA’s Head of Life Insurance’s paper of 26/01/2001 on approval of Equitable’s managing director, FSA’s Chairman says that FSA should avoid responding until they knew that a deal with a purchaser would be done. The Chairman says that Equitable’s Chief Executive was unlikely to be a positive factor in any GAR/non-GAR accommodation and ‘I cannot see why he should win a prize for having been so comprehensively wrong’.

[19:56] Managing Director A agrees that FSA should aim to see the Chief Executive depart but says that there needed to be ‘due process to an objection’. The Managing Director says that he would prefer FSA to encourage Equitable to put the application on hold, pending further information.

FSA meet Halifax (at Halifax’s request). FSA’s note records that they had discussed three possible stumbling blocks to a deal taking place:

Not waiting for an EGM. [Halifax’s Chief Executive] stressed that he couldn’t take the risk of waiting. [FSA’s Chairman] confirmed that we think the Equitable Board does have the power to take this decision itself provided that they satisfy themselves that it is in the best interests of policyholders. He added that we have the power to insist on a meeting but would not exercise this provided we were satisfied with Equitable’s due process; rather, we would look for an exchange of letters with them over key issues.

The legal construction of phase 2 of the deal. [FSA’s Chairman] noted that we would have to say in due course whether the deal was a reasonable offer to put to policy-holders. Our view was that a Section 425 would be needed – Section 2c being “too fragile” for the purpose. We might – as with [another life insurance company] – put an explanatory memorandum to policy-holders. [The Chief Executive] asked for an early sight of what we might be able to say about the deal – assuming that we would find it reasonable. [[Action] [FSA’s Director of GCD] + [the Head of Life Insurance] [please] to produce draft.]

Discipline. [FSA’s Chairman] asked why [the Chief Executive] attached such importance to this, given that any fine or censure would clearly relate to the past? [Halifax’s Chief Executive] stressed that the reputation of the Equitable brand and sales force had suffered greatly already this was one risk too far. [FSA’s Chairman] said that we would be prepared to put a proposal to the PIA Enforcement Committee. However, we would need an undertaking from Equitable that they would pay compensation in full and timely fashion (after it had been established by due process) and that the PIA could only reach agreement (if willing) in respect of currently known problems. [The Chief Executive] wondered whether Equitable needed to know why this undertaking was being required – he saw no problem in the undertaking being given. [[Action] We need to revert to [Halifax] after Tuesday’s PIA Committee meeting, with proposed wording and reach agreement on whether Equitable need to know the background – we think it would be better if they did.]

The extent of Halifax’s influence on Equitable’s Board is also discussed and ‘[Halifax’s Chief Executive] warmed to our suggestion that a single Director out of say 10 would better establish the desired relationship and avoid any suggestion that Halifax was in fact controlling Equitable’.

FSA’s Director of GCD comments on FSA’s meeting with the prospective President of Equitable on 26/01/2001, saying that the fact that Equitable’s Chairman had a GAR interest might be helpful ‘if what is needed is to encourage GAR holders to give up guarantees. It would be clearly understood that a deal he was prepared to recommend could not be that bad for GAR holders!’.

[18:07] The Director of Insurance gives his views on the problems that could arise if the individual, as a GAR policyholder, were to become Equitable’s President. These included whether this might enable a challenge to any scheme to compromise the competing claims and a destabilising effect any controversy might have.

The following day, the Director of GCD says that, during the discussions with Halifax (on 29/01/2001), they had contemplated that ‘a range of stronger and higher profile candidates might be available, who might not be affected by this problem’.

PIA send FSA a draft paper to be given to their disciplinary committee the following morning. PIA ask for comments ‘by 8am tomorrow’ and that Line Manager E should attend the committee meeting at 10:30.

[19:21] Line Manager E circulates the paper to other FSA officials, commenting that it had been ‘prepared at some haste by enforcement colleagues’. The Line Manager says that he had had ‘a very quick look through’ and did not see anything immediately worrying.

[19:33] FSA’s Managing Director A replies:

I don’t think any of us can access this so comments will be few and far between. What I can say from the meeting tonight with [Halifax’s Chief Executive] is that:

a) he confirms the importance of an understanding in this area to his willingness to proceed with the deal (he thinks the Equitable brand and sales force has suffered greatly already and Halifax’s name would inevitably be associated with any discipline no matter how hard we tried to make it relate to the past)

b) he understands that Equitable would have to commit to full and timely compensation once established by PIA after due process

c) he also understands that PIA can’t commit to how they would deal with anything they currently don’t know about.

[19:33] Line Manager E recirculates the paper.

[19:49] The Director of GCD says that Chief Counsel B had confirmed that PIA had a ‘useful’ rule, which required companies to assess and pay compensation due to their customers.

[20:35] The Director of Insurance says that the paper looked fine to him, and:

If, against expectation, the [Disciplinary Committee] do not accept this advice we may need to consider the issue of consultation with the prudential regulator as provided in [Schedule 10 of the FS Act 1986]. In this context I am not clear:

l whether [self-regulatory organisations], as opposed to the [Securities and Investments Board] (now FSA) are bound by the requirement to consult;

l whether the Prudential Authority for this purpose is HMT or FSA (ie whether the relevant function was contracted out)

l whether, before the [self-regulatory organisation] has formed an intention to discipline (as opposed simply to refusing to rule it out) there is anything to consult about.

But given the Schedule 10 arrangements it might seem pretty odd not to consider whether the possibility of damaging disciplinary action could be prevented by “prudential override”.

But, of course, the expectation must be that the need will not arise.

[20:58] Chief Counsel A asks the Director of GCD and Chief Counsel B to look at the Schedule 10 issue raised by the Director of Insurance.

FSA’s Chairman tells Managing Director A that he would be ‘firmer’ than his suggestion for dealing with the approval of Equitable’s Managing Director.

[09:55] The Head of Life Insurance suggests asking Equitable to withdraw the notice and replace it with one where the appointment was for a limited time (he suggests six months).

[11:24] Legal Adviser A reminds the Head of Life Insurance that FSA only had three months to serve notice of objection to the application, which had been received on 20 December 2000, and that they needed to allow one month for making oral representations.

[13:29] The Head of Life Insurance suggests to Legal Adviser A that they should discuss, with a view to the Adviser drafting the best notice they could devise.

Equitable express their concern to FSA about an article that had appeared in a national newspaper, which had included the alleged views of a PIA Director that all Equitable policyholders over the age of 50 should exit the Society.

FSA’s supervision file includes a letter, dated 31 January 2001, from the PIA Director to the newspaper explaining that her comments had been made in her role as Director of a firm of independent financial advisers. She notes that some investors had wrongly construed her comments to be a regulatory endorsement to move funds from Equitable.

Equitable also chase a response to the questions they had raised about the way that the GAR rectification scheme could handle complaints. Line Manager E asks Line Supervisor C to find out what their questions were.

PIA’s Disciplinary Committee convene at the request of their Enforcement division to consider a paper on whether disciplinary action on conduct of business issues against Equitable would be appropriate. FSA (Line Manager E) attend. The note of the meeting records:

The Committee considered the details of the two matters that had been referred to them by Regulatory Enforcement in respect of Equitable, these being Pension Fund Withdrawals details of which were contained in Appendix 3 and the Pension Review failings in Appendix 4. In respect of Pension Fund Withdrawals, Regulatory Enforcement had estimated that if disciplinary action were to be taken the likely penalty in these circumstances would have been in the region of £500,000, whilst the current assessment of the likely fine in respect of the Pension Review failings was likely to be in the region of £250,000 – £350,000. The Committee noted that the Equitable were in discussions with PIA staff regarding the review of past Pension Fund Withdrawals business and were, at this point, co-operating fully with PIA.

With the Equitable seeking a purchaser and only one bidder remaining, it was noted that if a public disciplinary action were mounted by PIA, the bidder would withdraw from the prospective purchase in order to avoid the reputational damage that would be likely in such circumstances. The principal question that the Committee therefore needed to address was whether or not PIA should discipline the Firm, taking into account the unique circumstances of the case when balanced out against the aims and provisions of PIA’s disciplinary policy. By issuing disciplinary proceedings, PIA would destroy the chances of the rescue bid being successful, which in turn would not be to the advantage of Equitable’s policyholders.

The Committee decide to take no action against Equitable on the sale of Pension Fund Withdrawal contracts and on Pension Review failings, provided remedial action acceptable to PIA was taken.

The Committee note that PIA would not hesitate to take disciplinary action should Equitable fail to carry out the required remedial action. This applied also to any future failure in respect of the Pension Review and to any issues not covered by the current referrals to Regulatory Enforcement. Should the bidder withdraw, the Committee would require submissions from Regulatory Enforcement as to the desirability of bringing disciplinary action against the Society.

Equitable send FSA the latest information (as at 28 January 2001) on the GAR buy-out proposals. This begins by stating that: ‘Our current best estimate of the GAR cost is about £1.5bn and the extra statutory reserve against that liability is similar. Of this, about £200m is the expected cost of the rectification scheme which is unlikely to vary much because we know most of the factors affecting its calculation. However, the remainder is subject to considerable possible variation depending on the trend of annuity rates, future premiums and take-up rates’.

The information provided by Equitable continues:

This variation, although covered to some extent by a reinsurance arrangement, is undesirable. There would seem to be considerable merit in a scheme, if possible, whereby we buy out those GAR options now, for an affordable and fair cost. The purpose of this note is to set out the objectives of the proposal and a particular way forward.

Appendix 2 to the note, under a heading ‘Buying Out The Guaranteed Annuity Options’, states:

The proposal is to cancel both the prospective GAR liability entirely (in respect of both accrued fund and future premiums) and future minimum guaranteed 3.5% increases on GAR guaranteed fund. In compensation for giving up these guarantees, both the policy values and guaranteed fund of GAR policyholders is to be increased by a fixed 20% regardless of age or policy contract. These enhancements are made as part of a compulsory scheme.

Equitable’s note then sets out detailed information as to ‘the estimated pre and post-buy out impact on the statutory position of the fund, if the buy out were to take effect at 31 December 2000’, noting that ‘it has been assumed that no reversionary bonus is declared during 2000 and that the end of 2000 [equity backing ratio] is 67%’.

The appendix also provided an assessment as to the effects of the proposal on specimen policyholders – and analysed this against attractive options.

[13:32] FSA’s Head of Life Insurance distributes the information to FSA officials and GAD’s Directing Actuary B, asking the latter to advise on whether there was anything significantly wrong or missing from the proposals.

[15:31] GAD’s Directing Actuary B notes that the schedule showing the potential impact of the scheme on the statutory balance sheet purported to show improvement of nearly £2bn in Equitable’s free reserves. The Directing Actuary says that this schedule was difficult to follow, and that GAD would wish to clarify in any event the following points with Equitable and with the appointed actuary:

1) Can they confirm that the post scheme free reserves still include both an implicit item of £0.8 Bn and the £0.3 Bn [subordinated loan]?

2) It is not clear how they have allowed for resilience effects. These appear at first sight to be included in both lines (i) and (iv).

3) I am not sure that the new Regulation 72 would allow them to achieve the reduction of £1 Bn in the provision as suggested in line (ii). This needs further explanation from them.

[16:37] FSA reply, saying that they had spoken with Equitable about the points raised by GAD, along with others. FSA say that Equitable had emphasised that the draft was a preliminary one, but that they were grateful for those comments. FSA also say that they could expect further documentation, and probably a request for a meeting, from Equitable over the next day or two.

FSA write to Equitable to confirm their ‘approach to the issue of whether the expected bid from [Halifax] should be put to [Equitable’s] policyholders before it is agreed’. FSA say that Equitable ‘need to be sure that it is legally open’ to the Board to decide this issue, rather than through consultation with policyholders or whether policyholder approval was required by their Constitution. On the assumption that it was open to Equitable’s Board to do so, FSA state:

We consider that for your Board to decide to go ahead without consulting policyholders, you would need to be fully satisfied that it was in their interests to do so. In practice, in the current circumstances, this will require you to assess the interests of policyholders in being consulted about the bid against the risk that if the bid were made subject to consultation, the bidder would withdraw it …

It seems to us that the judgement breaks down into two issues:

l Whether you are satisfied that the proposed bid is better than any realistic alternative, either in the form of another possible deal, or in the form of alternatives in the absence of a deal.

l If so, whether consultation would put the deal in jeopardy.

FSA conclude:

In these circumstances, we have considered whether it would be open to us to intervene to require you to consult policyholders on the ground that not to consult would involve failing to give due regard to the interests of your policyholders. It would be open for us to do so, if we considered that going ahead without policyholder approval involved failing to pay due regard to their interests. But if your Board can assure us that it has considered the points set out above I can confirm that, on the basis of our own assessment of the situation, we would not expect to intervene require consultation on this ground. Indeed we would fully understand it if you reached the view that going ahead without consultation in these circumstances is in the best interests of all policyholders.

FSA’s Director of GCD sends Managing Director A a revised draft of the letter to be sent to Halifax which says that FSA ‘are agreeable’ to the purchase of Equitable’s assets.

The draft concludes by saying that: ‘You also require that we should be ready publicly to confirm that this is the case, and this we are happy to do’.

[18:19] Line Manager E, noting that the draft refers to the disciplinary hearing of that morning, says that he had been working on a letter to be sent to Equitable, informing them of the outcome, and that he was intending to ask Equitable to allow FSA to disclose it to Halifax. The Line Manager says that the letter should be ready by tomorrow.

FSA’s Head of Life Insurance sends the Director of Insurance a copy of PIA’s paper of 26/01/2001, annotating it by saying: ‘Given the date, I think it needs to come under the terms of Enforcement’s expression of willingness not to fine if remedial action is properly undertaken’.

On 4 February 2001, the Head of Life Insurance writes ‘Now done’.

FSA’s Chief Counsel B advises the Director of GCD that the PIA rule (which gave them the power to require a company to make an assessment of, and provide compensation for, mis-selling) was not being carried forward into the new regime. The Chief Counsel says that the nearest thing was a piece of guidance in the supervision manual.

[10:16] The Director of GCD asks a PIA Head of Enforcement whether he was content that this was adequate ‘for purposes of the PIA “understanding”’.

[10:49] An official advises Chief Counsel B and the Director of GCD of one additional rule that might be relevant, but which was far weaker than the PIA rule.

The Director of GCD sends the Director of Insurance (copied to other FSA officials, GAD and Counsel) a note that aimed to ‘question the saleability’ of the GAR buy-out proposal. The Director explains: ‘The current proposal is that there should be a standard policy uplift of 20%. As shown in the proposals from the Equitable, the effect of this for paid up policies varies according to the age of the holder. A 60 year old would be offered 8% less than the value of the benefit, while a 35 year old would be offered 12% more. Similarly for those policies where the premium is still being paid, the proposal is that everyone older than 35 should be paid an under value’.

The Director of GCD says that the proposals ‘do not look all that attractive’ and so, in order to be accepted by the people they were being offered to, Equitable must ‘operate a sliding scale’. He continues:

This issue also seems to me to impact on the legal achievability of the scheme. [Counsel] has advised that the way to avoid needing the approval of a multiplicity of classes is to create a tapered offer. This offer seems to involve everyone else subsidising those in the 35 to 45 year age range with paid up policies. This seems to me to be a recipe for those who pay the subsidies to ask to be treated as separate classes.

The flat approach also seems to me to be problematic if we are to be asked to reach a judgement that the proposal is fair. Unless it is designed to give people a rough approximation of the value of the rights being bought out, it seems to me very difficult to regard it as fair.

[10:35] In reply, GAD agree that the idea of operating a sliding scale would be preferable and say that they understood that Equitable were now working on this possibility. GAD advise that:

The amount to be offered to those with the option to pay further premiums is more judgemental and depends also on the amount of premiums likely to be paid and the likely effect of such payment on the Equitable’s investment policy. In theory, though, the payment might be some multiple, varying by age, of the most recent premium paid.

There is also the difficult issue of how much of the offer should be in the form of an increase to the guaranteed fund and how much offered as non-contractual final bonus. I would expect that those near retirement would need to be offered mainly guaranteed benefits (or possibly a rather higher overall uplift if only part is guaranteed).

GAD continue: ‘I am also apprehensive about including policyholders who are able to claim immediate benefits alongside those with no immediate contractual entitlement to benefits. I understand that the Courts have previously declined to implement any reduction in benefits under a scheme arrangement for policies where benefits have become due for payment. Equitable may therefore need either to have the policies included as a separate class, or ensure that the proposed formula will not result in any such reduction in benefits’.

[15:06] The Director of GCD sends the Director of Insurance a further revised draft letter to be sent to Halifax. This version now says, in conclusion, that ‘this letter therefore confirms that we are agreeable to it … and [that] we will confirm publicly that this is the case’.

[17:02] The Director sends the Director of Insurance a revised draft letter to be sent to Halifax, as amended by FSA’s Chairman.

Equitable send FSA their latest discussion document, setting out their assessment of the three options for a compromise scheme under section 425 of the Companies Act 1985. The options are described as:

Option 1 – High, flat % uplift to cash benefits

Description:

• l All GAR policyholders are offered a flat uplift to cash values
• l The level of the uplift is set so that it can be very favourably compared with the current GAR/CAR uplift. For this note the uplift is assumed to be 30%
• l The uplift may be partly in guaranteed form and partly in non-guaranteed form.
• l The total cost of the benefits to GAR policyholders will be greater than the current best estimate of £1.3bn (assume £2bn for this note).

Option 2 – Medium, flat % uplift to cash benefits

Description:

• l All GAR policyholders are offered a flat uplift to cash values
• l The level of this uplift is set so that the total additional benefits are similar to the current best estimate of GAR costs of £1.3bn (20% for this paper)
• l The uplift may be partly in guaranteed form and partly in non-guaranteed form

Option 3 – Graduated uplift to cash benefits

Description:

• l GAR policyholders are offered an uplift to cash values depending on age with higher uplifts for older ages
• l The level of uplift should be set so as to encourage the perception of fairness at each age but without adding much additional cost to be paid by non-GAR policyholders
• l The uplift may be partly in guaranteed form and partly in non-guaranteed form
• l Figures have been produced on a scale from 25% at age 60 and above down to 10% at 45 and below.

FSA’s Head of Life Insurance circulates the document within FSA and to GAD and Counsel.

GAD write further on Equitable’s GAR buy-out proposals, having received a copy of the latest documents. GAD say that they could see why option 1 would be unattractive, as it would be costly and would give almost all the potential value of the Halifax payments to the GAR policyholders only. GAD say that they were less clear why option 3 was seen as unattractive and, regarding option 2, write: ‘I remain apprehensive though about applying a single factor to all GAR policyholders and treating them as a single class. It still seems to me that many of those policyholders who are entitled to take immediate benefits could allege that they are losing out unreasonably. At the least, I would hope that such policyholders would be given the option to take these immediate benefits instead of the Section 425 potentially reduced benefits’.

GAD also discuss the impact on Equitable’s financial position, saying:

Regarding the effect on the balance sheet, they appear to have accepted our point about Regulation 72. However, they still include an expected release of around £0.5 Bn for the “resilience impact” of the payment by [Halifax]. The rationale for this figure is not yet clear to me.

However, assuming that all these figures were accepted, then the scheme (if accepted) would appear to improve the statutory balance sheet directly by some £1 Bn, with a further £1.5 Bn resulting from the payments by [Halifax] (with the latter being of course dependent also in part on the actual performance of the salesforce, and the level of persistency of policies over the next few years.)

At the same time, the fund would become more resilient to falling interest rates but still relatively vulnerable to a fall in equity values. Moreover, the bonus expectations would continue to be difficult to manage, as they could have to reduce the final bonuses below the level already illustrated to individual policyholders, and of course apply a significant MVA in that latter event.

GAD note:

Incidentally, they have not, I think, mentioned the MVA in their recent papers, but I do not see anything to suggest that this could be reduced by more than 1-2 % in current investment conditions, even if the Scheme and the [Halifax] transactions could both take place.

FSA’s Director of Insurance informs the Director of GCD of a conversation he had had with Equitable about their preference for a ‘straight line approach’ to uplifting GAR policy values, in which he had said that FSA were ‘unpersuaded that this could be regarded as fair and did not understand their reasoning’.

The Director of Insurance’s record of the discussion continues:

[Equitable’s Chief Executive] said that their view was the result of very considerable analysis of the impact on the different categories of policyholders and they believed quite strongly that a flat line approach was fairer than a tapered approach. The nub of the issue, from their perspective, was the sacrifice that younger GAR policyholders would be asked to make, in giving up the right to put in future premiums over a long period of years, attracting the guaranteed rate at maturity. They believed that this opportunity, which was not enjoyed in the same degree by policyholders nearer maturity, offset the need that they accepted would otherwise arise to taper. If all policies were paid up with no possibility of future premiums being paid in, then they would share our analysis and approach. He pointed to the scenarios set out in the annexes to this note as demonstrating this.

We left it that we would need to reach a common view on this during the course of tomorrow morning. While such a view would not need to be definitive – the actual proposal needed to be worked up and might need to be amended subsequently in the light of the consultation which the Equitable plan to undertake with policyholders we did need to common understanding of the starting point if we were to be able to welcome the deal in suitable terms. [Equitable’s Chief Executive] will ensure that suitably qualified and empowered people would meet us tomorrow morning. (He could not come himself but [the Appointed Actuary] would.)

FSA’s Head of Life Insurance sends Halifax a copy of PIA’s letter to Equitable setting out the decision of PIA’s Disciplinary Committee. FSA write:

We discussed the fact that there is one issue which is not covered in that letter, which we think we should draw to your attention to avoid the risk of any subsequent misunderstanding. As you are aware some questions have been raised by policyholders about sales made by the Equitable in the months running up to its closure to new business, and whether the risks arising from the court action and from the uncertainty of the sale process were properly disclosed. We are considering the Equitable’s actions in this context, and have made some initial enquiries of them. We have reached no view at this stage and I therefore cannot rule out the possibility that we may find that some misselling took place.

You made clear that you would not wish to proceed with [Halifax’s] agreement with the Equitable without a similar understanding in respect of the possibility of disciplinary proceedings against the Equitable arising out of possible misselling in the circumstances I have described.

As you know the decision of the PIA not to institute disciplinary proceeding in relation to the issues identified in their letter is conditional on receiving, and the Equitable honouring, certain undertakings as to remedial action including paying compensation to policyholders where appropriate. In the case of possible misselling in the context of uncertainty over the litigation and subsequently the sale process, it does not seem to us that it would be appropriate to seek any blanket undertaking from the Equitable in respect of remedial action and compensation. In our view it follows that the PIA could not be expected, at this stage, to reach a definitive view on whether disciplinary action would be appropriate as it has in respect of the two cases identified in the PIA’s letter. I can say, however, that given the importance you attach to this issue in relation to your proposed agreement with the Equitable, and the clear interest that policyholders have in that agreement being reached, the FSA executive in advising the PIA, or the FSA (after N2) in determining whether itself to institute disciplinary proceedings, would take a similar approach to that taken by the PIA in the letter of [31 January 2001]. That is, provided the Equitable acted reasonably and quickly to compensate any losses suffered by policyholders arising from any misselling which we might find to have taken place, we would not recommend that the PIA should institute, or ourselves institute, disciplinary proceedings against the Equitable in respect of that misselling.

FSA inform Equitable, in reply to their letter of 25/01/2001, that:

… we are indeed keen to ensure that there is no further unnecessary exposure to the with profit fund. However, in the circumstances that you have outlined where “these particular clients are seriously disadvantaged by the restricted choice they can make” we do not intend to object to the further exposure envisaged (up to 317 policies).

However, we are concerned that where there are different possible retirement options for policyholders (whether or not they are currently invested in the with profit fund) that these are properly explained to them and that the risks of investing/continuing to invest in the with profit fund are clearly explained.

For example, you state that “most clients either have no choice but [to] buy their annuity from us, or to surrender and suffer a tax penalty”. But some policyholders may decide in the context of their own tax planning arrangements that a surrender may be in their own best interests.

Could you please confirm what the position is on best advice. We will wish to communicate the details of those arrangements to the [German regulatory authority].

FSA’s Chairman reports on a luncheon meeting he had had with Prospective Bidder A’s Chairman and Chief Executive, saying: ‘On the Equitable, they were careful not to ask what was going on. [The Chief Executive] said, looking backwards, that one of their key issues was the possibility of long drawn out litigation (a point he has also made to the Treasury, I understand). He also believes that expectations were so unrealistically high before Christmas that it was very difficult to make the deal add up. He was particularly scathing about

the [National Association of Pension Funds]. He says that one of their people had attended a [National Association of Pension Funds] meeting to talk about the Equitable in the autumn, where the discussion had all been about how pension funds would handle demutualisation bonuses. Their people had reported that they were completely unrealistic about the position’.

In a separate note, FSA’s Chairman noted that Prospective Bidder A:

… recognises that the Equitable affair, coming on top of the problems with endowment mortgages, will have a damaging effect on the image of with-profits funds and with-profits policies. And he is concerned to try to find a way of improving the way the policies are presented, so as to protect that part of the market which has a continued rationale.

He thinks one key is to improve the disclosure and the terminology. He agreed with me that the average bonus statement is incomprehensible and, indeed, that the term “bonus” itself is inappropriate for the yearly allocations to individual policies, which can hardly reasonably be described as bonuses. He was toying with terminology such as “minimum and guaranteed return” to replace the existing one about recurring bonuses or whatever.