February 2001

Equitable’s solicitors send FSA a note of a conference with Counsel that had taken place on 31 January 2001 concerning their Board’s powers in relation to entering into the deal with Halifax, and in doing so without a resolution of the Society in a general meeting (that is, without the members’ agreements). This note recorded that: ‘Counsel advised in summary that there is no obstacle under the Society’s Memorandum of Association in the Society entering into the transaction currently contemplated with Halifax, and that there is no obstacle to the Board approving the transaction without the support of a resolution of the Society in general meeting’.

[12:11] Chief Counsel A passes the advice to the Director of GCD and Managing Director A saying that, while it did not allay all concerns, she believes ‘it does provide additional comfort’.

With the note of the conference, Equitable’s solicitors also submitted their instructions to Counsel. As part of the background to the issue, the instructions stated that:

[The] financial position of the Society was adversely affected in July 2000 by the judgment of the House of Lords … The Society’s board of directors (the “Board”) announced immediately after the judgment that it would seek to find a buyer for the Society by way of a demutualisation. Efforts in this regard were unfortunately not successful … The Board thereafter took the view that it was probable that the most favourable return for the Society’s members/with profits policyholders would be obtained if the Society were to find a purchaser for as much as possible of the Society’s goodwill and operating assets, ideally combined with the negotiation of a third party administration agreement for the run-off of the Society’s in-force business.

After explaining that Board members were concerned about whether they had sufficient power to effect an agreement based on the Halifax proposals, the instructions indicated that:

… the pragmatic solution to the Board’s concerns might be to agree voluntarily to seek ratification by the Society’s members. There are strong commercial arguments in the present case that this would be not only inappropriate but also impossible in practice to achieve, largely because:

a)Halifax has made it clear that it is not willing to take the risk of entering into a transaction conditionally on members’ approval; and

b)in any case, the sales force is … perceived to be a rapidly wasting asset.

Among the detailed analysis, it was noted that:

• policyholders who could take retirement benefits immediately which attracted GARs would be able to gain ‘an uplift in value over the policy value (a smoothed asset share) of around 35%’; and
• that, taking into account the loss of flexibility associated with taking GAR benefits in restricted forms of annuity and also the loss of the opportunity of tax-free cash, a ‘realistic value’ of giving up their rights was ‘an 18% uplift to the policy value’.

For those who could not take retirement benefits immediately, it was noted that the uplift available to GAR policyholders – if interest rates stayed the same and if mortality improvements were as predicted:

FSA’s Head of Life Insurance circulates the information, saying it was the follow-up to a meeting with Equitable that morning.

Phase one

• £250m up front + £60m after two years + £70m after 5 years (both additional amounts subject to sales performance)
• administration to be provided at cost +25% profit margin
• asset management to be provided at arms length commercial rate

Phase two

• Subject to successful s425 compromise: £750m “surplus relief treaty” at best commercially available rate

Equitable tell FSA ‘that in their view this proposed new offer … was plainly less advantageous to policyholders than was the, now reasonably secure, agreement with the Halifax’. FSA record that Equitable had asked for an indication of FSA’s attitude.

FSA note that they had:

• reminded Equitable that both FSA and Equitable should ‘have regard to the probable commitment of any prospective purchaser, and the likelihood that they would see a deal through’;
• asked Equitable whether, if they now believed there to be a genuine potential alternative proposal, they should consider whether this made it desirable to consult policyholders before committing to a deal; and
• asked Equitable ‘whether they believed that it might be possible to secure an improvement in the proposed new deal, and what risks might be involved in trying to do so’.

FSA record that Equitable were of the opinion that it was ‘impossible to have any confidence’ in the new bid; that, as it ‘clearly offered the better outcome’ for policyholders, their efforts should be to secure the Halifax bid; and that the Halifax deal would be at risk if Equitable delayed agreement with them.

FSA record that they had told Equitable that:

… we believed that the Halifax deal would represent a significantly better outcome than no deal or than any piecemeal disposal of assets that was likely to be achievable. From what they told me, I could see why they took the view that the proposed new bid – even taken at face value – was less attractive than that on the table from Halifax, though this must, of course be a matter for them to decide … The issue of whether to consult their policyholders was one for the Equitable Board, but in the circumstances they faced I saw no reason to think that we should seek to influence their decision or to intervene to require consultation. Similarly, if they believed it to be in the best interests of policyholders to enter into the exclusivity agreement with the Halifax, without taking further time to see if the proposed new bid might be improved, because of the risk of jeopardising the Halifax deal, I saw no basis on which we should seek to second guess that view.

FSA note that, after some discussion, they had indicated to Equitable that ‘they could say, that we were closely in touch with the Equitable over the sale process; that we understood their position, and that we would continue to monitor the situation very closely’, when discussing these matters with Prospective Bidder F.

Legal Adviser A advises that FSA could object if a person were not ‘fit and proper’ to be appointed or where it appeared that, if the person were to be appointed, the criteria of sound and prudent management would not be, or might not continue to be, met. The Legal Adviser explains: ‘The relevant criteria are that each controller (which includes [the Managing Director]) must be fit and proper, the company must be directed and managed by a sufficient number of persons who are fit and proper, the business of the company must be carried on with appropriate integrity, due care and professional skill and with due regard to the interests of policyholders’. The Legal Adviser says, in this case, that it was likely to boil down to whether the individual was ‘fit and proper’.

Legal Adviser A examines the meaning of ‘fit and proper’, noting that fitness and properness had to be judged in relation to the particular company to which the appointment related. He explains that the legislation required the serving of a preliminary notice before serving notice of objection and that, while HMT were not obliged to disclose the grounds on which they are making such an objection, this would not be acceptable in European Convention of Human Rights terms.

Legal Adviser A suggests there were three possible areas to consider in deciding whether there are grounds to object: the history leading up to closure to new business; matters arising after the closure to new business; and the effect of the appointment on the future of the company. The Legal Adviser advises:

I do not think it can be successfully argued that by reason only that a person has been involved with a company that has failed (or otherwise got into difficulties) that it must follow that he is not fit and proper to hold the position of [Managing Director]. It is necessary that we point to particular areas/decisions where we consider that he was at fault either by omission or commission. Without some specificity, it is difficult to see how he can defend himself.

I have discussed this with [the Head of Life Insurance]. Although there may be a number of decisions made by the company which were questionable (and will be questioned) we do not believe there is anything which the FSA can say in a notice of objection, in effect, “this was wrong and your part in it demonstrates that you are not fit and proper”.

Legal Adviser A continues:

I understand the position to be the same with regard to the second area. I am not aware of any specific matters which can be put forward as evidence of lack of fitness and properness.

The third area is dependent on the particular circumstances of the company. The argument is more tenuous and would run along the following lines. [The individual] is involved in the public mind with a management that has lost credibility in the eyes of the policyholders. This is at a time when the policyholders are going to be asked to make decisions in relation to their policies relying in part on information/recommendations made by the management. This could work against the interests of the policyholders i.e. by them going against a proposal because it is put up by a discredited management. This would be so even if, in fact, [the individual] has done nothing wrong and that the information/recommendations, viewed impartially, cannot be faulted.

Legal Adviser A concludes:

However, this comes down to whether we have sufficient evidence for us to suggest that [the proposed Managing Director] is so closely involved in the policyholders mind with the perceived failure of the previous management that this is a serious risk. On present information I tend to doubt whether this is the case.

FSA’s Director of GCD says to the Director of Insurance that the material received from Equitable, on 01/02/2001, concerning the compromise proposals was disappointing. The Director of GCD says that, when FSA had met Equitable on the previous day, FSA had made it clear that the proposals should not just be fair between GAR and non-GAR policyholders but also that there should be ‘a reasonable degree of fairness’ within those groups.

The Director of GCD notes:

The Equitable urged us that a flat line increase of 20% across the board was fairer than any form of sliding scale. This was on the basis that the value of top-up rights to younger policyholders would provide a reason for what we had previously regarded as disproportionately beneficial to them.

We said that we could see that this argument meant that it might be fairer to operate a flat line, rather than some form of sliding scale. But we said that we were looking for some rational basis for believing that it actually was fairer.

In order to assist with this, we asked them to provide two sets of documents. The first was a set of illustrations of how the proposals would operate for policyholders in different positions. The second was a distribution graph which would show the proportions of policyholders who would do well by the offer, and those who would do less well by it. Neither of these is included in the material received yesterday evening.

In considering whether these proposals are fair, we need to be clear what we mean by “fair”. We do not mean that each policyholder must necessarily be offered some estimate of the value of his own share. Though this might be an ideal, the Equitable have asserted, and our own advisers have not denied, that it is not practical, given the number of uncertainties, for such an estimate to be made.

But as Counsel pointed out, we do not mean only that the scheme is fair between the GAR and non-GAR policyholders as groups. In particular the court will look, under the Section 425 Scheme, at whether it is sufficiently fair to the dissentient minority for it to be prepared to bind them to the scheme.

In relation to the example, the Director of GCD says that the key question was whether the deal overall was sufficiently good to compel him to give up his GAR rights. He notes further:

What in my view we still need is a proper assessment from the Equitable of the different anomalies which a flat line proposal would create, and the basis for concluding that the deal is nevertheless fair for those concerned. If they cannot do this, my view would be that we should endorse the proposal only in terms which leave open the possibility that either a flat line or a sliding scale may be the route chosen.

[13:15] The Head of Life Insurance informs the two Directors that he had spoken to Equitable and they were going to send over some supplementary material and had suggested a meeting later that day to take FSA through it. Equitable had said that, in relation to providing a distribution graph, it would be difficult to produce anything meaningful, due to the element of discretion over future payments.

[14:08] The Director of GCD notes that the material provided did not compare different policyholders but the average policyholder and, therefore, ‘it would be good to know how significant are the variations from the average’. He also says ‘the fundamental problem seems’ to be that a compromise offer ‘based on the current value of a policy may not work well’ for policyholders whose interests result primarily ‘from the fact that they have top-up rights, rather than the current value of their policies’.

[15:03] The Head of Life Insurance gives his opinion that: ‘the fundamental problem is that, because the value of the option depends crucially on how much an individual pays in future premiums – which is entirely at their discretion, and is by definition unknowable at this point – the only significant variable is age’. The Head of Life Insurance concludes:

Since all policyholders have the right to pay future premiums, it may be reasonable to give greater weight to the results in that category. These are already pretty “flat” and thus arguably fair … for younger policyholders, whose rights to future payments were more valuable than those of older policyholders, the benefit of the greater GAR value which they were giving up was broadly offset by the greater value they obtained from the effect of the uplift combined with greater investment freedom in the fund.

Halifax send FSA their suggested amendments to a draft FSA press notice and letter to be sent to Halifax. Halifax suggest the inclusion of the following in FSA’s letter to them:

Moreover we recognise the special circumstances surrounding this transaction and understand and accept the reasons why the contractual agreements do not follow our published guidelines on outsourcing.

This drafting is not included in the final version of the letter sent on 04/02/2001. An official circulates the drafts and asks for comments by 17:00. FSA’s Director of GCD notes in manuscript that ‘we have a problem with saying that the proposed compromise scheme represents a fair deal’.

Additional text is suggested by Halifax, including: ‘at no stage will you exercise any control over its financial affairs. There are therefore no circumstances under which we would look to you to stand behind the closed fund if it were to get into difficulty’.

Halifax also suggest deletion of text, which states:

The court will need to consider the transfer of the in force business under Schedule 2C of the Insurance Companies Act. On the basis of the proposals in the draft heads of agreement, we would not be minded to object to such a transfer.

FSA’s Director of GCD writes to the Head of Life Insurance about two substantive doubts that he has concerning the proposed compromise:

The first relates to the three statements about the proportion of GAR policyholders taking GARs, rather than alternative benefits. My concern is that we have no reason

to doubt that these proportions represent the actions of policyholders who are properly advised. My worry would be if we thought that there was any reason to believe that, for example, people have been encouraged to take the maximum tax free cash sum because it was cheaper for the company rather than because it was in their own interests.

The second is that he did not understand how the figures added up to the direct uplift of 18%. The Director of GCD says that, while ‘these points are not fundamental’, he would be reassured to know that GAD were happy with the analysis and that the material was consistent with what they had seen before.

[15:46] GAD reply that they ‘remain uncertain’ about Equitable’s analysis and they set out some concerns. GAD say:

While I can understand that almost all policyholders would take the maximum cash sum (both for tax reasons and a likely preference for cash upfront), they do not indicate what alternative forms of annuity have been taken by the unquantified “majority” or what their reasons may have been for this alternative selection.

… The note of [the Head of Life Insurance’s] conversation with [Halifax’s Chief Executive] suggests that they are now though thinking of presenting this as proposed uplift as being equal to 80% of the “value” of the annuity option, although this begs the question of what is the present “value”. It sounds though as if they would like to be able to say that assuming everyone takes maximum cash, then they are making a further 20% deduction to allow for the additional flexibility that will be available for all policyholders. If this interpretation is correct, then I would guess that many policyholders near retirement would be willing to accept this percentage reduction in benefits as being a reasonable trade-off for the new flexibility.

I am less sure though about his other suggestion of applying all of the 20% uplift only in the form of final bonus. Many policyholders may well not appreciate that they are giving up a guarantee and at the very least may consider that they have a reasonable expectation that this uplift will always be maintained. Accordingly, they may well still need to set aside some provision in the balance sheet for this uplift.

The flat rather than sliding scale probably can be rationalised by the arguments presented for an average policyholder. However, I agree that it would be useful to know rather more about the level of premiums relative to accumulated funds for a spread of policyholders. This should give some measure of how much benefit individual policyholders may be giving up. (Even though some may have the theoretical option to pay much higher levels of premiums now than they have in the past, I am not sure that they need to offer very much for such an option to increase the level of premiums paid each year, if in practice this option has never been utilised to its full extent.)

[16:48] The Director of GCD believes that FSA needed to urgently understand how the value of the uplift, being equal to 80% of the value of the guaranteed annuity rate, worked, as he had ‘seen nothing on it beyond the original phone message this morning’.

FSA request from Equitable further information on the section 425 scheme. FSA say that they are concerned about the fairness of the scheme being fair to all policyholders. FSA note that the scheme was designed to attempt to be fair to average policyholders, but that they were still concerned about ‘non-average policyholders’. FSA ask for a ‘breakdown of the fairness of the offer to policyholders’ of different age groups and size of policy. In doing so, FSA say that:

[We] think that account needs to be taken of the different interests of two policyholders of the same age with policies in widely differing values. How are they properly to be described as fairly treated in respect of their top-up rights?

In addition, FSA note that such a breakdown would be especially helpful if it were ‘related to any method of determining expected take-up under top-up rights’.

FSA’s Head of Life Insurance informs Managing Director A that Halifax had called him about the press notice and letter to be issued. The drafting issues discussed include that the paragraph explaining the transfer of Equitable’s unit-linked business by the Schedule 2c scheme was no longer needed, as Halifax now planned to transfer the business by means of reinsurance. FSA say that Halifax had been told that:

… we could not go as far as he wanted without further discussions with Equitable on the GAR/non-GAR compromise. He accepted that; said they wanted more time, and would come in on Monday. (In fact, I think we could accept this first amendment now; but the second (“represents”) goes too far at this stage.)

The issues also include that: ‘[Halifax’s Chief Executive] wants a reference in this letter to the understanding already given on enforcement, and also to the understanding on marketing issues …’.

[16:50] The Director of GCD says that he did not understand why Halifax no longer needed a Schedule 2c scheme. He also asks whether the unit-linked business would no longer be automatically transferred.

Equitable provide FSA with the information requested earlier that day.

The Head of Life Insurance circulates the information within FSA and to GAD and suggests that they should meet on 5 February 2001.

FSA write to Halifax and say that they saw no difficulty with them becoming the owner of the relevant parts of Equitable. FSA say:

We understand that the proposed relationship between you and Equitable Life means that it will not be a subsidiary and that at no stage will you exercise any control over its financial affairs. There are therefore no circumstances under which we would look to you to stand behind the closed fund if it were to get into difficulty … We see no difficulty with you as owner of relevant parts of Equitable Life. No issues of regulatory standing or consulting an overseas regulator arise.

The Board of Equitable Life will form its own views about whether the bid can be agreed without consulting policyholders. Our current assessment is that there is unlikely to be any basis for us to intervene to require such consultation.

FSA continue:

… More work remains to be done, and the FSA will need to consider the detail before forming a definitive view, but the FSA’s view is that this is a promising basis for a fair deal for policyholders. The FSA will continue to work with Equitable Life and the Halifax to ensure that the terms of the deal are communicated clearly to the policyholders, and that policyholders understand the choices they will have to make as part of the court process.

Your proposed agreement indicates that it is subject to the FSA being agreeable to the proposed transaction. This letter therefore confirms that we are agreeable to it, as set out above, and we will confirm publicly that this is the case.

FSA conclude:

You also have [FSA’s Head of Life Insurance’s] letter to you of 31 January 2001, enclosing a copy of a letter to Equitable Life on enforcement issues, and [PIA’s] letter to [you] of 2 February 2001 on marketing issues.

FSA’s Line Manager E circulates a revised draft of a ‘defensive briefing’ in the form of a question and answer guide and says that FSA’s Consumer Relations Department was working on some general lines to take for the consumer helpline.

The briefing deals with the compromise, the sale to Halifax, and FSA’s note in reference to both. Amongst the answers suggested in relation to the compromise, and for GAR policyholders, were:

• … that buying out GARs will reduce uncertainties about the future liabilities of the Equitable. If policyholders agree to this, it would enable Equitable to achieve greater certainty about [it] in its financial position and it should be able to produce better returns for policyholders as its investment freedom is restored.
• Any proposals to buy out [the right to a guaranteed investment return] would be set out in the detailed compromise scheme.
• The cost of buying out the guarantees will be met from the with-profits fund. It is intended that reserves held to meet the GAR liability (estimated following the House of Lords judgement) will be used to cover the cost.

  In response to non-GAR policyholders, it was suggested that the following should be stated:

  The value of your policy should be protected. Moreover, in future you should get the benefit of the increased investment freedom that will be available to the Equitable from the release of statutory reserves (and the consideration being paid by the Halifax). This should allow greater investment freedom which in turn should lead to higher bonuses than would otherwise have been available, although ultimately the benefits will depend on the relative performance of the different types of investments such as gilts and equities.

  The FSA, in relation to how the compromise might work, said that:

  • [If] the required majority vote in favour, dissenters can be bound to the terms of the compromise by the court … If the proposed compromise is rejected, the second tranche of capital that was to be injected into the with-profit fund by Halifax will not happen. And the opportunity for the Equitable to release statutory reserves will be lost. This will mean that the constraints on the investment policy of the Equitable will continue. It will have to carry on investing more heavily in safer investments such as government stocks and bonds to protect its financial position.
  • We cannot prejudge the court. And there are a number of steps to be taken before the matter can be taken to the court, including a vote of the policyholders concerned. Equitable and Halifax believe their proposals offer a fair compromise. At this preliminary stage, we would agree there is a promising basis for a fair deal for policyholders. However, there are still many details to be sorted out.

  In relation to the proposed Halifax deal in this context, FSA said that:

  Equitable believes that the initial consideration of £500 million, that is not dependent on the compromise, is better than any other offer that had been firmly put on the table … and that the bid from Halifax was the only firm proposal it received.

  In response to more general questions about whether the Equitable situation showed that ‘it is risky to invest’, FSA suggest a reply as follows:

  Investments do carry a certain risk and regulation seeks to ensure that people are protected from unreasonable risk and that consumers are aware of the risks that they face and the gains they may make.

  The FSA understands the importance of stability and certainty in personal finance arrangements, such as pension. We believe that this package goes a long way to achieving this. We think that there is a promising basis for a fair deal for policyholders. If a resolution is achieved this should improve investment freedom going forward which should help bonus levels. The actual levels of future bonus will depend on the relative performance of the different types of investment such as gilts and equities.

  In response to a question, which asked why there was ‘such a rush … If Equitable is solvent’, FSA state:

  The last few months have caused anxiety for many Equitable customers. While the with-profits fund is still solvent, it had been seriously weakened by the House of Lords judgment; the longer the uncertainty about Equitable’s future lasted, the greater the risk that the assets of the Equitable would fall in value. The directors of the Equitable believed that the Halifax deal on the table was too good to risk letting it slip away.

  On their own role, FSA state:

  The deal announced … is a commercial matter between Equitable and Halifax, and in the case of the compromise, the Equitable and its members. However, the FSA has powers to act if it believes that the reasonable expectations of policyholders may not be met or if it considers that policyholders have been treated unfairly. We therefore considered the broad terms of the deal before the Halifax went ahead … We think the deal with Halifax is good news for all Equitable policyholders. We also think it is important that there is a compromise to deal with the GAR problems. At this stage, we think that there is a promising basis for a fair deal for policyholders.

  Ultimately it will be for the policyholders to express a view on the compromise and for the court to decide whether to approve it.

  FSA also explain that ‘there was no case for [an industry] bail out’ as:

  [It] is important to remember that … the Equitable has been solvent throughout and the issue of compensation does not arise.

  FSA concluded that they have:

  … acted in accordance with the statutory framework throughout, and in particular has always had as its priority the objective of protecting the interests of the policyholders. We have sought to facilitate a deal, by providing appropriate support to Equitable, Halifax and other interested parties, including representatives of policyholders and other prospective purchasers. We have also sought to ensure that so far as practicable, any outstanding regulatory issues have been dealt with so that a deal could be concluded at the earliest opportunity.

  Other points include that:

  • FSA had done the same for Halifax as it would have done for any other bidder that was offering a deal that FSA thought would be fair to policyholders – that is, to reassure the bidder that the regulator would not seek to use its powers to prevent a deal being completed;
  • FSA did not need to formally approve the deal, as a whole;
  • if the majority of policyholders voted in favour of the compromise scheme, FSA need not give specific consent as the court must approve it; and
  • FSA had met with various parties to facilitate a possible deal by discussing regulatory issues that might arise from a bid by these parties. FSA had also worked closely with Equitable’s management to provide advice and assistance on regulatory matters.

FSA hold an Equitable Life Lawyers Group meeting.

Chief Counsel A reports that there appeared to have been little progress on formulating a response to the OFT’s letter about Equitable’s use of the market value adjuster. Legal Adviser C says that some concern had been raised by FSA’s consumer protection division that the proposed letter to be sent to the OFT was too ‘pro-Equitable’ and that such a letter might ‘limit FSA’s hands with a view to future policy’. However, Legal Adviser C felt that this last concern was misplaced. The Director of GCD emphasises it was important that Equitable made a public statement to policyholders that: ‘the MVA discretion was a fettered discretion so that the policy holders understood that there was an implied term that they could enforce’. It is agreed that Legal Adviser C would ask Line Manager E to establish if he was content for the letter to be sent to the OFT.

Chief Counsel A reports that a meeting on winding up issues had been held on 2 February 2001 and an accountancy secondee (FSA’s Insolvency Practitioner) was to be taken on to map out what would happen in the event of insolvency.

Chief Counsel A notes that the Halifax deal now proposed the use of reinsurance ‘to avoid’ Schedule 2C of ICA 1982 procedures.

The Director of GCD requests that the minutes of their meetings were accompanied by a list of current legal issues and that the following issues were added: Article 4 of Equitable’s Articles of Association; work on the compromise scheme; counterfactuals, including winding-up; and reviews.

Attached to the minutes is a list of outstanding legal issues.

Equitable’s advisers for the sale send FSA a letter received by Equitable from Prospective Bidder F on 2 February 2001 and a draft comparison (of the deals from both Prospective Bidder F and Halifax) underlying the Board’s decision to accept Halifax’s offer.

FSA’s Head of Life Insurance comments, when forwarding the document to various colleagues, that: ‘At first glance, this looks inferior to [Halifax’s] offer (see final paragraph). But it envisages reopening the [Equitable] with profits fund in due course’.

FSA meet with Prospective Bidder F, at their request, in order to be informed about the counter-bid which they envisage putting to Equitable the following day.

Following the meeting, FSA (Chairman, Managing Director A, Director of GCD, Director of Insurance, Head of Life Insurance, Head of Press Office and Line Manager E) meet to discuss the proposed bid.

According to Line Manager E’s note, FSA say that the bid could be described as being worth £1.5bn (compared to the £1bn Halifax offer), but in real economic terms was worth much less. FSA agree to attempt to establish the true value of certain parts of the proposals. FSA note that the Halifax proposal was already ‘in the bag’ and any negotiations that Equitable entered into with Prospective Bidder F could jeopardise that. The Line Manager’s note also records that Prospective Bidder F had given an undertaking to sell the sales force to Prospective Bidder D on completion of the deal, which could complicate matters.

FSA agree that it would be important for Equitable to ensure they followed due process when reacting to any further bid. FSA record: ‘The FSA was entitled to form a view as to the economic and legal assessment of Equitable and its professional advisers. However, on the basis of the facts before us, we saw no basis to intervene provided we were sure that the Society’s and the Board’s obligations had been properly assessed and considered’.

FSA consider whether they could disclose information about the meeting to Equitable and Halifax. It is agreed that Managing Director A would warn both companies and the Head of Life Insurance would inform Equitable’s advisers for the sale.

FSA write to the OFT setting out their thinking on Equitable’s use of their market value adjuster. FSA provide a copy of a note prepared by FSA legal advisers, which concludes that it could be argued that the Unfair Terms in Consumer Contracts Regulations 1999 did not apply in this case.

FSA note that the OFT had:

… indicated that your latest thinking was to accept the arguments as to why it was not unfair for an adjustment to be made to the value of policies on early transfer or surrender.

FSA’s letter continues:

As I understand it, your concern is not so much about the application of an mva in itself, but rather the way in which any adjustment is calculated. You indicated that you might be looking to ask [Equitable] to take steps to amend the wording of its policy documentation to explain more precisely the basis on which adjustments would be made.

There is of course a wider industry issue. I think I mentioned that [Equitable’s] position is slightly different to that of most other life offices (even if overall the outcome is the same in economic terms). This is because of the way in which [Equitable] has declared (annual) reversionary bonuses at higher than usual rates and because, in calculating the surrender value, [Equitable] also takes into account the value of the policyholder’s share of the “terminal bonus” which in most companies would only be payable on a contractual date under the policy. Other companies are less transparent about the way in which the surrender values are calculated. However, I think that in the light of our discussion, you were going to talk to the Association of British Insurers to get a clearer picture of general industry practice.

FSA inform the OFT that:

[Our] own legal view is that the [Unfair Terms in Consumer Contracts Regulations 1999] are unlikely to apply to the mva, as it is currently applied to policy values, provided that the MVA operates in a way that is reasonable. If the mva were applied in a way that was entirely arbitrary and without regard to the kinds of factors described in my letter of 21 December 2000, we too would be concerned about the effect that that could have on policyholders (and indeed in such circumstances we would have to consider the exercise of our powers of intervention under section 45 of the Insurance Companies Act 1982). That seems to be consistent with the position that you are moving towards in looking for a more explicit form of words to be inserted in the policy documentation.

FSA conclude by saying:

I think that achieving your objective by way of a contractual change may present some difficulties and you will understand our concern, for prudential reasons, that nothing should be done to undermine [Equitable’s] (or any other life office’s) ability to adjust contract values at early termination in appropriate circumstances. Given that in policy terms we seem to be thinking along similar lines, and our objectives seem entirely consistent, I think it would be useful for us to meet fairly soon to work out how those objectives might best be achieved.

FSA’s Director of Insurance seeks advice from GAD’s Directing Actuary B on the surplus relief treaty element of the bid by Prospective Bidder F. In particular, the Director of Insurance asks whether it was possible to evaluate what impact this would have on Equitable’s investment freedom.

[11:05] The Directing Actuary says that it would be difficult to make such an assessment from the limited information he had. However, the Directing Actuary’s ‘very rough estimate would be that this might allow another 5% of the fund to be invested in equities, probably then generating no more than 0.1% per annum additional investment return’. The Directing Actuary says that it would be helpful to see any notes or papers that had been received from the bidder.

[12:57] The Director of Insurance explains that Prospective Bidder F did not leave anything with FSA at their meeting the previous day but that FSA had just received copies of an offer that had been submitted to Equitable that morning.

[14:14] Directing Actuary B provides FSA’s Director of Insurance with his views on the differences between the bids from the two companies.

FSA hold a telephone conference with Equitable, their advisers and solicitors about the bid from Prospective Bidder F. According to Line Manager E’s note, in summary:

[Equitable’s advisers] had advised that the new offer was only of marginal better value;

Equitable had clear legal advice that they could not entertain the new proposal;

Halifax had made it clear that they would seek to enforce the contract;

Equitable wanted to reject the offer quickly, but we recommended to them that they should ensure that in so doing, they followed due process including with the support of the board.

FSA say that their starting point was that the bid was a commercial matter for Equitable, but:

… we felt we had a responsibility because of our duties and the statements we had made about being closely involved. We therefore wanted to be sure that due process had been followed. We therefore took the view that Equitable needed to:

• take proper legal advice;
• make a comparison of the merits of the offer, including as to security;
• if they concluded the bid was very much better, they needed to look at the options available to them, including considering whether Halifax would release them;
• consider the extent to which the board should be involved in the decision (which was not very clear from the minutes of the last board meeting).

[Equitable’s Chief Executive] said that the board had been appraised of the last [Prospective Bidder F] offer last Thursday, when it was telephoned through. It was for that reason that there was limited consideration given to it when the Board met on Sunday to commit to the Halifax deal. [FSA’s Director of Insurance] said that our concern was that a disgruntled policyholder might seek to argue that the board had not properly considered all the options available. For that reason, we preferred the more detailed letter that made it clear that due process had been followed. [The Director] said that we would wish to be able to say that that had been done, and be satisfied that the position had the full support of the board. [Equitable’s Chief Executive] took the point but said that he was concerned that the imperative in his mind was to close the matter as soon as possible to avoid the risks of a row in the media. He said there would be difficulty in calling a board meeting within the timescale required. He expressed concern about the fact that one regulated firm was seeking to induce another into breaking a binding contract.

Equitable’s solicitors confirm they had been told by Halifax that they would seek to obtain an injunction if they thought that Equitable would break the terms of the contract. The Society’s solicitors also say that there would be a real risk of a claim against Equitable for loss of value, damages and performance of the contract.

FSA agree to review the drafting of a letter that had been prepared for Equitable to send to Prospective Bidder F, rejecting their proposals.

FSA have a further discussion with Equitable, their advisers and solicitors, in which FSA offer comments on the proposed letter to Prospective Bidder F and clarify some points in the ‘side by side’ comparison of the Halifax and Prospective Bidder F bids which underpins it. On the letter, FSA:

• Ask whether Halifax were subject to regulatory clearance from PIA. Equitable’s advisers say that they had received confirmation that clearance had been agreed.
• Express concern about the references to consideration of the bid by Prospective Bidder F by Equitable’s Board, as: ‘If, as seemed likely, consideration would formally [be] by a directors meeting (since it would be a minuted directors meeting by conference call rather than a board meeting which, under Equitable articles required the physical presence of a quorum meeting together) to claim that the board had been involved might leave the Society open to criticism and possible challenge’.
• Repeat their concerns that Equitable should be absolutely certain that decisions taken on the basis of discussions in a directors’ meeting had been properly taken and could not be challenged subsequently.

On the side by side comparison, FSA:

• Ask whether Equitable’s advisers were confident that they had properly reflected the combined effect of the charges Prospective Bidder F had proposed on asset management and administration. Equitable’s advisers say they are confident and there was no difference between the bids on charging structure. Therefore, Prospective Bidder F’s proposals were not as good as Halifax’s, as their cost charging was 25% higher.
• Seek clarification on the element in the comparison relating to the benefits obtainable from the different upfront cash offers and Prospective Bidder F’s proposals for £400m ‘surplus relief reinsurance’. FSA’s Director of Insurance records: ‘While this showed some advantage to [Prospective Bidder F] the £400m was calculated to provide a benefit of only £40m. [Equitable’s advisers] were confident of their calculation of this benefit. While neither [Chief Counsel A] or I were competent to judge the methodology (essentially calculating the charges payable as, in effect interest on a loan, and the return achievable through equity investment) was reassuringly familiar’.

Halifax write to FSA to express their concern about Prospective Bidder F’s approach to Equitable. Halifax say:

[We] are very much in uncharted waters. However, the situation is becoming so serious that I believe I have no alternative but to set out our position on paper.

Throughout the process of our acquiring Equitable Life we have done everything in our power to ensure that our behaviour is completely beyond reproach, and in particular does nothing to destabilise the position of Equitable Life policyholders. And after eight months of uncertainty we were the only organisation prepared to stand up before its shareholders and argue for a transaction which genuinely holds out for the real prospect of ensuring the future solvency of the closed fund.

FSA meet a policyholder action group to discuss recent developments at Equitable. FSA record:

[FSA’s Director of Insurance] began with a few key points about the Halifax announcement. He noted that the Halifax deal was a good one, in the circumstances, and that the proposals for contracting with Clerical Medical were on the basis of reasonable charges. He then commented on the proposed compromise over which Equitable would be looking to consult before putting forward a formal proposal. Equitable wanted to be fair to all policyholders and the Halifax deal, with the goodwill element of the consideration conditional on a deal being accepted, gave an incentive for policyholders to accept it. He noted that the transfer of value as a result of the House of Lords judgment had happened so the intention was to seek to remove future uncertainties by crystallising current entitlements. There was no prospect of the lost bonuses being restored but the compromise, along with the sums payable by the Halifax, gave a reasonable prospect of restoring the investment freedom of the with-profits fund so that it would be able to support higher equity backing ratios going forward.

… [the Director of Insurance] said that we had had discussions about Equitable’s GAR liabilities in late 1998, which had led to an increase in their reserves of £1.6bn, which represented a prudent estimate of the likely GAR take up at the time. [FSA’s Head of Life Insurance] said that there had been some discussion about the right level of reserving, with Equitable taking the view that it did not need to hold significant reserves because of the evidence of low levels of take up. However, we had insisted that reserves be held on the basis of close to full take up. [The Director] said that the reserving requirement had been met in part by the reinsurance, which would cover the costs if the take up exceeded 25% but that the cover was conditional on Equitable maintaining the same policy towards the allocation of terminal bonus. The House of Lords judgment imposed a new bonus policy, which meant that the reinsurance had to be renegotiated – it now provided cover if take up exceeded 60%. The combination of the impact of the judgment and the further tightening of the reserving requirements generally had left Equitable in a position where it had relatively few free assets which constrained its investment freedom, and this was the reason for looking for a buyer. Now that the deal had been done with the Halifax, the financial position would be stronger and current policy values should be protected.

They asked whether there was any prospect of a sweetener being offered to non-GAR policyholders to sign the deal … We … pointed out that the removal of future uncertainty of the size of the GAR liability, the increased investment freedom and the fact that it was intended that the costs of the deal would be contained within the cost of the transfer of value that had already taken place would all be beneficial to non-GAR policyholders. They asked why this had not been proposed before now. We pointed out that before the closure announcement, it was unrealistic to believe that people would have agreed to any kind of deal – some were expecting windfall payments from the demutualisation at that stage. They also asked about the role of the independent actuary and whether it would be possible for the appointment to be made by one or more of the action groups. We said that it might be difficult for them to make the appointment, but we could consider whether there was any way that the action groups might have an input to the appointment, or the drafting of the terms of reference.

We answered a number of detailed questions. We confirmed that the Halifax deal did not have any impact on the operation of the Policyholders Protection Acts … FSA’s report into its regulation of Equitable was being worked on …

In relation to the particular difficulties that with-profits annuitants currently faced, FSA acknowledged the difficulties and invited the action group to suggest what kind of protection might be achievable and desirable, perhaps as part of the compromise scheme.

On FSA’s supervisory file for Equitable is a copy of a letter from PIA to the Society about their continuing supervision work. In that letter, PIA had said:

Much of PIA’s contact with Equitable over the last two months has concerned your firm’s closure to new business and related issues. Whilst this new work has been undertaken, PIA has continued work on issues relating to Equitable before its closure to new business.

These pre-closure issues fall into two broad areas:

1)Work arising out of PIA’s Supervision Visit to Equitable in June 2000.

2)Assessment of the standards of business written by Equitable since the Court of Appeal ruling on 21 January 2000.

PIA had said that they had received Equitable’s response to their supervision visit report and would respond in due course. PIA then explained that the purpose of writing had been to request information to help them quantify and assess the business written since the Court of Appeal ruling.

PIA sought information from the Society on: new business data; information about all new with-profits and unit-linked contracts; complaints information; advertising and promotional material; training and briefing material for sales staff; standard paragraphs used in communications with policyholders; and sales process documentation. PIA asked for the information to be categorised into the periods: 21 July 1999 to 20 January 2000; 21 January to 20 July 2000; and 21 July to 8 December 2000.

FSA hold an Equitable Life Lawyers Group meeting. The minutes of the meeting record that:

• FSA had now replied to the OFT’s letter.
• An update was provided on the sale to Halifax and the Prospective Bidder F bid.
• FSA had not yet made a formal approach to Halifax/Equitable regarding amendments to Article 4 of Equitable’s constitution. It is noted that, if at any stage it became necessary to express a view, the appropriate time would be during the second stage of the sale.
• A paper on ‘counterfactuals’ was being prepared.
• With regard to the proposed appointment of Equitable’s Managing Director, FSA would serve notice under Schedule 2D of ICA 1982, requesting further information and that:

This will have the effect of preventing further moves to appoint [the individual]. The additional information will help the FSA to decide whether as a matter of fact [he] is fit and proper to act as managing director. As to whether the FSA can impose conditions on [his] appointment (should it go ahead) such as a time limit, we are reasonably confident that we can but there may be policy issues to consider fully first.

FSA meet The Consumers’ Association to discuss Equitable. According to a note of the meeting made by the Head of Life Insurance, FSA explain the recent history of the bidding process and indicate that FSA were satisfied that Equitable had gone through due process to decide that the Halifax offer was the best available.

FSA explain that it was for Equitable to propose a compromise scheme and for FSA to satisfy themselves that the scheme was the result of a proper and thorough process.

FSA have a telephone conversation with Equitable about their new President, advertising post-House of Lords, and the value of withholding seven months’ bonus.

FSA say that their PIA colleagues had not been successful in getting information from Equitable on advertising post-House of Lords’ decision. Equitable promise to provide some figures the following day; however, Equitable say that they did not think that their expenditure on advertising at that time had been out of line with previous years.

On the loss of bonus, Equitable’s Chief Executive estimated that it represented a 5% reduction in policy value: ‘But he thought that this somewhat misrepresented the true position’. FSA record the Chief Executive as saying:

To set aside funds to cover the transfer of value from non-GAR to GAR it would have been necessary for the Equitable to distribute less by way of bonus in earlier years. While this would avoid some of the inter-generational unfairness the overall result would have been no different. The Equitable would be trying to get this point across at the [Treasury Select Committee], emphasising that no funds had been lost or misappropriated and that the value of the fund remained as it would otherwise had been. It was the uncertainty which currently afflicted the fund, and which limited investment freedom, which was the major problem. This would be resolved by the Halifax deal and the GAR/non-GAR accommodation if it went through.

Commenting on the Director of Insurance’s note of the call (see 13/02/2001 [19:45]), the Director of GCD says:

We need to be cautious about appearing to accept the Equitable’s characterisation of the [House of Lords’] decision as involving a transfer of value from non-GAR to GAR. The effects of the [House of Lords’] decision is that all with-profits holders participate in the overall profitability of the business, and similarly bear their share of its liabilities. This may appear to be a transfer of value, but only because the Equitable had characterised the position of the non-GAR with profits policyholders as participants in a separate non-GAR fund, unaffected by the liabilities to the GAR holders – a characterisation the Court did not accept.

[12:29] The Director of Insurance replies:

Yes, but it certainly represents a change from what had previously been assumed to be the aggregate shares of the fund represented by the GAR and non GAR policies so that the assumed value of the one declined by the same amount that the assumed value of the other increased.

I don’t think, as a matter of fact, that the Equitable did characterise the GAR and non GAR policy groups as separate sub-funds. In practice their belief that they could distinguish on the basis of exercise rather than availability of the option meant that they never faced up to this issue. It is interesting to consider what the [House of Lords] might have concluded, had they been faced with a situation in which there had been two defined and separate sub-funds (even if the assets were pooled).

Nonetheless I am sure your analysis is correct. But for the purposes of gaining understanding it seems to me that the concept of transfer is very helpful, provided it is clear that this is a transfer between the shares in the fund that had previously been assumed.

FSA’s Director of GCD asks Chief Counsel A, in the light of a point made at the meeting on 12/02/2001 with one of the policyholder action groups, whether it was right that there could be no ring-fencing of the costs of providing a guaranteed interest rate on certain policies.

[21:10] Chief Counsel A replies: ‘The 3½% guarantee is not an issue now because it has not been triggered. Investment returns continue to be well in excess of 3½%. If it were triggered, then I am not sure the Equitable judgment would necessarily mean no ring fencing, but it would almost certainly raise a “case to answer”.’

The OFT reply to FSA’s letter of 07/02/2001 about the Unfair Terms in Consumer Contracts Regulations 1999. The OFT say:

[We] are clear that the Regulations apply here. We cannot agree with the argument that the mva terms are fair or fall outside our scope to take action under the Regulations if they are operated fairly. The question is whether the terms have the potential to be used unfairly in the future or mislead customers, and we consider that they have. Equitable will need, in order to meet the requirements of the Regulation, to limit the scope of its “absolute discretion” and conform its conditions to the fair practices that it says it applies and the fair principles that are enforced by regulation, though these principles may need further elucidation. Similarly, the scope of the FSA to regulate Equitable and Equitable’s present practice in operating the relevant terms, do not remove the problem or confer any kind of exemption. The Regulations set a new and high standard for business and public authorities contracting with consumers; they give consumers additional protection, and they put us under a continuing obligation to ensure that unfair terms with potential for unfairness are modified or removed. Whether a standard term is unfair does not depend on an assessment of factors such as the practices and potential remit of any regulators, the likelihood that the courts will overturn the unfair term when it is challenged, or the current practices and policies or culture of the business using the terms.

The OFT continue that:

We discern few points of agreement with the legal advice that you have received. The second and third paragraphs lead to an analysis of the “core terms” exemptions in Regulations 6(2) which is incorrect. [A named bank] failed to persuade the High Court and then the Court of Appeal of the validity of this kind of approach in relation to the use of the “interest after judgement” clause. The court preferred a narrow definition of what was a “core term” and considered that the exemption could not apply to terms that determined what would happen if the agreement was in default (or thus – by extension – was terminated early).

The advice discusses the application of the core terms exemption. But a core term is by definition very much at the forefront of the consumer’s mind (even ambiguity in core terms relieves it of the exemption). So the argument that consumers invest in full knowledge that the Society might decide to give them nothing at all is implausible. Equitable would have been in severe difficulties many years before if it had tried to sell its products on that proposition.

The arguments on “absolute discretion” are addressed in the letter to Equitable. The width of the discretion is at the core of our concern. The term in question does not at all imply that the term will be exercised “reasonably”. “Absolute” means precisely that – the discretion cannot be challenged – and the whole point of including this word is to make the discretion immune to any such challenge. This is reinforced by the inclusion of “(if any)”. The reason that the term is not expressly subject to “reasonableness” is that it would modify or contradict the “absoluteness” of the discretion. At any event if there were an implied reasonableness requirement in the term, it would not meet the transparency requirements of Regulation 7 unless it were expressed.

The OFT conclude by stating:

I note your concern that nothing should be done to undermine Equitable’s ability to adjust contract values at early termination in appropriate circumstances. However the effect of the Regulations is that the relevant terms should not enable Equitable to make unfair adjustments. The width of the terms is without doubt challengeable under the Regulations and could therefore be seen as unenforceable, whereas fair terms would not be. It seems to us essential therefore for Equitable to face this concern and that it would meet both your prudential concerns and ours for Equitable to do so by revisiting the terms to clarify and objectify the expectation that investors can legitimately have. Given, as you say, that our objectives essentially mesh together, I agree that it would be very useful to meet, perhaps early next week, to discuss these issues and next steps.

The OFT also enclose a copy of a letter to Equitable, dated 8 February 2001.

FSA’s Head of Life Insurance asks Line Manager E to put together an agenda for a proposed meeting with Equitable’s Appointed Actuary. The Head of Life Insurance says that he had spoken to the Appointed Actuary and that possible topics for discussion would include: end-2000 results; current and ongoing solvency position; surrender rates; and section 425 scheme. A meeting is arranged for the following day.

[18:15] FSA send Equitable a letter setting out these key issues that they would like to discuss at the meeting, in the following terms.

End year 2000 results

FSA would like an update on Equitable’s likely year end solvency position (i.e. 31 December 2000). FSA would also like to explore the possibility of their returns being provided to an accelerated timetable.

Current and ongoing solvency position

FSA would like an indication of the latest solvency position. FSA emphasise the importance of the timely provision of all reports on the solvency position of the Society, while noting that Equitable had not yet provided the monthly reports for November and December 2000 and that the January 2001 report was now due.

Surrender rates

FSA suggest that it would be helpful to discuss trends in the levels of surrender requests since closure to new business and since the announcement of the Halifax deal. FSA say that relevant to this was the discussion with the OFT regarding the market value adjuster.

Section 425 scheme

FSA request an update on the compromise scheme, including a discussion on the approach that the Society would take and its thinking on whether an uplift to GAR policy values should be on a flat rate or a sliding scale. FSA say that it would be helpful to have an indication of the likely timetable.

The Halifax deal

FSA ask for an indication of when the contracting-out agreements were to be finalised and whether any late changes were being proposed.

On a copy of this letter, an official has written the following further points to raise:

• Assuming no compromise what can be done to protect position?
• [financial condition report] at some point
• 2000 bonus declaration, content/timing.

FSA hold an Equitable Life Lawyers Group meeting. Among other things, the Group discuss the issues on the legal issues list and add a status report to each of the actions. Chief Counsel B informs the Group that he had recently become aware of a letter from Equitable to PIA of 20 December 2000, informing them that, prior to the court case, they had vested several policyholders with annuity rate guarantees into non-guaranteed rate annuity policies. He says that Equitable were proposing a mechanism for dealing with complaints about this but, as it would not be ready in time, had requested a PIA Rule waiver. Chief Counsel B reports that PIA were minded to grant the waiver but that it would need senior approval.

The legal issues list attached to the minutes of the meeting includes:

• Advice from Counsel on the interpretation of Article 4 had not yet been received.
• The OFT had responded to FSA’s letter of 07/02/2001, disagreeing with FSA’s interpretation. It is noted that FSA were to meet the OFT on 22/02/2001 [13:27] and also that FSA had concerns about the implications for the industry of the OFT’s stance on market value adjusters.
• Under ‘Possible use of intervention powers should MVA be further increased’, the Group record that this is ‘not an issue at the moment, though it may become so should the FTSE index drop below 6000’ which ‘was at one stage mentioned as a potential “trigger” for a further review by the Equitable of the amount of the mva’.
• Work on the need to consider the full implications if winding up were undertaken and on any breach of solvency margin was ongoing.
• It is noted that there was a difference of view between FSA and GAD on the interpretation of Regulation 72 of ICR 1994 and that a meeting was to be held on 21 February 2001.

An email exchange occurs between FSA officials about a proposed meeting with the OFT regarding Equitable’s use of the market value adjuster.

[13:33] Legal Adviser C notes:

[If] this is to be a meeting primarily to discuss the legitimacy of the Equitable’s mva provisions in its policy documents, I wonder what a meeting with the OFT is going to achieve. I attended a meeting of the Equitable Life Lawyers Group this morning at which the letters to Equitable and to ourselves from the OFT were briefly discussed; the feeling around the table was that were we not likely to persuade the OFT to change their minds on this and would be wasting our time and energy doing so.

… The good point that emerges from the OFT letter is that they at least appear to agree with us that on 8 December Equitable exercised its discretion to increase the mva in a way that was not unreasonable. Consequently, the prospect of action against Equitable by the OFT for the increase itself seems very remote.

Line Manager E replies that his:

… concerns are wider than just the interests of Equitable in all this since it has potential implications for the whole industry …

[It] also seems to me that their analysis is a bit theoretical and does not take into account certain practical realities – not least that the “notional fund values” take into account growth, in the form of bonuses, that would never have been awarded if Equitable had the slightest idea that something was suddenly going to be found to be objectionable about its current practice. If the answer is for Equitable to clarify the basis on which the discretion might be exercised, I would like to know how OFT think that the terms of the contract might be amended. If a satisfactory exchange cannot be delivered and the terms were struck down, in practical terms this could cause a risk of insolvency and if that happened, people would get less than they would had an mva been applied since they would lose the entitlement to terminal bonus, and so get less than the surrender value. And going forward, Equitable and other firms will just reduce the amount of the bonuses they declare in the future.

It may be that this does not affect the underlying analysis, but it seems odd that legislation that is designed to protect the interests of consumers might be used in a way that leaves them clearly disadvantaged.

FSA’s Line Manager E provides the Head of Life Insurance with the action points for FSA that arose out of the recent meetings with the National Association of Pension Funds and with a policyholder action group. (Note: these were provided as points to be raised with Equitable at the meeting later that day.)

Line Manager E says that, for the National Association of Pension Funds, FSA were to:

• seek clarification from Equitable on how pension fund trustees would vote on any compromise. The Line Manager notes that the Association was also concerned about what would happen where the group schemes included GAR and non-GAR policyholders; and
• seek reassurances from Equitable that ‘“sensible” suggestions for new [non-executive] appointments were being given proper consideration’.

In relation to FSA’s meeting with the policyholder action group, Line Manager E says that the action group:

• wanted a ‘token sweetener’ for non-GAR policyholders;
• believed that something needed to be done to protect the interests of with-profits annuitants, as this group had been disproportionately affected by ‘recent events’; and
• were concerned about the ‘independence of the independent actuary’ and would like to see policyholder action groups having some involvement in the appointment and/or the terms of reference for that appointment.

FSA and GAD meet Equitable’s Appointed Actuary.

Equitable provide the monthly solvency figures for December 2000 (note: I have not seen the information disclosed) and explain that one of the reasons for the delay had been due to the strain that had continually been put on resources since closure. FSA record:

The position disclosed demonstrated fairly thin solvency cover and had assumed that both the concessions for the artificial bond (valuation rate of interest) and for an increased valuation taking into account the sale of the Permanent [Insurance] had already been given. Without these concessions the company would not be able to demonstrate coverage of the [required minimum margin] in its statutory returns. The [Appointed Actuary] had, however, now adopted the stronger resilience basis that had been required by recent changes in the regulations in these figures. He thought that all other reserving issues had been ironed out but GAD pointed out that there was still an issue surrounding Regulation 72 and retirement dates to be resolved.

FSA confirm that Equitable had not yet applied formally for the section 68 Order for the valuation of Permanent Insurance and for the ‘artificial bond’ Order that Equitable still needed to confirm that, once issued, it would be used permanently.

Equitable say that they thought that their current financial position had improved as they had disposed of £1bn of equities since the year end, which had reduced the resilience reserve required. Equitable report that their equity backing ratio was now 61%, down from 68% last year, and which had historically been as high as 75-80%. Equitable say that the £500m Halifax payment, due next month, should boost solvency.

Equitable say that the current effect of the market value adjuster on remaining members was broadly neutral. Equitable inform FSA that they had rejected the OFT’s arguments about the need to identify the circumstances in which an adjuster would be used and how it would be applied. Equitable say that they thought the OFT had raised generic industry issues to which the whole industry had to respond.

Equitable say that they were not keen on the possibility of having to submit accelerated returns, as staff would be concentrating on integration with Halifax and on the compromise scheme. FSA explain that the main driver for accelerated reporting would be that the information was in the public interest. Equitable argue that the compromise scheme would make available to policyholders a lot of details on solvency and that ‘it was also possible that the availability of further public information at this time could muddy the waters’.

Equitable next explain that the timetable for the compromise scheme was not clear, although the substance would need to be settled and made public by the annual general meeting set for 23 May 2001. FSA say that they would need to be involved in the construction of the scheme proposals, as they might be able to play a role of ‘honest broker’ in the proceedings, as they had done in another case. FSA say that they would also like to vet the Independent Actuary for the scheme and be involved in setting his terms of reference.

On the bonus declaration for 2000, FSA record:

The [Appointed Actuary] proposed to postpone the 2000 bonus notice until after the vote on the accommodation. If there was a positive vote it may be possible to offer a [guaranteed] bonus to everyone for 2000 of possibly 4%, (although as 3.5% is guaranteed under some GAR policies the real additional cost of this bonus was effectively the same as a 1% bonus across the board). This could be another carrot to help “sell” the deal to all classes of policyholders.

Under ‘Action Points’, Equitable agree to send FSA their latest response to the OFT as soon as possible and to provide their January 2001 solvency figures in the next two weeks. FSA’s action is ‘to push Equitable to apply for Section 68 orders’.

FSA’s Managing Director A sends a note to the Director of Insurance and others at FSA saying that the FTSE 100 Index ‘fell like a stone this [afternoon], through the 6000 barrier’. The Managing Director suggests that the most obvious impact of this would be on Equitable and their solvency cover. He says: ‘I’m hoping? correctly? that Halifax’s £500 mn gives a fair bit of lee-way below 6,000 before our technical solvency requirements are breached’.

[17:45] Line Manager E replies and relays information from the meeting with Equitable earlier. The Line Manager says that he did not wish to speculate on Equitable’s solvency position but suggests that the current level of the stock market was the same as it had been on 31 December 2000. On the meeting, the Line Manager says:

… [Equitable’s Appointed Actuary] reported that at the year end (at 31 December 2000), Equitable had free assets of £340 million, giving 1.3 times coverage of the solvency margin. That valuation relies on the granting by the Treasury of certain accounting concessions, none of which has actually been granted yet:

• allowing them to count more than the normal permissible number of shares in [a company] following the merger, which is fairly straightforward and routine (and worth less than £10 [million]);
• the valuation of Permanent [Insurance], which was on the books at about £30 million, but the sale of which was agreed before the year end at £150 million. Our willingness to recommend the concession may depend on the auditors’ willingness to allow the higher valuation in the companies act account, but I think there is a good case for a fair valuation to be on the basis of the agreed value of the transaction;
• and the valuation of the synthetic bond, which is still under discussion, but the likely impact on the final figures is an improvement of up to £300m.

So there will be issues for us and the Treasury to consider about the way in which the statutory returns show the end year position – the third of the concessions above seems to me to be the most difficult one to deal with.

Since the year end, Equitable has sold £1 billion of equities which reduces exposure to the market, but even now 61% of the assets are in equities. The first tranche of the Halifax payment will help matters, but it is not payable until completion, scheduled for 1 March 2001.

The above does point to the need to be careful about what we say, if we want to be certain that we are right. Either we should refer specifically to the position at 8 December, or simply say that the company is solvent.

[17:58] The Managing Director responds with a few points:

a)re [the newly merged company], I think their shares have fallen quite a lot in recent weeks …

b)the extra valuation for Permanent [Insurance] sounds reasonable.

c)I’m unsighted on the synthetic bond. Can we [please] have a bit more on this? (we are going to have to be very careful in the current climate before giving anything remotely unusual to [Equitable]).

[18:13] In response to ‘a)’, Line Manager E explains that Equitable’s application for a section 68 Order (see 12/01/2001 [entry 2]) is:

… one of a kind that has been granted whenever major plcs merge, and so is routine. Several companies are in line to receive concessions for this, and it has been with the Treasury for weeks. There is no reason to treat Equitable differently.

Line Manager E provides some text from a note on section 68 concessions that he had prepared ‘a while back’. He says:

On the face of it, the concessions themselves are not of great concern, though clearly they will be subject to abnormal levels of scrutiny. What is more difficult (assuming that the concessions have been granted before the returns are due) is that Equitable would like to be able to report the year end position as if the concessions had been in place at the year end.

FSA’s Chairman underlines ‘as if the concessions had been in place at the year end’ and writes ‘If we are to concede that, I hope there are precedents (and preferably hundreds of them)!’. His comments are sent back to Line Manager E, Managing Director A, the Director of Insurance and the Head of Life Insurance.

Having been passed the documents by FSA’s supervisory officer for Halifax, Line Manager E distributes to colleagues at FSA and GAD the agreements which set out the basis on which Halifax would provide services to Equitable. The Line Manager writes:

I am not aware that any of these arrangements require formal approval under any of the regulatory regimes. However, we will wish to ensure that the contracts enable Equitable to maintain satisfactory arrangements, for example, for the protection of its policyholders, and to ensure that it continues to be able to comply with PIA conduct of business rules. We probably need, therefore, to focus on whether the contracts transfer to Halifax group any responsibilities that we consider should not be contracted out by an authorised insurance company. It will be important to ensure also that adequate arrangements will be maintained by Equitable to monitor performance against the contracts, and we will in due course need to discuss that with the Society.

FSA meet the OFT to discuss Equitable’s application of a market value adjuster on surrenders and transfers. According to Line Manager E’s note of the meeting, FSA and the OFT continue to disagree on the underlying legal analysis of the application of the Unfair Terms in Consumer Contracts Regulations 1999 but did not pursue their differences; instead, they ‘focussed on the substance of the issue, using the fact that we agree that a 10% adjustment is not unreasonable or unfair as a starting point’.

FSA point out that, as Equitable were no longer writing new business, they could not improve the terms of contracts for the future. FSA also suggest that policyholders might be reluctant to consent to any changes to their current contracts. The OFT indicate that they would be satisfied if Equitable were to explain to policyholders the basis on which they would exercise their discretion and provide some examples. FSA say they would be happy to attempt to encourage Equitable to reply to the OFT along those lines. However, Line Manager E:

… also emphasised the need for us to be sure that whatever was done would not leave the Equitable exposed to unforeseen events; and that it would not cause problems for the industry …

I also warned against us trying to do too much at this stage, pointing to the fact that it is an industry wide issue about the operation of with-profits business, and that it is something that really needed to be looked at in the context of practice among all life offices. I told them about the with-profits review that we have announced and suggested that it was an issue that would very usefully be addressed in that context. Again they thought that would be helpful (and indicated that they had no appetite for carrying out an industry-wide review themselves).

The following day, FSA’s Head of Life Insurance comments that the meeting appeared to have produced a promising means of defusing the issue.

FSA’s Legal Adviser A expresses some concerns about the agreements with Halifax. He notes:

[That] we are going to have to be satisfied with all the [reinsurance agreements related to the Halifax bid] that they are satisfactory with regard to the interests of the policyholders in Equitable, Halifax and [Clerical Medical] although I accept that not all the agreements are going to impact equally or at all on all the companies …

[We] need to be satisfied that there will be no variation in the rights of policyholders such that they should have been given an opportunity to make representations. Therefore it is necessary to bottom out exactly how the rights of policyholders will be changed if the reassurance goes ahead.

Chief Counsel A notes to the Director of Insurance and the Director of GCD that some of these were significant issues ‘to bottom out’ by 1 March 2001.

FSA write to Equitable about the sale to Halifax. FSA explain that PIA and IMRO had given urgent consideration to the applications in respect of the change of control of Equitable Investment Fund Managers Ltd. FSA say they understand that a letter confirming approval of the change of control was to be sent later that day.

FSA state that they needed to examine the detail of the transaction and consider whether to give approval to those areas that required it and whether to use their intervention powers. FSA say:

It remains the case that we do not have any objections in principle to the proposals. However, this is a complex transaction and we have not had sufficient time properly to review the papers that have been provided so far by the Halifax’s legal advisers and the Equitable. Indeed even now we understand that we do not have a complete set of the final documents.

In reviewing the papers that have been provided we have already identified some issues that we would need to pursue further. For example, in the proposed reassurance agreement under which the Equitable’s unit linked and non-profit business is to be effectively transferred to Halifax Life, we have concerns about the position of relevant policyholders in the unlikely event of the insolvency of Equitable Life. We also wish to have a better understanding of the continuing powers of the Board of the Equitable to control aspects of the business for which they retain legal responsibility. Finally, we will wish to be satisfied that the arrangements are properly communicated and explained to the relevant policyholders. We have been looking at the reassurance agreement with … the appointed actuary of Halifax Life, today who has been able to give us comfort on some of our concerns.

FSA reiterate that they do not have any fundamental objections to the proposed transaction and say they did not wish to frustrate or delay completion of the deal. FSA say it would, therefore, be helpful for Equitable and Halifax to give an undertaking that they would address any reasonable concerns FSA might raise.

FSA write similarly to Halifax.

FSA’s Legal Adviser A writes to Line Manager E about the interpretation of Regulation 72. The Legal Adviser notes that benefits under personal pensions policies could be taken at any time from the age of 50. Legal Adviser A sets out GAD’s view, quoting them as saying:

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

and Equitable’s view, being that:

I am not sure why you feel that Regulation 72(3) requires that one should assume that all policy holders will take retirement benefits at age 50. The regulation states that one should ensure that the value will provide for payment if the option were exercised assuming the valuation assumptions were fulfilled in practice.

Legal Adviser A says that his preference is for Equitable’s interpretation. He reproduces the Regulation and advises:

Regulation 72(3), of course, deals with the provision that must be maintained in respect of options under the contract. It must be such as to ensure that if the assumptions adopted for the valuation of the contract are fulfilled in practice then the provision is not less than the amount required to provide for the payment which would have to be made if the option were exercised.

The fundamental question is whether the “assumptions” in regulation 72(3) can include assumptions as to the age at which benefits are taken. I cannot see anything in the wording or structure of the regulation that leads me to the view that the (prudent) assumptions that are to be made do not include assumptions as to the age at which benefits are taken.

Additionally, I am struck by the contrast between regulations 72(2) and 72(3). Regulation 72(2) requires a provision to be made on the basis that the option will be exercised with no scope for assumptions as to whether or not the option will be exercised. I would have thought similar drafting could have been employed if the intention was to give a similar effect to regulation 72(3).

Thirdly, as a matter of practicalities, there seems no good reason for the regulation to demand a scenario (everyone retiring at 50) that is highly unlikely to be fulfilled in practice. Obviously, if the particular circumstances of a company made that more likely then the actuary would have to take this into account in deciding what assumption was prudent.

Legal Adviser A says that he has circulated the note fairly widely given the importance of the matter and that he understands that the amounts involved could be around £200m, depending on the assumption taken.

The Financial Ombudsman Service’s Chief Ombudsman writes to FSA ‘because of my concern about how [the Financial Ombudsman Service] and FSA can handle complaints arising from Equitable Life’s closure to new business’. The Chief Ombudsman says that there had been a significant number of complaints arising from Equitable’s use of a differential bonus policy for GAR policies. He informs FSA that: ‘Unsurprisingly, following the announcement in December that Equitable Life was closing to new business, we have received a significant number of new contacts from policyholders concerned that they had not been properly advised and were not informed of the potential impact on the company of an adverse House of Lords’ decision’.

The Chief Ombudsman says: ‘the level of co-operation required to ensure that Equitable Life’s policyholders who have complaints, whether raised solely with the company or in due course referred to [the Personal Investment Authority Ombudsman], are treated fairly and have their complaints resolved appropriately seems to be singularly absent’.

FSA’s Director of GCD suggests to Managing Director A that: ‘If [Equitable’s Chief Executive] is to have any continuing role, I think we should now revisit the evidence we have about inadequacy of disclosure to the regulator’.

[14:08] The Managing Director says that he does not think the Chief Executive’s future role was subject to FSA’s approval. The Managing Director says that this suggests to him that FSA should await all relevant material, including the actuarial profession’s report on Equitable (the Corley Report), before deciding whether to launch an investigation. He says that he was ‘not keen to spend very scarce resources now unless we have to (because [the individual’s] new position is indeed authorisable)’.

FSA’s Director of GCD suggests to the Director of Insurance that it would be wise for FSA ‘to stand back a little from the view that the only way of achieving an accommodation among the Equitable’s policyholders is by means of a court process following majority policyholders votes’. The Director of GCD says that, while it would bind policyholders, it was ‘a high risk strategy, where dissentient policyholders can cause difficulties’. The Director of GCD suggests that FSA should explore the possibility of a ‘pro tanto’ accommodation.

[13:57] Managing Director A agrees that FSA should rule nothing out but understood that a ‘pro tanto’ approach would be ‘suboptimal’ because:

a)… it leaves more uncertainty (in respect of the policies that don’t accommodate, reducing the possibility of reducing reserves)

b)it involves adverse selection in that those who don’t agree stand to benefit from those who do (because in [the Director of Insurance’s] immortal words the piranha have more goldfish to eat). It therefore encourages people to vote against accommodation and subsequently those who don’t accommodate are more likely to put more money in compounding the problem.

A third issue is whether the Halifax deal is all or nothing – if as I suspect it is, that is a 3rd reason why pro tanto is clearly sub-optimal (albeit no doubt better than nothing at all).

[16:20] The Director of GCD responds to the Managing Director’s arguments, and says that ‘it is precisely this mutuality [of the scheme proposed] that makes what the Equitable has discussed so far high risk. It means that each policyholder is invited to give up his rights in the interests of policyholders as a whole rather than his own interests. So it encourages the designers of the scheme to believe they need not make the offer to each policyholder reflect a fair offer [for] that policyholder’s own rights’.

Equitable send FSA a draft letter that they proposed to send to the OFT. Equitable ask FSA for any comments. In the letter, Equitable say:

I was obviously disturbed by your belief that a term reserving to the Society discretion in setting surrender values is unfair within the meaning of the Regulations because of the breach of the reserved discretion; and by your belief that a number of other policy terms are insufficiently clear as to be transparent and intelligible to policyholders.

The Society’s rules and policy terms in respect of its with profits business are at least as clear as most used elsewhere in the industry, and the provision reserving discretion on surrender values is, I believe, virtually standard.

FSA speak to Equitable and they: ‘Suggested they might offer an olive branch up front. And also noted the final paragraph on publicity was out of date following the leak’.

Halifax write to FSA about the sale. They make a similar statement in reply to FSA’s letter of 26/02/2001 to that made by Equitable: they would consider and address any issues that FSA might raise in regard to the sale.

On ‘Other Regulatory Issues’, Halifax say that, in conjunction with the Equitable management, they would do their best to ensure that the various issues with PIA’s enforcement team were satisfactorily resolved. Halifax say that they have commissioned an independent compliance risk assessment and would share the results with FSA.

Halifax give their thanks to FSA ‘for the exceptional and very flexible manner in which you and your colleagues have responded to our various requests over recent weeks’.

FSA reply the same day saying that, on the basis of their letter and a similar undertaking by Equitable, FSA had no objection to the sale being completed as planned.

FSA write similarly to Equitable.

FSA’s Line Manager E asks Line Supervisor C to consider Equitable’s letter of 26/02/2001 about new business and to consult with their legal department and GAD. He says that he has ‘no objection in principle to allowing this provided they ensure policyholders are clear about any implications of exercising the options’.

Line Supervisor C sends Legal Adviser A and GAD a copy of Equitable’s letter of 26/02/2001 about continuing to write new business in limited circumstances. He notes that Equitable remain authorised to write new business but had given FSA a formal undertaking to ‘stop writing new risks’. The Line Supervisor says that FSA had generally adopted a sympathetic approach to the small number of cases where policyholders had wanted to switch to a different product. The Line Supervisor asks Legal Adviser A and GAD for their views about this case.

GAD prepare a review of the administration and asset management agreement between Equitable and Clerical Medical.